April 2, 2015

Social democrats propose dangerously flawed ISDS reforms

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Social democratic ministers from six EU countries published reform proposals for the highly controversial investor-to-state dispute settlement (ISDS) mechanism.

ISDS gives foreign investors the right to bypass local courts and use international arbitration to fight out conflicts with states. The claimants have a 50% influence on the make up of the arbitral tribunals.

For the short term the social democrats from Germany, Sweden, The Netherlands, Luxembourg, Denmark, and France propose to ratify the agreements with Canada and Singapore. These agreements are seriously broken.

Ratification of these agreements would lock in the EU as it is practically impossible to withdraw from trade agreements. Multinationals from the US and other countries would be able to use the agreements with Canada and Singapore.

Moreover, both agreements are rigged to the advantage of the US. The social democratic ministers set the EU up for defeat. If the US demand the inclusion of ISDS in the US-EU trade agreement (TTIP), agree with the approach taken in the agreements with Canada and Singapore, but refuse further reforms, the EU has to accept a broken system that gives the US an unfair procedural advantage, or reject TTIP.

To avoid this scenario it is essential to say no to ISDS in the agreements with Canada and Singapore.

For the agreement with the US the social democratic proposals do not solve these issues:
– foreign investors equal standing to states,
– no exhaustion of local remedies,
– no limitation to a marginal test,
no legislative feedback loop,
lock in,
– only investors, not states, can start cases,
– rights but no obligations for foreign investors,
– foreign investors greater procedural rights than local investors,
– competing adjudicative forums,
– no standing for other interests,
no separation of powers,
no institutional safeguards for independence,
for profit arbitrators,
perverse incentives,
rigged to the advantage of the US.

The social democratic reform proposals are dangerously flawed.

Analysis

To avoid cherry picking I will quote the whole social democratic document.

Ratification of the agreement with Canada (CETA)

“Improvements to CETA and beyond

Making a milestone for modern investment protection:

Free and fair trade is a key factor to foster prosperity in Europe and throughout the world. An ambitious agreement between the EU, its Member States and Canada provides economic opportunities on both sides of the Atlantic Ocean. CETA is of strategic importance: it shapes global trade and promotes common high standards for the protection of the environment, consumers, workers and public welfare. Thus CETA will inspire the ongoing negotiations on TTIP, especially regarding Investor-State Dispute Settlement (ISDS).

We welcome the conclusion of negotiations of CETA by the EU commission, as stated at the EU-Canada summit in Ottawa in September last year. We are now in the period of legal scrubbing before a text is submitted to the Council for approval and goes through the process of ratification by the European Parliament and Member States’ legislators.”

The European commission put the CETA text to the test last year in the ISDS consultation. Over 110 scholars published a joint submission to this consultation; in their Statement of Concern they show that the commission failed to solve a long list of crucial issues in the CETA text.

A legal scrub is an insufficient approach as it only allows minor changes; it can not solve the crucial issues.

Ratification of CETA would lock in the EU as it is practically impossible to withdraw from trade agreements. Multinationals from the US and other countries would be able to use CETA against the EU and its member states.

Furthermore, in 72 annulment appeals of ISDS cases the President of the World Bank appointed all three the arbitrators. This is problematic in itself and because this president of the World Bank has always been the candidate of the U.S. This is only one example of procedural rules which give the U.S. an unfair advantage. The US never lost an ISDS case.

The commission added procedural rules which give the US an unfair advantage to agreements that are a model for the agreement with the US: CETA and the agreement with Singapore (EUSFTA).

The social democrats set the EU up for defeat. If the US demand the inclusion of ISDS in the US-EU trade agreement (TTIP), agree with the approach taken in the agreements with Canada and Singapore, but refuse further reforms, the EU has to accept a broken system that gives the US an unfair procedural advantage, or reject TTIP.

To avoid this scenario it is essential to say no to ISDS in the agreements with Canada and Singapore.

“ISDS has triggered an intensive public debate, including in the European Parliament and in some Member States’ parliaments, on the necessity and legitimacy of ISDS provisions in TTIP, as well as in other agreements like CETA. Recent cases have raised genuine and strong concerns that ISDS carries the risk of abusive claims which could successfully challenge sovereign legitimate public laws and regulations.

We welcome the publication of the results of the public consultation launched by the Commission. The general scepticism expressed in the consultation cannot remain unanswered. It is crucial, that well-founded criticism is addressed in a timely and transparent manner.”

Conceptual flaws

“We need new principles for a modernized investment protection system. It is of utmost importance to ensure a fair balance between the interests of States and investors.”

“A fair balance between X and Y” language is ubiquitous in EU policy documents. In this case however it is as inappropriate as telling. “A fair balance between the interests of States and investors” implies that foreign money is as important as democracy.

This highlights that ISDS gives foreign investors equal standing to democracies.

This has inherent systemic consequences. The adjudication takes place at the supranational level, above democracies. This
– creates, always, a risk for democracies,
– takes away, always, the legislative feedback loop: democracies need a legislative feedback loop to correct unacceptable interpretations by courts; changing a treaty takes the consent of the other party or parties,
– changes, always, the dynamic of treaty interpretation: private parties have less restraint than states (See Flynn, part C),
– gives, always, foreign investors greater procedural rights than local investors: they have an extra option.

If there should be a role for adjudication at the supranational level, to limit damage to democracies and treaty interpretation, exhaustion of local remedies and limitation to a marginal test are necessary. The best safeguards are needed. To avoid lock in, withdrawal from treaties has to be possible, without a long termination period.

As we will see, the social democratic proposals provide none of these.

TTIP: fundamental flaws

“We therefore advocate necessary changes which reflect this new approach. The principles and proposals that we support are in line with the four areas identified by the Commission following public consultation on investment protection and ISDS in TTIP.”

The four areas identified by the commission are:
– the protection of the right to regulate;
– the establishment and functioning of arbitral tribunals;
– the relationship between domestic judicial systems and ISDS;
– the review of ISDS decisions through an appellate mechanism.

These four areas in combination with a speech commissioner Malmström gave lead to a provisional list of issues that the commission would not solve:
– foreign investors equal standing to states,
– no exhaustion of local remedies,
– no limitation to a marginal test,
no legislative feedback loop,
lock in,
– only investors, not states, can start cases,
– rights but no obligations for foreign investors,
– foreign investors greater procedural rights than local investors,
– competing adjudicative forums,
– no standing for other interests,
no separation of powers,
no institutional safeguards for independence,
for profit arbitrators,
perverse incentives,
rigged to the advantage of the US.

As we will see below the social democratic proposals confirm this provisional list.

Regarding perverse incentives: for profit arbitrators have an incentive to attract more cases. Only investors can start ISDS cases; for profit arbitrators have an incentive to give them value for money.

No limitation to a marginal test

“First and foremost, States shall be able to keep their full capacity to regulate. While CETA implies welcomed improvements, by clearer and more precise scope of protection standards, we call for the clarification of “fair and equitable treatment” and “legitimate expectations” of investors: an investor cannot expect that laws will remain unchanged and that changes in profit margins, including significant ones due to government measures, cannot in themselves constitute a breach of protection standards.”

First, this shows that ISDS is not limited to a marginal test.

Second, the commission’s earlier attempts did not work out well. See the joint Statement of Concern, published by over 110 scholars, answer to question 3. See also Dan Ikenson: “ISDS is ripe for exploitation by creative lawyers”.

Third, textual improvements may work with domestic courts (tenure, fixed salary, prohibition of outside remuneration, neutral case assignment). But in the hands of foreign for profit arbitrators, working in a system with perverse incentives, textual improvements may easily turn out to be futile.

Fourth, a fair and equitable test would make ISDS so invasive and arbitrary that it gives credibility to threats to use ISDS.

Fifth, note that the social democrats admit that the changes to CETA do not go far enough.

No legislative feedback loop

“Nothing should deter parliaments from implementing legitimate public policies. We urge that State parties retain the full right to interpret the protection standards of an agreement even after it has entered into force.”

As we saw above democracies need a legislative feedback loop to correct unacceptable interpretations by courts. There is no legislative feedback loop at the supranational level.

First, state parties to an agreement can change an agreement. But that takes the cooperation of the other state(s). And these states may have other interests. An other state may have a predatory interest. With a treaty our democracy is at the mercy of other states.

Second, under NAFTA the parties issued interpretations twice. The arbitrators were not impressed and used expansionist interpretations regardless.

Greater procedural rights

“Also, considering the existing high level of investment protection under the legal systems of the EU and its Member States, foreign investors shall in principle not be granted better substantive treatment than domestic investors within the EU.”

This, first, shows that ISDS would not be limited to a marginal test.

Second, the substantial rights may be better at the supranational level (note “in principle”).

Third, the social democrats do not mention procedural treatment. Foreign investors will have an extra forum, with 50% influence in the make up of the tribunals, without institutional safeguards for independence, with perverse incentives, with backward looking damages, including expected profits and interests.

Fourth, rights without responsibilities for foreign investors places states and citizens in an unfair position.

Vulture capitalism

“States shall be able to restructure and reschedule sovereign debts with no exposure to investment protection proceedings, clear carve-out provisions on bank resolutions shall be introduced.”

Exclusion of sovereign debts from the definition of investment is a more solid solution. See the Statement of Concern, answer to question 1. It would be irresponsible to not solve this in CETA.

No wide margin of appreciation

“We will not compromise on our rights to protect core European values, such as respect for human dignity, liberty, democracy, equality, the rule of law and respect for human rights, protection of health, safety and the environment, as well as cultural and linguistic diversity, media freedom and media pluralism, which should be clarified in the preamble and text of the CETA agreement, in line with the current scope of exclusion of audiovisual services and other cultural services.”

These are good intentions; I welcome them. However, they face a systemic issue. It is possible to exclude a field, like audiovisual services. Arbitrators may respect that – may.

But you can not exclude (interference with) human rights, liberty and democracy. They are not fields, they are principles to be applied. They can not be cut out like audiovisual services.

The right approach would be to give states a wide margin of appreciation. But neither the commission, nor the social democrats consider this.

Let’s assume a best case scenario: TTIP will include a wide margin of appreciation. Then the next issue comes up. There is no guarantee that foreign for profit arbitrators working in a system that creates perverse incentives will respect the wide margin of appreciation. See also: Van Harten, Arbitrator Behaviour in Asymmetrical Adjudication: An Empirical Study of Investment Treaty Arbitration.

Regarding democracy: in 35 – 40 percent of the cases foreign investors challenge regulations. Foreign for profit arbitrators would have the discretion to decide on regulations.

Regarding equality: ISDS is only available to foreign investors, not to local investors.

Regarding the rule of law: the reform plans do not solve the lack of institutional safeguards for independence, the perverse incentives, and the unfair advantage for the US.

Perverse incentives versus ethical requirements

“The legitimacy of arbitral awards must be further enhanced in particular with regard to ethic requirements for arbitrators and transparency of investment protection procedures.”

Adjudicative processes have to be free of reasonably perceived bias. The social democrats do not demand institutional safeguards for independence: tenure, fixed salary, prohibition of outside remuneration, and neutral case assignment. They allow for profit arbitrators and perverse incentives, only demand ethic requirements. The result is not free of reasonably perceived bias.

A secretariat

“We call for a new approach for enforcement of the right to regulate and investment protection. We support the creation of a new mechanism with a permanent secretariat. A Trade and Investment Court, whose task is to judge on investment protection cases, could constitute this new mechanism.”

The social democratic ministers only mention a court as an option.

At best, a court would be a long term solution. Moreover, a permanent international investment court has the systemic issues of supranational adjudication we saw above. See also: International investment court plan threatens our democracy.

For the short and middle term we would be stuck with ISDS. And why would the US, once they got an ISDS rigged to their advantage, cooperate in creating a court?

Adding a secretariat is not an improvement as secretariats already exist. The Permanent Court of Arbitration, and the International Centre for Settlement of Investment Disputes already have a secretariat. They may be handy but do not change decisions.

Appeal

“We support the introduction of an appeal mechanism, which has the potential to rectify some of the legitimate concerns that arbitral tribunals are facing. Appeal shall be open for all judicial decisions. This principle is well established in our legal systems and should apply also to investment protection in future agreements with investment protection provisions. An appeal mechanism will improve consistency, coherence and credibility of arbitration practice.”

An appeal mechanism could provide more consistency, but would not provide institutional safeguards (unless a court) and would not remove the perverse incentives (idem).

Perverse incentives versus ethical requirements 2

“The choice of arbitrators should be limited to fixed pools of highly qualified arbitrators appointed by the EU, Canada and EU Member States, as far as possible qualified professional judges and academics, while seeking to secure specialist legal expertise. Ethic standards shall be raised with the introduction of a compulsory code of conduct for arbitrators. Mandatory disclosures requirements for third party funding should be introduced.”

See above: for profit arbitrators, perverse incentives.

The social democrats do not mention the US’ unfair procedural advantage.

Conflicts of interest

“We need to prevent conflict of interests, for example in cases where an arbitrator in one dispute subsequently becomes a legal representative in another similar dispute, or vice-versa, for example through a ‘quarantine’ period long enough to prevent conflict of interests.”

A weak approach compared with tenure with prohibition of outside remuneration. There are still many secret ISDS cases. It will be impossible to know all conflicts of interest.

In the CETA and EUSFTA texts an executive official linked to the US would decide on conflicts of interest.

Don’t shoot at democracy

“We strongly encourage settlement of grievances to the greatest extent possible without resort to litigation through ISDS. We stress the importance of actively promoting consultations and mediation.”

ISDS gives foreign investors a mighty weapon. Social democrats plead: please do not use it.

Perverse incentives and frivolous claims

“Abusive litigation by investors shall be tackled: frivolous claims should clearly be deterred through reinforcing the principle of ‘loser pays’ where a claim is dismissed as frivolous and for example by the possibility of penalties.”

Arbitrators can already dismiss claims as frivolous. They never did that; they have a financial incentive to let cases drag on.

Stimulating small claims

“In the new approach for investor protection, we want equal possibilities for SMEs as well as large investors.

Access to dispute resolution should also be an option for SMEs investing abroad. They cannot afford long and costly proceedings. We propose to limit these costs for claims up to a certain amount.”

On average the legal costs are 8 million US dollars, 4 million for each party. With appeal added the costs may double. It may be possible to bring down the costs of the arbitrators. But how to bring down the costs of lawyers?

If successful there will be more ISDS cases. The EU and member states will have full legal costs to bear. They will lose more cases. Will have to settle more cases. Will attract more threats. Foreign small and medium sized enterprises (SMEs) will have ISDS; local SMEs won’t.

SMEs, and societies as a whole, are better of with strengthening local court systems.

Tribunals competing with courts

“Investment protection shall not allow for national court decisions to be challenged by arbitral mechanisms. Arbitral mechanisms shall not be allowed to act de facto as a ‘Supreme Court’, overturning national court decision. We therefore strongly favour to introduce a clause making it mandatory to choose between arbitration and local remedies (‘fork in the road’ and ‘no U-turn’).”

First, no exhaustion of local remedies.

Second, no limitation to a marginal test but vast discretionary powers for foreign for profit arbitrators.

Third, the proposal would create competing forums. To attract business, for profit ISDS arbitrators would have to deliver: provide more value for money than local courts, through expansionist interpretation – at the expense of our democracies. Foreign investors will then opt for ISDS, an option not available to local investors.

Fourth, if a state sues a multinational, it has to do this before a local court. The multinational can defend itself. And afterwards the multinational can still use ISDS. ISDS will still “act de facto as a ‘Supreme Court'” and arbitrators would be able to interpret EU law.

Fifth, if we do not want investors to challenge national court decisions through ISDS, creating a parallel track doesn’t make sense, as it equally takes away the power of our national courts to deliver the final decision; it equally devaluates our courts.

Alternatives

“Our overarching objective with regards to investment arbitration is to strike the right balance between private and public interests by ensuring an appropriate level of protection for investors while, at the same time, preserving legitimate public interests. It is necessary to take action to address concerns in the EU, but also to promote a modern and effective investment policy that allows the EU to grant a high level of protection for our investors abroad.”

Major investment projects usually come with contracts, often with their own dispute settlement clauses. Local courts, insurance and state-to-state dispute settlement are other alternatives.

ISDS is not necessary.

Conclusion: dangerously flawed

“We encourage the European Commission to use the time ahead of us to engage with other partners in order to introduce these new principles in future agreements. If successful, we firmly believe that this will be a milestone for establishing new standards of investment protection both in favour of growth orientated investments and the preservation of the States’ legitimate interests.”

We saw that it is essential to say no to ISDS in CETA and EUSFTA.

We saw that the social democrats fail to solve crucial issues. The social democratic reform proposals are dangerously flawed.