Commercial Law Reform and Foreign Direct Investment
The nature of foreign direct investment (FDI) is changing, and the role of commercial law reform is now a more significant factor for FDI than before in many developing and emerging country markets. Many FDI arrangements are evolving from bilateral (whether private, government, or international organization) investment to multitiered market arrangements involving international credit markets, venture capital, private equity and hedge funds, and a variety of securitization mechanisms. Cross-border corporate arrangements are now used more frequently, and less seen but also important are medium- to longer-term counter-trade deals involving tied-marked arrangements for the output of FDI-based goods and services.
All this involves an increase in structured credit arrangements for FDI, and that in turn involves assessment not only of business risk and country risk but, in recent times, broader market and financial risk, with distant and not always directly related rumbles in the markets now affecting FDI and requiring more ex ante risk valuation. The risk assessment community, which used to rely on trade agreements and multilateral and bilateral investment treaties (such as the U.S. bilateral investment treaties, or BITs), is now also looking more closely at investment recipient countries’ signals as their readiness to enhance their competitiveness and capacity building through adoption of modern commercial laws. In some cases this enhancement can also reduce systemic risk.
BITs and trade agreements tend to open and liberalize markets or provide more readily accessible foreign investor entry, protect against discriminatory treatment, ensure access to international arbitration, and in some cases ensure or facilitate export rights, repatriation of capital, and so on. One continuing trend, however, is that market liberalization works, but only partially, without also upgrading commercial laws to facilitate affected transactions. The latter has lagged behind the former. That said, structured finance and credit risk assessment have migrated to assessing as frontline issues the degree of modernization of secured finance law, business bankruptcy law, and cross-border treatment as important indicators, and in some cases, depending on the type of direct investment, participation in interbank payment systems, modernization of letter of credit and bank guarantee law, and similar factors.
Commercial lending and structured finance credit depend on ex ante risk assessment, in which assessing the extent of such legal reforms is made up front, when decisions to proceed with an investment or transaction or financing commitment are made. This is increasingly less related to legal dispute risk or the pathology of particular cases and is thus less dependent on the pace of local court and judicial system reforms. International capital markets can and often do self-correct for cases of country legal risk where a state fails to uphold rights granted investors. Experience also has shown that countries may be more willing to adopt such modernizing commercial laws if they have the imprimatur of international bodies rather than bilateral sources.
Examples of commercial law reforms that have a substantial effect ex ante are the two closely related areas of business bankruptcy law and secured finance law, which have been the subject of major developments in international commercial law in recent years. Countries that adopt, for example, the 1997 United Nations Commission on International Trade Law (UNCITRAL) model law on cross-border bankruptcy, broader bankruptcy law reform based on the 2004 UNCITRAL Legislative Guide, and the soon-to-be-issued World Bank and International Monetary Fund (IMF) assessment standards (ROSCs) can significantly improve credit risk for FDI as well as lower systemic risk to their economies.
Modern secured finance laws are the second linchpin. UNCITRAL concluded a 2001 convention on assignments of payment rights (that is the economic driver of American commercial finance under Uniform Commercial Code Article 9) and is about to conclude a four-year project on a legislative guide to secured finance reform that will reflect many of the market-tested concepts in the Uniform Commercial Code (UCC). Coordinated implementation of the convention is currently under consideration by the three North American Free Trade Agreement (NAFTA) states, under the auspices of a tri-country project of the National Conference of Commissioners on Uniform State Laws, the American Law Institute, and their counterparts in Canada and Mexico.
The Organization of American States has concluded a shorter 2002 Inter-American Model Law on secured finance with similar basics, and the European Bank for Reconstruction and Development has promoted some of the same approaches. All these initiatives can widen the scope of participants in commercial finance and considerably expand both the types and value of legal interests that can serve as collateral, especially in lesser developed countries. That said, one cannot overestimate the resistance to these modernizing currents in some countries, either because it contradicts more traditional property-based ideas of the law or it changes the lineup of commercial participants and may challenge those who have controlled local economies, or for other reasons, sometimes including the fact that original testing of some of these concepts took place in U.S. and Canadian commercial law.
Related to the foregoing, FDI can also be significantly affected in developing countries by adoption of the International Institute for the Unification of Private Law (UNIDROIT) Cape Town Convention and either or both of the first two protocols, one on aircraft finance and the other on railroad rolling stock finance. Although arguably affecting only more narrow markets, adoption of the new treaty-based concept of international secured finance interests, which can be perfected by notice filing in new global computer-based registries, signals a willingness to enter the modern world of asset-based finance and adjustment to those standards. Close to 20 states, mostly developing countries, are now parties to the air finance protocol that came into force in 2006, and more than 50 percent of transactions worldwide of larger commercial aircraft are already subject to the new treaty-based rights system. The new railway finance protocol may have particular relevance to FDI because in addition to enabling modernization of rail rolling stock and thus upgrading the infrastructure of countries in which direct investment is made, it can spur regional rail development where that is feasible in view of geographical, market, and political factors. Work is underway on a third protocol to extend the new treaty system to financing of space assets, including satellites and space-based telecommunications and other services. A fourth protocol supported by the United States is at an initial discussion stage and would cover agricultural, construction, and mining equipment—all significant infrastructure factors for developing countries.
Other important multilateral commercial law initiatives include the 1995 UNCITRAL Convention on independent guarantees and the earlier UNCITRAL Convention on international bills of exchange and promissory notes. This is not to give less importance to the traditional pace setter in international private law, the Vienna Convention on contracts for international sales of goods, or its parallel convention on limitation periods for sale of goods. Modern cross-border risk assessment, however, and the effect on FDI are more dependent on areas of law closely linked to structured finance. Adoption of either or both the guarantees and bills of exchange conventions would move a country’s banking system toward modern approaches that amplify the collateral value of such guarantees and commercial paper and increase liquidity in FDI recipient countries.
For More Information About the Section of International Law
- This article is an abridged and edited version of one that originally appeared on page 23 of International Law News, Winter 2008 (37:1).
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Hal Burman is at the U.S. State Department Office of Legal Adviser; he may be reached at email@example.com. Don Wallace Jr. is a professor at Georgetown University Law School; he may be reached at firstname.lastname@example.org.