In a recent article on Brexit and International Arbitration, we explained our view that the UK’s departure from the EU would have only a limited impact on London-based commercial arbitration. However, the impact of Brexit on the UK’s role as a hub for foreign direct investment could potentially be more transformative and – in contrast to the doom and gloom that has understandably followed in the wake of the referendum result – may actually create positive opportunities for the UK.

The End is Nigh… or is it?

Both sides in the referendum campaign made a big fuss about trade and investment, with bold assertions that the UK would, on the one hand, be cast out into an abyss characterised by high tariffs and hostile negotiations or, on the other hand, released into a utopia, free of red tape and brimming with new friends, anxious to secure trade deals. Of course, neither of these scenarios is likely to reflect the true consequences of Brexit, but there is reason to believe that the UK could exploit the recent uncertainties around EU international investment policy to re-establish itself as a hub for foreign direct investment, both inbound and outbound.

Europa, Quo Vadis?

The European Commission has earned a degree of notoriety for its scepticism towards bilateral investment treaties (BITs). It has jealously guarded its exclusive competency to negotiate new investment treaties (newly acquired under the Lisbon Treaty) and has tried its utmost to demolish what remains of the existing network of BITs signed prior to the Lisbon Treaty, with particular emphasis on those between EU Member States.

Extra-EU BITs (i.e. treaties between an EU Member State and a third country) are now subject to Regulation 1219/2012, which allows for “grandfathering” of existing treaties (thus declaring them temporarily valid under EU law) and grants authorisation to Member States to renegotiate these treaties in order to address any incompatibilities with EU law. However, the European Commission retains a power to direct the relevant Member State to take “appropriate measures” to deal with any “serious obstacles” to the conclusion of future EU BITs (which presumably includes a demand for termination of the existing treaty).

In contrast, the European Commission has proactively intervened in arbitral proceedings conducted under intra-EU BITs (i.e. treaties concluded between two EU Member States prior to one or both of them joining the EU), arguing that such treaties are invalid and incompatible with EU law, on the basis that they inherently discriminate against other EU Member States who are not party to the relevant treaty. More forcefully, the European Commission has also commenced formal infringement proceedings against five Member States[1] and informal procedures against another 21 Member States[2] to compel them to terminate their existing intra-EU BITs. It even went as far as issuing an injunction against Romania, prohibiting it from complying with the order of an arbitral tribunal in the Micula case.[3]

However, the question of whether intra-EU BITs are inherently incompatible with EU law has not yet been addressed by the Court of Justice of the European Union (CJEU). The German Federal Supreme Court recently submitted a reference to the CJEU on this very issue, but in the interim there is considerable uncertainty over the status of such treaties and so investors cannot be sure whether they are able to rely on the protections contained therein.

It’s a long way to TTIPperary

Aside from the uncertainty caused by the European Commission’s approach to existing BITs, there is also an ongoing debate in the EU over investor-state dispute resolution more generally, especially in the context of the Transatlantic Trade and Investment Partnership (TTIP). Following an unexpectedly strong response from civil society against the idea of subjecting their governments to the scrutiny of independent arbitral tribunals, the European Commission published its proposals for a new Investment Court System (ICS) which would replace the traditional ICSID/UNCITRAL arbitration model with a two-tiered tribunal made up of publicly-appointed judges, divided equally between US, EU and third country appointees. Aside from the laudable aim of increasing transparency, this proposal requires a massive financial investment to establish a standing court system (as opposed to traditional ad hoc tribunals) and opens the door for appeals based on both alleged errors of law and errors of fact (unlike the relatively limited grounds for annulment under the ICSID Convention), thus increasing the likelihood of protracted proceedings and reducing its attractiveness as a means of settling disputes.

The European Commission has indicated that it intends to roll out this model to all its future investment treaties. It is currently unclear how the addition of other treaties will impact on the ICS’s caseload or how the appointment of judges to represent other treaty counterparties will work. What is clear is that this dispute resolution mechanism will be very different from its predecessors and will result in a considerable loss of autonomy for both disputing parties. It has been met with scepticism from both investors and other states (including the US) and it is entirely possible that the European Commission’s insistence on including this mechanism will hinder its ability to negotiate new treaties.

Golden Opportunity?

The UK has existing BITs with twelve EU Member States,[4] three of the five candidate countries for EU accession[5] and a further 81 non-EU States.[6] Subject to any intervention by the European Commission under Regulation 1219/2012, these treaties will all remain in place following the UK’s departure from the EU and eligible investors will be entitled to rely upon the investor-state dispute resolution provisions they contain.

The UK also has the largest network of double-tax treaties in the world, which means that it is well-placed to act as a conduit for investments between countries that do not necessarily have direct investment treaty or tax treaty relationships. Subject to the provisions of the relevant treaties, a multinational seeking to invest in an emerging market (or even one of the newer EU Member States) might prefer to structure its investments through the UK, where the status of investment treaty protections is more stable, rather than risking the uncertainty of doing so through traditional jurisdictions such as the Netherlands or Luxembourg, which will be bound by the EU’s international investment policies.

All of these factors give the UK a competitive advantage over other EU Member States in a post-Brexit world, at least until the status of intra-EU BITs is resolved by the CJEU. Even then, the European Commission’s likely insistence on the inclusion of its ICS proposals in future treaties may deter investors from relying upon such treaties to protect their overseas investments and might therefore lead to an exodus of outbound investors from the EU to the UK.

Hold the champagne…

Of course, the picture may not be a rosy as this. Considerable uncertainties remain over the practicalities and legal consequences of Brexit and in an extreme scenario, it could even lead to the break-up of the UK as a whole. This would raise a plethora of questions over the status of each successor state and their respective rights and obligations under international law, including their inheritance of the UK’s BITs and double-tax treaties, as well as their status as signatories to the New York Convention and ICSID Convention. What fascinating times we live in!