The US, the EU and many of the major Pacific states are poised to enter into two new trade agreements: the Transatlantic Trade and Investment Partnership(TTIP) and the Trans-Pacific Partnership(TPP). [Both expected to contain investment chapters that will provide for direct recourse to compulsory investor-state dispute settlement (ISDS)].  While participant states trumpet the economic benefits that they hope will flow from the TTIP and TPP, the response to the prospect of ISDS in these treaties has by no means been universally positive.  One of the United Kingdom's leading national newspapers considers ISDS to be “a full frontal assault on sovereignty and democracy”;[1] a sentiment echoing the position put out by the United States’ national newspaper of record[2] and by various other commentators, NGOs and academics.  Investment arbitration has had its malcontents for some time, including a limited number of states that have signalled an intention to walk away from investment arbitration entirely.  Despite TTIP and TPP, or perhaps because of them, could the backlash against ISDS be about to go mainstream?       


TTIP is a proposed free trade agreement between the US and the EU, the two largest single trading blocs in the world, which together account for 46% of world GDP.  The purpose of the agreement will be to eliminate tariffs, enable close cooperation between regulators, harmonise intellectual property rights and cap subsidies to state owned enterprises.

TPP has similar objectives.  It is expected to include the US, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam (with several other major Asian states including India and Indonesia observing progress with a view to joining at a later date).  The economic value of the trading bloc established under TPP will be second only to that created under TTIP. 

Negotiations have been secret but prone to leaks.  Assuming no further government shutdowns in the US, TPP will be signed in early 2014 and TTIP will follow in late 2014.     

The function of ISDS

In addition to their other objectives, TTIP and TPP are expected to function as investment treaties between their respective member states.  Investment treaties (or international investment agreements – IIAs) were developed to encourage foreign investors from one state party to invest in the territory of the other state party.  They seek to achieve this by laying down reciprocal investment guarantees.  These guarantees differ from treaty to treaty (and the content of TTIP and TPP as yet remains unknown to outside eyes), but typically will provide principles regarding expropriation, transfer of funds and a guarantee of fair and equitable treatment.  Similar rights exist in customary international law, but without the additional protection of an IIA investors would generally have had no standing to bring proceedings against states that violated such rights.  With ISDS, investors are able to bring legal proceedings, often before a neutral arbitral tribunal, directly against the host state for compensation for breach of any treaty rights.

The first modern IIAs were entered into from 1959 onwards,[3] predominantly driven by the investment policies of western European states.  While formally reciprocal, at the outset IIAs tended to be de facto asymmetrical in political and economic terms.  The major European economic powers (being “capital exporting states”) sought to protect the economic interest of its nationals when investing in developing economies.[4] European states were then joined by other world economic powers during the 1970s and 80s, including the US (1977) and China (1982), and by many emerging and newly industrialised states.  Throughout the 1990s there was a rapid increase in the number of IIAs, both bilateral and multilateral, including many between states with developing economies, as states adopted policies aimed at opening their economies to private investment and competed for foreign direct investment to supplement or replace foreign aid.[5]  IIAs are now numbered in the thousands, and include several regional or thematic multilateral IIAs, including the North America Free Trade Agreement (NAFTA) and the Energy Charter Treaty (ECT), which contain investment chapters adopting familiar provisions to those in many IIAs.   

Is ISDS “a toxic mechanism”?        

One high profile journalist and anti-globalisation campaigner is not in favour of ISDS in TPP:

“[TPP] would allow a secretive panel of corporate lawyers to overrule the will of parliament and destroy our legal protections… The rules are enforced by panels which have none of the safeguards we expect in our own courts. The hearings are held in secret. The judges are corporate lawyers, many of whom work for companies of the kind whose cases they hear. Citizens and communities affected by their decisions have no legal standing…”[6]

ISDS has also been the target of some stinging attacks from environmental groups, globalism activists and NGOs concerned about the impact of ISDS by private companies in relation to key services.  One NGO describes ISDS as providing “grandiose new powers to multinational corporations” that “essentially privatise certain aspects of our international legal system”.[7]

The European Commission responded to the above attacks with a tepid defence of the necessity of retaining ISDS rather than referring such disputes to national courts.  According to the Commission, in some circumstances relying on national courts may be unattractive to investors because of the risk of home team bias.[8]  States may even deny foreign nationals access to court, leaving an investor with nowhere to go (other than home, or prison).  Finally, many national courts are not competent to adjudicate upon the investment rights in the IIAs, which often do not form part of the state's domestic law.

More could have been said by the Commission in order to defend the integrity of the arbitral process adopted in most ISDS.   

There is a high degree of transparency about the working of investment arbitration proceedings before the International Centre for the Settlement of Investment Disputes (ICSID or Centre), which is the most popular destination for arbitration pursuant to ISDS.  There is nothing secretive or improper about how tribunals are appointed.  The usual procedure is that each party chooses one of the three arbitrators and the third is chosen either by the Centre or by the party-nominated arbitrators.  In each case, the nominated arbitrators must confirm that they are independent and impartial.  The parties have the right to challenge the appointment of anyone not meeting the necessary standards of integrity.  Such challenges are rare, even though the prejudiced party would have every incentive to raise a challenge if it perceived bias on the part of the prospective tribunal.  In general, while investors and states have free reign to appoint whomsoever they wish as arbitrator, there has emerged an elite of established arbitrators from a diverse range of backgrounds, the vast majority of whom are of the highest intellectual calibre and standard of probity.  

The ICSID arbitration rules are freely available on the Centre’s website, which also houses a database of the Centre’s caseload.[9]  The database records the appointment of arbitrators, procedural orders and awards in each case.  Far from existing in the shadows, the awards are fully and often exhaustively reasoned. 

There is also little truth in the charge that ICSID proceedings alienate public interest groups.  Hearings are frequently held in public, sometimes being webcast to a worldwide audience, for free.   NGOs can and do participate in proceedings and submit amicus briefs, just as they can in many domestic court systems.[10]

Some investment arbitration does not take place before ICSID, and may take place in private unless the parties agree otherwise.[11]  This is because the arbitration rules commonly employed are primarily used for commercial arbitration and are tailored to private disputes.[12] This is likely to change in future: the most common arbitration rules employed for such disputes are promulgated by the United Nations Commission on International Trade Law (UNCITRAL), which has adopted new Rules on Transparency in Treaty-based Investor-State Arbitration.[13] Those rules, in certain circumstances, will allow public access to material documents, public hearings and third party submissions.  The EU has also committed itself to ensure investment arbitration proceedings are no longer held in private.

In any event, a perceived lack of transparency does not equate to a want of due process and procedural oversight.  ICSID awards can be subjected to a review by a second panel, known as an Annulment Committee, which is in part charged with ensuring that due process has been complied with.  Other types of investment arbitration may be subject to the often broad supervisory powers of national courts in order to ensure due process is observed.  A case in point is BG Group PLC v Republic of Argentina, where in June 2013the US Supreme Court granted leave to hear arguments about the jurisdiction of an arbitral tribunal appointed under an IIA.

When economists attack

The criticism levelled against ISDS has also come from certain economists.  One of the central justifications for IIAs is that they encourage foreign investment by providing an investor with comfort that it has the rights provided by the treaty and, should there be a breach of the treaty by the state, an investor can take its dispute offshore before a neutral tribunal.  To the host state, the benefits of additional investment obtained should outweigh the cost of complying with the treaty.  While the positive effect of IIAs on international investment was long regarded as axiomatic, evidence in support of the real world economic benefits of IIAs had been a disappointment to its proponents.  A UN study showed a “weak correlation between the signing of [IIAs] and changes in FDI flows”[14] while the World Bank found “little evidence that [IIAs] stimulate additional investment”, and where such evidence existed it tended to be associated with states that had stronger institutions and property rights: “those that are benefiting from them are arguably the least in need of an [IIA] to signal the quality of their property rights”.[15]

Despite a lack of empirical evidence,  economists recognise that states should be dissuaded from the inefficient behaviour associated with a classic expropriation of private property without compensation.    However, the more expansive range of investment protection afforded to investors is criticised as creating a risk of unforeseen economic inefficiency.[16]  For instance:

Some behaviour that an investor might characterise as “expropriation” may have wider benefits that create economic efficiency.  For instance, environmental regulation may render an investment worthless .  An economist may argue that the tax is nevertheless necessary to reflect the true cost of the investment, and that arbitral tribunals are often ill-equipped to judge such wider economic consequences.[17]

  • A state may refrain from undertaking regulation that is necessary to create economic efficiency (so-called “regulatory chill”).  Alternatively, the decision making function within any given state as regards environmental policy may be so far removed from that concerned with investment protection policies that IIAs simply have no effect on decision making, but nevertheless result in costly litigation.
  • Some treaties are said to provide protection for investments that is so expansive that  investors may face little real risk, particularly in comparison with domestic investors or those that are from third states not afforded such protection, which may cause greater economic distortion than it cures.    
  • It may be more cost effective for an investor to buy insurance or to specifically negotiate investment contracts tailored to the risks at hand than for the parties to refer disputes to ISDS.
  • IIAs may act to reduce foreign pressure on states with weak domestic institutions to commit themselves to reforms that would otherwise be of general effect and more widely beneficial. 

The concerns raised by economists warrant serious consideration, particularly when they call into question the very efficacy of IIAs.  However, it is important to note that such attacks do not address the fundamental legal argument in favour of ISDS, which is that investment treaties are designed to provide investors with a remedy that they would otherwise lack.  States that commit themselves to adopt a certain course in relation to foreign investment should be held to their bargain.  Whatever the issues raised about economic efficiency, in the eyes of the law, foreign investors are entitled to redress for breach of obligations owed to them by states parties.  It falls to the states to ensure that the substantive protection provided under IIAs to ensure that they are in the wider public interest and that, in economic terms, the benefits outweigh the costs. 

As regards concerns about whether IIAs may cause states to under-regulate, it may be that the assumption-based models applied may overstate this risk.  Most investment claims referred to ISDS relate to the narrow examples provided by economist critics of economically efficient redress against abusive state behaviour, such as classic state expropriation.  Some of the high profile cases that have fuelled criticism towards the existing system are outliers. 

One such case involves the Swedish energy utilities company Vattenfall, which commenced international arbitration under the ECT in 2012, seeking compensation from Germany for terminating its policy supporting nuclear power generation, after the Fukushima disaster, including the closure of two nuclear power plants.[18]  This case raised  public concerns about a state’s ability to regulate its own environment, safety and energy matters without liability, in response to disasters and evolving social attitudes.  Challenges to such decisions are not limited to the “secretive” world of investment arbitration.  On 14 January 2013 the German Federal Administrative Court, one of the highest in the land, determined that Germany’s decision to close a nuclear power plant (not owned by Vattenfall) after the Fukushima disaster was unlawful under domestic law.[19]

Another case involves a tobacco company seeking compensation in respect of Australia’s  plan to impose plain packaging for tobacco products.[20]  At that time, the government successfully defended a related challenge in the High Court of Australia,[21] Philip Morris Asia Limited (based in Hong Kong) commenced arbitration proceedings under the ISDS provisions of the Australia-Hong Kong IIA[22] in June 2011.  This is the first investment treaty claim against Australia and it sparked community concerns about the Government’s ability to make laws in the interests of public health.  It remains to be seen whether Philip Morris will prevail in its claim (there must be some considerable doubt about its prospects).

Advance Australia, for you are young and free (of ISDS?)

The economic argument against IIAs was presented to the Australian Government, which was the first developed state seriously to contemplate abandoning its former commitment to investment arbitration.  Indeed, in April 2011, the Australian Government announced that it would no longer include ISDS provisions in its trade and investment agreements.  The Government at the time accepted the view of its economic experts that ISDS provisions had the potential to “confer greater legal rights on foreign businesses than those available to domestic businesses” and to “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”.[23]

While this announcement came as a surprise, it was made in the context of two significant local developments.  First, the Productivity Commission – the government’s independent economic advisory body – recommended this course of action in November 2010.  In a report on Australia’s trade arrangements, the Commission concluded that “it seems doubtful that the inclusion of ISDS provisions within [trade and investment agreements] affords material benefits to Australia or partner countries”.[24] Second, the Government was facing a highly controversial Philip Morris case referred to above. 

Following a change of Government in September 2013, Australia has again signalled a new, softened approach to ISDS which nevertheless continues to recognise the threat that investment treaties may pose of “regulatory chill”.  In the first trade and investment agreement concluded since the federal election, the new Government agreed to include an ISDS provision but adopted “carve-outs and safeguards in important areas such as public welfare, health and the environment”.[25]  The role of ISDS in the Government's desired bilateral Free Trade Agreement with China remains an open question.  The Government has also pledged to fast-track negotiations on the TPPA notwithstanding that it will almost certainly contain an investment protection chapter and ISDS. 

Australia is now expected to be a party to the TPP.  It is probable that the new Australian Government will officially abandon, or considerably dilute, the former Government’s policy towards ISDS provisions.  Nevertheless, as a western country enjoying the benefits of high levels of foreign trade and investment, Australia’s strong stance has encouraged broader (and often very critical) attention to these provisions.  It has no doubt encouraged other resource-rich states to reconsider their own positions.  ISDS had been a sticking point in the TPP negotiations, and a compromise ISDS mechanism with expanded “carve-outs and safeguards” may become the model for future agreements.

Even if Australia climbs down from its opposition to ISDS, a number of other states have taken concrete steps to withdraw from ISDS.  Venezuela and Ecuador have both withdrawn from the ICSID convention.  South Africa has unilaterally withdrawn from investment treaties with Germany, Switzerland, Spain, Belgium, the Netherlands and Luxemburg; and has indicated that it will terminate more in the future.  It is expected that further African states may follow suit, either in withdrawing from existing IIAs or in adopting a more cautious approach as regards the substantive protection contained in IIAs going forward.

Reflections for the future

ISDS seems prone to generating bad headlines.  In practice, the notion that investment arbitration is inherently pro-investor does not bear close examination.  Some high profile investment arbitrations - those that have provoked the strongest response from public interest groups have ultimately been rejected by the arbitral tribunal.  

It is true, however, that many IIAs contain broadly drawn obligations on the state that are open to interpretations that the contracting parties may not have anticipated.  Indeed,  Pakistan’s former Attorney General Makhdoom Ali Khan has suggested that many states have entered into IIAs without any understanding of what they were signing up to.[26]  In the circumstances, it can scarcely be a surprise that states have encountered unwelcome claims. 

The system of IIAs and ISDS is merely decades old.  States have learned – some the hard way – that greater care must be taken to negotiate the substantive contents of IIAs better to reflect their interests.  The suggestion by economists, as adopted by Australia, that the substantive protection afforded to investors should be refined in light of perceived abuse, carries weight.  States must strive to improve the drafting, clarity and precision of treaties if, as the backlash described above suggests, state parties want to reserve sovereign powers so as to minimise possible future liability and thaw any risk of regulatory chill.  This is applicable to all future IIAs, as well as TTIP and TTP.  On this charge the EU is making headway.  The European Commission recently announced that it will seek public consultation on the EU's proposed draft text for TTIP investment and ISDS provisions, in an effort to make the "investment protection system more transparent and impartial".[27]  EU Trade Commissioner Karel De Gucht has set his sights on closing IIA “legal loopholes”, permitting EU states to “regulate in the public interest”, improving arbitral procedure and opening up public access.  As for existing IIAs, it is not without precedent for states to issue ex post facto bilateral notes of clarification as regards interpretation.[28]


ISDS works.  It provides a valuable remedy where there would otherwise be none.  The backlash about the procedure adopted in most investment arbitration is largely unmerited, but to the extent that procedure was opaque, public criticism has largely been accepted and steps have been taken to open the process up further.  To the extent that investors are perceived as abusing the substantive protection afforded, it is suggested that a solution lies not in abandoning  a new and largely effective system of investment protection, but by applying better consideration to the standards of treatment appropriate both to safeguard investors and to ensure that states remain free to regulate in a fair and efficient manner.