Investors sometimes forget that the converse side of lucrative returns for investing in overseas territories is that host governments sometimes seize their assets. Expropriation, confiscation and nationalisation of assets, often referred to as resource nationalism, is one of the most significant challenges confronting companies operating in developing markets.
Bilateral Investment Treaties (BITs) have for many years acted as a safeguard for investors. These agreements between states are designed to provide investors with protection in the event of government action or inaction that makes investments unviable. The United Nations estimates BITs cover approximately two-thirds of global FDI and one-fifth of possible bilateral investment relationships.
Today there are over 2,800 BITs in existence. At the heyday of such agreements in 1995, four new agreements were signed every week. By 2012 this figure had declined to a rate of one per week. As it is theoretically possible for over 40,000 BITs to be in existence when one considers that there are around 200 countries in the world, the reason for the decline is more to do with the efficacy of BITs in the presence investment environment, rather than an exhausting of the possibilities.
The appeal of signing BITs has decreased amongst sovereign governments because the stability they bring to the investment environment is perceived to thwart their room for independent action. For foreign investors the appeal of BITs is that they generally offer arbitration under the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States, better known as the ICSID, the dispute resolution arm of the World Bank. ICSID arbitration has become an increasingly popular and effective forum for dispute resolution, with victorious investors being able, for example, to reclaim assets seized by a host nation overseas. The number of arbitrations against host countries has grown enormously in recent years. In 1997 the number of known Investor v. State disputes in arbitration was seven. By 2012 this number had reached fifty-eight.
South American countries, assisted by the outstanding efforts of Venezuela, which nationalised over a thousand companies during Hugo Chavez’s tenure as president, account for 30 percent of cases registered with ICSID. As one might expect, the developing world accounts for the majority of cases lodged with ICSID, as governments in Russia, Uzbekistan, Bolivia and Uganda have resorted to the outright expropriation of assets to seize a greater share of returns from the exploitation of their natural resources. In contrast, although just six percent of cases concern North America and western European countries, these governments have proved themselves as adept as their counterparts in the developing world at taking the money of foreign investors. In 2012 Canada was sued by a petroleum company for USD250 million, challenging a moratorium on fracking enacted by the government of Quebec.
The ICSID has become a victim of its own success. Aggrieved investors, who have received recompense through the system, believe it performs well. Host nations who have been instructed to honour claims have been less pleased. There is a widely held view among governments that BITs are too investor friendly, and place too much restriction on a government’s ability to make changes to the legal or regulatory changes that might be in the broader public interest. Governments are citing this apparent bias and lack of freedom as their reasoning not to renew individual treaties. In 2009 the South African government announced that it would not be renewing a treaty with the Belgo-Luxembourg Economic Union when it expired in 2013, and would be allowing all other BITs with European Union states to lapse as well.
As fewer new BITs are signed and some of those already in existence are permitted to lapse, we will see a broad deterioration in the investment landscape. Future agreements are likely to offer host governments more flexibility to make legal and regulatory changes, which will of course be to the detriment of investors. We are also likely to see less recourse, in treaties which are new or renewed, to robust and independent arbitration forums such as ICSID.
Careful due diligence and the adoption of effective risk management strategies will become even more crucial as protection offered by BITs declines. For those risks that cannot be managed can often be insured. The credit & political risk insurance market continues to evolve and for well structured transactions can offers a final safety net that neutralises many of the more pernicious aspects of country risk.
Dr Elizabeth Stephens is JLT Head of Credit & Political Risk Advisory