By Mathabo le Roux*
South Africa’s decision to terminate its bilateral investment treaties (BITs) has elicited strong and mixed reactions from around the world. Countries on the receiving end of the revocation reacted with the unusual vehemence and commentators at home were mostly critical, some even alarmist, claiming that the action marked the government’s intention to embark on wholesale nationalisation.
Yet, in other quarters, South Africa has been held up as something of a trailblazer, taking action in a particularly contentious area of international law where no international oversight body exists to bring clarity and direction, while clarity and direction are sorely needed.
The situation is indeed complex. On the one hand, developments in the area of international investment agreements (IIAs) provide ample grounds for South Africa’s decision. And other countries are following its example. But on the other, the domestic context gives standing to detractors of the country’s actions, as this article tries to explain.
The spirit of the time: Are BITs still the right instruments?
In the world of IIAs, Ecuador is an interesting example. In 2012 it was on the wrong side of a US$1.77 billion arbitration award. Add US$589 million in backdated interest and that comes to a hefty 2.6% of Ecuador’s gross domestic product that year. The award was the result of a brush with Occidental Petroleum Corporation.
In the 1980s the Houston-based firm started exploring for hydrocarbons in Ecuador’s Amazon region, an arrangement that turned into a partnership agreement with Ecuador’s national oil company by 1999. A year later things turned sour. Occidental carved out a 40% stake in its exploration block to Canadian firm Alberta Energy Corporation, but it never asked for ministerial approval, as required by Ecuadorian law. The government suspended its partnership agreement with Occidental.
The suspension came back to haunt Ecuador when Occidental, feeling unfairly treated, took recourse to the US–Ecuador bilateral investment treaty and filed an international dispute. An International Centre for Settlement of Investment Disputes (ICSID) tribunal ruled against the country and tallied the company’s assumed losses. The case involved the seizure by Ecuador of Occidental assets. The award is the biggest in the history of so-called investor–state dispute settlement (ISDS), which is provided for under IIAs. It shows the power of ISDS tribunals – and the exposure of states to ISDS if they are deemed to flout the rather hazy legal confines set out in old-era IIAs. It also goes some way to explain why many countries have become uncomfortable with the power these treaties give commercial actors. Increasingly, countries are looking to change their policy frameworks to better align them with pressing social and policy realities. In so doing, they run into the systemic risk of arbitration provided for under IIAs to which they have signed up, at a time when modern-era policy imperatives tend to be more sidelined.
ISDS on the rise
The risk of arbitration is no idle threat. ISDS has spiked in recent years, often in response to new policy measures. The total number of known ISDS cases is now 568, and 98 countries have faced at least one claim according to UNCTAD data. But ISDS is by no means the only problem with the current IIA regime. Concerns also abound about the ad hoc nature of the tribunals that hear these cases; the related inability of the system to build up general principles of interpretation; the lack of an appeals mechanism; and broad treaty provisions that give scope for sprawling and therefore sometimes conflicting interpretations of different cases on similar types of issues.
What about foreign investors’ own obligations towards the countries that host their investment? The rights conferred under IIAs do not cut both ways. States that deem their countries to be adversely affected by the actions of a foreign investor have no concomitant recourse to ISDS. On the contrary, even where foreign firms are rightfully submitted to legal action in domestic courts, they have on occasion claimed their rights under an IIA to evade their legal obligations.
The above gives some context to South Africa’s decision to pull the plug on 14 of its 47 BITs, for which the Department of Trade and Industry (dti) received a barrage of criticism in the local press and from the business community. This negative publicity is out of step with what is happening in the area of international investment law. In fact, South Africa is not the only country weighing its options in relation to investment treaties. Bolivia, Ecuador and Venezuela have opted out of ISDS, with India and Indonesia also reviewing their BIT regime with a view to renegotiation. The UNCTAD’s guidebook for policymakers looks to change treaty provisions for the sake of clarity, and to align them better with sustainable development imperatives. UNCTAD is also doing important work spearheading an incremental process of plurilateral regime reform – a kind of a coalition of the willing – in the absence of an international oversight body to steer a comprehensive reform process.
Even BIT originators are having second thoughts
The need for change is by no means a developing country concern. BITs were conceived by Germany in the 1950s to protect its investors from developing country institutions, perceived to be not as sound and stable as those of the developed world. With changing policy imperatives, however, developed countries are now also increasingly facing challenges. Australia is locked in a battle with tobacco firm Philip Morris over the introduction of plain packaging laws for cigarettes. Between them, Spain and the Czech Republic face no fewer than 13 challenges to their respective energy-related policy changes. Even Germany faces a challenge – from Swedish energy firm Vattenfall – following its decision to phase out nuclear from its energy mix. The ISDS provision has also become a potential deal-breaker in the ongoing negotiations on the Transatlantic Trade and Investment Partnership, the proposed mega trade deal between the EU and the US. Resistance from the European Parliament to ISDS has seen this component of the talks suspended. This is somewhat ironic considering that EU investors have been some of the most prolific users of ISDS against developing countries.
In another important development, the UN Commission on International Trade Law (UNCITRAL) has developed two texts to advance transparency in IIAs, particularly in relation to arbitration involving public interest issues.
So in the broader context, South Africa’s BIT decision is not as out of step as the critics would like to suggest. Moreover, it was informed by an extensive review, with a proposal that the void left by the revoked treaties be filled by a comprehensive piece of legislation that sets up a framework for all investment.
SA’s new legal framework for investment
The legislation is the Promotion and Protection of Investment Bill (PPIB) and was published for comment in November 2013. It is a commendable attempt to bring all investors under the same legal umbrella and to clarify provisions that are too broadly or vaguely defined under the BITs. It also deals with one of the gravest concerns of IIAs – the ISDS – because it compels investors who believe they have been wronged to seek relief in domestic courts.
Provisions in the PPIB on expropriation, a particularly sensitive concern for investors, were initially brought in line with those in the constitution. However, indications from the dti are that expropriation will be left out of the new version of the bill, expected to be introduced to Parliament during the 2015 session. A separate Expropriation Bill is currently before Parliament.
BITs are the ears of the hippopotamus
It is necessary to also consider the real world context, in which actions and reactions are part of a broad spectrum of diverse elements concerning investment, which variously interact with each other. As it goes with matters concerning money, signals are important. Foreign investors, like nervous racehorses, pitch their ears at every squeak and scamper. And in the hierarchy of signals, international investment treaties are but the ears of the hippopotamus: visible, but only a small part of the massive whole.
An investment agreement will not guarantee handsome foreign direct investment inflows for a country. Rather, it takes a great many things to attract foreign investment – a potential market of meaningful size; adequate and competitively priced resources for inputs; and an adequate and competitively priced work force, with the commensurate skills needed to get the job done. One should also add the need for a solid framework for property rights protection, a sound policy environment and political stability. Only after these primary requirements have been met will a potential investor consider whether there is a specific treaty in place that grants additional rights before sinking money into a country. So developments that influence these primary concerns of investors matter a great deal. They provide a gauge – rightly or wrongly – of political intent and future direction. This is where the South African story needs broader contextualisation.
When South Africa notified Belgium on 7 September 2012 of its decision to revoke the BIT with the Belgo-Luxembourg Economic Union – the first treaty to be terminated by South Africa – it was an accident of fate that the denunciation followed the tragic events at Marikana by mere weeks. The revocation was the culmination of a four-year governmental review of the country’s international investment policy position. And as the dti has explained repeatedly, the treaties that were revoked had come up for review; they had reached ‘maturation’, in BIT speak. If the termination had not been notified at that point, the Belgo-Luxembourg BIT, and other treaties subsequently revoked, would have automatically been extended for anything from 10–20 years (depending on the specific treaty terms). So, while it increased jitters among international investment ranks, no covert intent can be read into a process and action that had at all times been – if not prominently – in the public eye.
Slew of legislation
However, another phenomenon accompanying the BIT revocation was less obvious, for it was spread over a period of time and in different sectors, and is in fact continuing. This is the raft of legislation published at regular intervals around the same time the treaty revocations commenced. What is conspicuous is that all these policies signal, variously, a hardening stance toward investors, foreign and domestic: they feature clauses that erode property rights protection; burdensome and cost-raising requirements with which business must comply; and a heavy hand for government in the economy. Seen together, the policy proposals spell less security, more hassle and increased risk for investors in South Africa.
The need for South Africa to rectify apartheid’s legacy and redistribute wealth is widely acknowledged, and business, particularly big firms, are making concerted efforts to advance the transformation objectives. However, the contribution of these policy changes to the furthering of transformation imperatives is not always obvious. Some commentators have pointed out how many proposed policy changes could in fact even detract from that agenda.
A survey in 2012 of foreign investors about the biggest concerns related to business operation and growth in South Africa – commissioned by the EU and conducted by consulting firm Genesis – illustrates some of the concerns. South Africa’s high formal unemployment rate of over 25% is arguably the biggest challenge the government faces, yet among the most common problems identified by investors in the survey are workforce skills and education (1) and labour legislation (7). In relation to the first, operators observed the acute shortage of skills and the related price premium demanded by those skills when available with salaries for scarce skills being higher than those of comparable European countries. They also noted bureaucracy-related delays and the high costs associated with skills development, as well as the difficulty of locking in the benefits from skills development because of the high churn rate of skilled workers associated with the scarcity of skills. In relation to the concerns about labour legislation, operators observed increased input costs in order to generate ‘disproportionately’ low levels of output. In other words, South Africa’s labour legislation is out of sync with the realities of its labour market, and in fact works against solving the problem of unemployment.
The other most prominent concerns listed by investors in the Genesis survey – BEE requirements; government bureaucracy; corruption and public procurement processes; currency volatility; and the cost of utilities – are all (bar currency volatility) under the purview of the government to tackle and improve. However, the survey findings indicate that a combination of policy requirements and poor public service delivery actually compounds these problems rather than improving them.
We need your money, Smooth Operator
Investors play a critical role in building and fortifying economies: they bring economic activity, jobs and technology. Importantly, they also contribute to the fiscus. If a country spends more than it earns, as South Africa does, someone else has to fund the shortfall; another compelling reason to recognise that foreign investors bring valuable capital. And what is particularly worrying about South Africa’s foreign investment situation is that it is not attracting nearly enough of the stuff. The country is performing poorly in comparison with peer countries. The reason why investment flows see such sharp spikes or deep troughs on a year-to-year basis is exactly because South Africa’s investment flows are at such a low level: the presence or absence of a single deal in a particular year is what makes the needle jump.
It is somewhat alarmist an assessment to see onerous intent on the side of South Africa with the revocation of its BITs. Was South Africa justified in pulling the plug on the basis that these treaties are flawed? Possibly. Was the decision to bring all investors under the same umbrella with a consolidated piece of legislation that explicitly set out both state and investor rights and obligations too ambitious? Quite probably. From an international policy point of view, though, South Africa’s denunciation of BITs is reasonable. It may even be seen as a refreshing retreat from a legal quagmire.
But the domestic reality requires wider consideration. That South Africa is setting the trend in an issue of such great global interest will be cold comfort for those who need the jobs and skills that international operators can bring. And if successive and related policy proposals increase risk in an environment where public service delivery already flounders, prospective investors will dither. What solutions can be conjured? The government may have to consider entering into new generation BITs in which it balances outs investors’ needs and its own policy imperatives.
*Mathabo le Roux is a research associate with the South African Institute of International Affairs.