What will a U.S.-China BIT do to Investor-State Arbitrations?

Today’s Financial Times has a story on how unhappy U.S. businesses have become about Chinese government restrictions interfering with their access to Chinese markets.  So, one can understand how U.S. exporters would welcome news that the United States and China are getting closer to including a Bilateral Investment Treaty (BIT).  And, let’s be clear, this would be the mother-of-all BITs, given the relative size and importance of the two economic markets.  Like other BITs, I assume this one would include provisions requiring national treatment and most favored nation status, both of which would constrain Chinese efforts to undertake protectionist behavior generally or against the United States specifically. 

In Today’s Guardian, however, Sarah Anderson ponders how a Chinese BIT might circle back and affect U.S. markets:

Similar to the investment chapters in US trade agreements, BITs give foreign investors the right to bypass domestic courts and sue governments in international arbitration tribunals. The United States has been at limited risk of being the target of such “investor-state” lawsuits because its 40 current treaty partners are nearly all developing economies with little investment in the US market. This lopsidedness has created a one-way street in favour of US corporations operating abroad. The China negotiations could change all that. Chinese investors have ploughed billions into the US economy, particularly in the financial industry. Under a treaty based on current models, these investors would have standing to sue the US government over breaches of a long list of host government obligations.

Of particular relevance to the China BIT is the obligation to provide foreign investors “fair and equitable treatment.” In some cases, tribunals have interpreted these vague terms to mean that a government must provide a stable and predictable regulatory environment. On this basis, they have ordered governments to pay compensation to investors who claimed that changes in regulations or tax policies had made their investments less valuable.

At a time when our regulations have just failed to prevent the worst financial crisis in nearly 80 years, predictability should not be a top priority. And indeed, the Obama administration is pursuing reforms that would have been quite unpredictable two years ago and which would strike at least a short-term blow to some Chinese investments. Take, for example, the nearly 10% stake in Morgan Stanley held by China Investment Corporation (CIC), a sovereign wealth fund. Recently, Goldman Sachs researchers estimated that proposed regulatory reforms could reduce Morgan Stanley’s annual earnings by 15%. President Obama’s plan for a Financial Crisis Responsibility Fee could cost the firm $800m, they predict, while the proposed “Volcker rule” to prohibit proprietary trading by banks could cost another $600m per year.

Could Chinese investors use a bilateral investment treaty to undermine such US financial reforms? Legal experts are divided. Some argue that a provision in current US treaties gives sufficient protection against claims related to financial stability measures. Others, such as Professor Robert Stumberg, director of the Harrison Institute for Public Law at Georgetown University, disagrees, pointing to language in the same provision that arbitrators could interpret as a self-cancelling loophole.

If the ambiguity isn’t fixed, investors could file their claims before a tribunal and let the commercial arbitrators decide. If the government lost, they’d have two choices: repeal the reform or pay off the foreign investors. Neither option would be a winner with the American public.

U.S. BIT negotiators have long discounted the chance that these treaties’ substantive provisions would ever be turned around and applied to U.S. markets and U.S. regulations (but insisting, of course, that the United States would be compliant if they did).  There’s certainly some precedent though for such proceedings and outcomes if we look to the NAFTA context.  I assume, however, the controversy those investor-state arbitrations have generated might be magnified a bit if, instead of neighboring Mexico or Canada, the investment came from a publicly-owned Chinese corporation.  Such concerns are likely to generate some strategic maneuvering in advance of the BIT’s conclusion.  For example, might a U.S.-China BIT be labeled non-self-executing, contrary to existing practice, which treats BITs mostly as self-executing treaties?  That might alleviate concern that an investor-state arbitration opinion would have the status of U.S. law and override earlier federal or state law.  On the other hand, it would also raise the prospect of U.S. non-compliance if it ends up on the losing end of an arbitration, especially if it has to rely on Congress to “do the right thing” and enact legislation to authorize U.S. compliance with such an opinion (and the BIT itself).  I must say this latter prospect is not terribly appealing to me; we’ve already seen in other contexts how difficult it is to get Congress to correct an on-going violation of a U.S. international law obligation.  Needless to say, the U.S.-China BIT negotiations bear watching.