In view of these assumptions, it becomes clear that State A acting as a rational decision-maker seeking to maximize its payoff will always defect, regardless of what State B does. Indeed, from State A’s perspective, if it defects, it either gets 80% of foreign investments or 50% of foreign investments (albeit in both cases it would have to offer additional protections to foreign investors and/or relax its SDG and CSR rules). On the other hand, if State A cooperates, it either gets 50% of foreign investments or 20% of foreign investments (albeit in this case it will not need to offer additional protections to foreign investors and/or compromise on their compliance with SDG and CSR rules). State B faces the same considerations. For both states, it becomes a better move to defect, regardless of what the other state does. And so, they will defect, ultimately each getting 50% of foreign investments, but only after offering additional protections to foreign investors and/or relaxing their domestic law requirements as to investors’ compliance with SDG and CSR rules. As the prisoner’s dilemma illustrates, acting rationally, State A and State B will ultimately find themselves in a worse position (having offered additional investor protections and/or relaxing their SDG and CSR rules) than would be the case had they both cooperated. Such cooperation would allow them to achieve a more optimal outcome with each getting 50% of foreign investments without providing additional protections to foreign investors and/or compromising on their SDG and CSR rules.
It is this prisoner’s dilemma that investment treaties seek to resolve. In theory, through negotiations and signing of agreements between them, rational players can coordinate their actions, moving back into the best outcome scenario for both of them. And in many areas of international law, treaties would indeed offer a solution to the prisoner’s dilemma by allowing sovereign states to coordinate their actions by concluding a treaty and providing for its enforcement.
Yet, international investment treaties are inherently different. As explained above, by their nature they are the “hybrid” treaties, concluded between sovereign states for the benefit of the third parties—foreign investors. As beneficiaries of these treaties, foreign investors will seek to enforce IIAs in ISDS, if the host state breaches its foreign investor obligations or adopts a domestic regulatory measure (e.g., a measure seeking to protect environment or public health) that infringes on the rights of a foreign investor. But if the opposite happens—that is, a host state enhances its foreign investor protections (above and beyond of what is required in a treaty) and/or relaxes its domestic SDG and CSR rules (and their enforcement) with regard to foreign investors—a foreign investor as a beneficiary of a treaty has no incentives to complain. On the contrary, foreign investor will generally enjoy the increased level of protections, without raising any objections in ISDS or otherwise. In other words, because they are treaties for the benefits of third parties, international investment agreements are unable to offer a solution to the prisoner’s dilemma.
This inability of modern IIAs to resolve the prisoner’s dilemma is inherent in their third-party nature, regardless of the substantive provisions and enhanced level of protections they seek to provide. As the game theory suggests, unless the enforcement of IIAs is left to other actors—for instance, the non-state parties to IIAs or non-state actors with interest in SDG or CSR—investment treaties are unable to resolve the issue of incentives to defect. As a result, the reforms of international investment law and dispute settlement focused on treaty-making and treaty revisions are unable to rebalance the system of international investment law until incentives are created for the host state to either cooperate irrespective of the investment agreement, or the right to enforce modernized IIAs is granted to additional state and non-state actors. The proposed and ongoing treaty and institutional reforms do not address this concern so far, instead focusing on the substance of treaty provisions and the overall coherence among provisions and across different treaties and rules.
III. Reforming International Investment Law
A. UNCTAD and Investment Treaty Revision
In the area of substantive investment law, the reform efforts have been focused on revising or concluding new investment agreements safeguarding the state’s right to regulate and seeking to meet the sustainable development goals. Noticeably, the United Nations Conference on Trade and Development (UNCTAD) is actively seeking to assist sovereign states in updating their investment treaties. To this effect, at the end of 2020, UNCTAD published its IIA Reform Accelerator—a “tool to assist States in modernizing the existing stock of old-generation investment treaties.” The Accelerator focuses on eight provisions commonly found in investment treaties, which UNCTAD identified as in need for revision in line with the sustainable development goals and state’s right to regulate. The Accelerator offers to the states model language for inclusion into the revised treaties and provides examples of treaties that have already incorporated the proposed language. UNCTAD stresses the need to ensure “coherence” between treaty provisions, across different treaties of a sovereign state, and the overall coherence between reforms of “international and national investment policies.”
The efforts of UNCTAD and individual countries have led to the ongoing revision of the scope and content of investor protection treaties, moving away from the bare-bones provisions of the first generation of IIAs. In revising their IIAs, sovereign states seek to clarify the outdated treaty provisions, especially those that are prone to different interpretations and ISDS challenges. Amendments and additions to the treaty language also reflect modern trends in international investment law, such as clarifying the definition of investment and investor, investor protection standards, and public policy exceptions.
The right to regulate occupies a prominent place in the treaty revision efforts. Modern IIAs seek to safeguard the ability of the host state to adopt measures for the benefit of the public at large, without facing a potential challenge in ISDS for introducing measures that might impact the rights of the foreign investors. In doing so, investment agreements acknowledge several legitimate public policy goals with respect to which the host state reserves its right to regulate, regardless of the obligations to foreign investors. This includes protection of the public health, the environment, human rights, and social values. According to the UNCTAD’s IIA Mapping Project, which includes 2,584 investment treaties to date, forty-five treaties contain a refence to the right to regulate in their preamble, while 133 treaties include separate provisions on the right to regulate in the body of the investment treaty. Although these numbers remain low in the overall number of IIAs globally, UNCTAD continues to stress the importance of treaty provisions on safeguarding the right to regulate. This includes calls for clarifying the scope of the IIAs and definitions of the concept of investment, as well as the use of exceptions and denial of benefits provisions that “may provide a counterweight to otherwise broad treaty coverage.” This also includes calls for clarification of the standards of protection, such as determining “like circumstances” for national treatment standard, which, according to UNCTAD, “can go some way in safeguarding the right to regulate.”
In response to the reform efforts that seek to protect the state’s right to regulate and to achieve the sustainable development goals, the revised and more recent IIAs increasingly contain provisions on protection of the environment, sustainable development, human rights, labor standards, and CSR. They range from the general references to environmental protection and CSR in the preamble of the investment treaties to separate provisions establishing the obligations of the foreign investor and/or state parties to comply with the broadly defined international environmental and sustainable development principles. They also include treaty provisions that incorporate by reference international soft law instruments of environmental protection and CSR, such as the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises (hereinafter OECD Guidelines).
Outside of the UNCTAD-led reforms, the modernization efforts are ongoing with regard to the Energy Charter Treaty (ECT), a multilateral agreement establishing a framework for cooperation between state parties in the energy sector, including investments and surrounding dispute resolution with reliance on ISDS. Yet, following recent notifications of withdrawals by the state parties, led for the EU Member States by the European Commission that has proposed a coordinated withdrawal from the ECT for the European Union, the European Atomic Energy Community (Euratom), and the EU Member States, further destiny of the ECT revisions is currently unclear.
The European Commission’s calls for withdrawal came as the result of failed attempts to modernize the ECT to tackle climate change and achieve sustainable development goals. The Council of the European Union specifically requested the European Commission to work on modernizing the ECT to include stronger provisions on sustainable development and CSR. The European Commission responded with several proposals, including a new draft article “Sustainable development—Context and objectives.” The article “recall[ed]” the Rio Declaration together with other instruments of soft law on sustainable development, such as Agenda 21 of 1992 and the U.N. 2030 Agenda for Sustainable Development of 2015 with its Sustainable Development Goals (SDGs), and affirmed the states’ commitment to the goals of sustainable development.
The European Commission also proposed a separate new article “Sustainable development—Responsible Business Practices,” where it addressed CSR, with a reference to the U.N. and OECD soft law instruments:
The Contracting Parties recognise the importance of responsible business practices in contributing to the goal of sustainable development. Accordingly, they shall promote the uptake of corporate social responsibility or responsible business conduct, in line with relevant international instruments, such as the OECD Guidelines for Multinational Enterprises, the ILO Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, and the UN Guiding Principles on Business and Human Rights.
Inclusion of these and similar provisions in IIAs is a relatively new practice, which does not support the traditional view on international investment law as “silent” with regard to the soft law instruments relevant to foreign investors and their activities in the host state. What unites these treaty revision efforts is their reliance on enhancing the state’s right to regulate and introducing provisions into investment treaties with regard to investor obligations, such as compliance with environmental, sustainable development, and CSR rules. As with any international treaty, the success of these treaty-revision reforms will ultimately depend not only on the substance of the proposed treaty provisions, but also the desire of sovereign states to conclude respective treaties and comply with treaty obligations without lowering their standards in search of foreign investments.
B. UNCITRAL and Possible Reform of Investor-State Dispute Settlement
While sovereign states are looking for ways to empower themselves in international investment law with the help of more balanced investment treaties and empowered arbitral tribunals, the ISDS as a dispute resolution method has itself received a fair amount of criticism in recent years. The lack of consistency and predictability of arbitral awards, double-hatting by arbitrators, forum and treaty shopping by claimants, and multinational corporations challenging government regulatory measures in investment arbitration—have all contributed to the alleged “legitimacy crisis” of ISDS. This led to the initiatives at the international (the United Nations/UNCITRAL) and regional (the European Union) levels to reform or abolish the current institutional framework of ISDS.
Noticeably, the UNCITRAL agenda on possible reform of ISDS comprises of a broad range of items, including the codes of conduct for arbitrators and judges, investment mediation and dispute prevention, procedural rules reform and cross-cutting issues (such as interpretation of investment treaties by treaty parties, exhaustion of local remedies, procedure to address frivolous claims, multiple proceedings, reflective loss and counterclaims by respondent States, expedited procedures, principles/guidelines on allocation of costs and security for cost, third-party funding, assessment of damages and compensation, ISDS tribunals members’ selection, appointment, and challenge), multilateral permanent investment court, appellate mechanism, and multilateral investment to implement reforms. Among these agenda items, counterclaims deserve special attention in view of their ability to rebalance international investment law and dispute settlement.
In investment treaty arbitration, host states may seek affirmative relief in ISDS where the investment dispute involves the alleged illegality of the investments or the investor conduct, corruption, bribery, or breach by the investor of domestic law of the host state or international law obligations. Providing for the state’s right to bring counterclaims in ISDS mitigates the inherent asymmetry of international investment law and becomes particularly important as we continue to modernize the existing IIAs and look for ways to include into investment treaties obligations for foreign investors, in addition to their rights. Counterclaims rebalance the rights of the host state with those of the foreign investor by enabling the host state to bring affirmative claims in ISDS. They also enhance the overall efficiency of the international dispute resolution process by permitting the claims of an investor and related claims of the host state to be heard in the same forum during the same arbitral proceeding.
Yet, under current investment law, the grounds for the investment tribunal to establish jurisdiction over a counterclaim by the host state remain limited. The limits on counterclaims stem from the requirement of consent to ISDS, which has to be provided by the disputing parties—a claimant and a host state—for an investment tribunal to accept jurisdiction over a case, including jurisdiction over counterclaims by the host state. Such consent serves as a prerequisite for the tribunal’s jurisdiction if the investment treaty invoked in ISDS does not provide for the counterclaims. Alternatively, a host state can bring a counterclaim if an IIA invoked by the foreign investor in ISDS has broad provisions permitting the counterclaims by the host state. Yet, most IIAs concluded to date do not provide for the host state’s ability to bring counterclaims in ISDS although the relevant arbitration rules do. Notably, the ICSID Convention (Article 46), together with the ICSID Arbitration Rules (Rule 48.1) and the ICSID Arbitration (Additional Facility) Rules (Rule 58.1), provide for the counterclaims in ICSID arbitrations. Similarly, Article 21(3) of the UNCITRAL Arbitration Rules provides that “the respondent may make a counterclaim or rely on a claim for the purpose of a set-off provided that the arbitral tribunal has jurisdiction over it.” And so, legal scholars and arbitration practitioners have argued that counterclaims should be accepted as long as the relevant arbitration rules provide for counterclaims, regardless of the language of the IIAs.
On their side, in the last two decades, investment tribunals have shown an increased willingness to expand their jurisdiction to counterclaims by host states. In several arbitrations, investment tribunals have accepted jurisdiction over the counterclaim, but rejected the counterclaim on the merits. More recently, counterclaims were submitted in Naturgy (formerly Gas Natural) v. Colombia and Société des Parcs d’Alger and Emirates International Investment Company LLC v. Algeria. Yet, counterclaims in treaty-based investment arbitrations remain very rare, in large part due to the restrictive language of the investment treaties and consent to arbitration, as well as what Jean Kalicki refers to as “an instinctive preference by States to pursue any affirmative claims in their own courts,” where they might have a home-field advantage over the outcome of the case.
Thus, the work of the UNCITRAL to reform ISDS and, doing so, to rebalance international investment law, remains especially important as it supplements the treaty revision efforts of the UNCTAD and individual states. Yet, the ability of the UNCITRAL reform to address the race to the bottom concerns, as disclosed by the prisoner’s dilemma, remains limited, unless the existing ISDS mechanism of dispute resolution is supplemented with the incentives for disputing parties and investment tribunals to invoke and consider the substantive rules of more recent IIAs that impose obligations on foreign investors. In addition, the ISDS itself must be supplemented with the enforcement mechanisms, for instance, in the form of state-to-state arbitrations, that would allow non-disputing state parties (or other actors with standing, such as NGOs) to prevent the host state from lowering its investor protection standards as they relate to the environmental protection, sustainable development, human rights, employment laws, CSR, and other areas of legal regulation that are increasingly prominent in international investment law.
IV. Assessing the Impact of Proposed Reforms
A. Goals and Achievable Outcomes
A look inside the proposed and ongoing reforms of international investment law and dispute settlement shows that international organizations and sovereign states actively seek to rebalance the current system of international investment law and dispute settlement. Their efforts include both the enhancement of the rights of the host state (the right to regulate, the right to use the denial of benefits clauses, the right to bring counterclaims in ISDS), as well as the introduction of the foreign investors’ obligations (the obligation to operate in the host state in compliance with the environmental, sustainable development, CSR rules) in international investment law and dispute settlement. The main tool of such reforms is international treaty-making with a focus on increased coherence of treaty provisions within a particular treaty and across different treaties, as well as across different investment treaties and arbitration rules as part of investment treaty arbitration.
Noticeably, investment treaties now seek to ensure responsible investment by incorporating the U.N. and OECD soft law instruments on environmental protection and sustainable development. By doing so, sovereign states seek to harden the soft nature of these rules by making them binding on foreign investors and—depending on the nature and content of a soft law instrument and the language of the investment treaty—on sovereign states parties to the treaty. Yet, a mere incorporation by reference of soft law does not on itself offer routes for enforcement of these provisions in ISDS by the host state. The right to bring a claim in ISDS rests exclusively with foreign investors and is not available to the host state. As a result, ISDS does not allow the host state to bring a claim against a sovereign investor for non-compliance with substantive rules of environmental protection and sustainable development, human rights, and CSR. And so, in case of non-compliance by a foreign investor with a soft law instrument—made binding through incorporation by reference into an investment treaty—the host state is left with no option but to leave its claims for another day and forum.
Recognizing this weakness of the ISDS regime, in addition to changing the regulatory landscape for foreign investors, sovereign states now seek to equip arbitral tribunals with the tools of assessing investor’s conduct as to its compliance with SDG and CSR rules. In this framework, it is still the investor who brings a claim in ISDS, but arbitral tribunals (in view of the state defenses or counterclaims) can reduce damages in consideration of investor’s non-compliance with soft law provisions, which may result in environmental harm, violations of labor standards, human rights, and CSR norms. The most recent and novel approach in this regard comes from the Model Dutch bilateral investment treaty (2019), which directs arbitral tribunals to assess investors’ conduct as to their compliance with otherwise non-binding norms of international environmental law and CSR and “take it into account” as part of damages calculations. How exactly arbitral tribunals are to take such investors’ non-compliance and factor it into the damage assessment is left to the tribunals to decide. Yet the idea itself is worth exploring and following up once the Netherlands begins concluding its bilateral investment treaties (BITs) based on the 2019 model and starts seeing investment disputes based on these treaties.
Overall, however, traditional investment treaties (albeit modernized and enhanced) are unable to resolve the prisoner’s dilemma because in the absence of an investment agreement coordinating the sovereign states’ actions with respect to foreign investors, a sovereign state will always defect in search for a higher amount of foreign investments that allegedly come with the enhanced regime of foreign investor protection and/or lowered regulatory standards. Furthermore, by contrast to other areas of international law, such as international trade law, international investment agreements by their nature cannot resolve the prisoner’s dilemma as they cannot be enforced by non-disputing state parties in instances where the host state offers enhanced protections (beyond of what is required by a treaty) or lowers its domestic standards of environmental protection, sustainable development, and CSR rules with regard to foreign investors. Thus, despite the hopes of the proponents of rebalancing international investment law and dispute settlement, current treaty reforms are unlikely to rebalance the system of investor protection or prevent sovereign states from lowering their SDG and CSR standards on the market for foreign investments. Other solutions with reliance on private incentives for sovereign states, foreign investors, and arbitral tribunals are needed.
B. Incentives and Alternative Solutions
International organizations involved in the reforms of international investment treaties recognize that sovereign states have incentives to defect from investment treaties, which may in turn lead to the race to the bottom in setting SDG and CSR standards for foreign investors. For instance, the UNCTAD has opined that “international competition for foreign investment may lead some countries to lower their environmental, human rights and other laws and regulations, and that this could result in a ‘race to the bottom’ in terms of regulatory standards.” To resolve these concerns, UNCTAD has offered to consider several solutions, including (1) incorporating into investment treaties provisions “to explicitly reaffirm parties’ commitments under international agreements that they have concluded (e.g. human rights, core labour rights or the environment),” (2) to “include a ‘not lowering of standards’ clauses in the IIA,” and (3) to introduce a “follow-up mechanism” for reporting on issues related to implementation of the “not lowering of standards clause.” But the UNCTAD itself questions the efficiency of these solutions, in particular, of the proposed clause, in view of the inability of contracting parties to enforce such clause in traditional ISDS. Yet, these solutions may move us closer to a more balanced system of international investment law and dispute settlement.
The proposed inclusion in the IIAs of the non-lowering of standards provisions (also known as the non-regression clauses, or the non-relaxation clauses) deserves a special attention. Such clauses in the form of provisions that seek to prohibit state parties from loosening up domestic environmental protection standards in order to attract foreign investments may help in preventing race to the bottom, especially if their scope is expanded beyond the environmental protection, where they are commonly used. An example comes from article 20 of the Georgia-Japan Investment agreement, which provides that:
Each Contracting Party recognises that it is inappropriate to encourage investment by investors of the other Contracting Party and of a non-Contracting Party by relaxing its health, safety or environmental measures, or by lowering its labour standards. To this effect, each Contracting Party should not waive or otherwise derogate from such measures or standards as an encouragement for the establishment, acquisition or expansion of investments in its Territory by investors of the other Contracting Party and of a non-Contracting Party.
But there is a caveat in reliance on the existing non-regression clauses. Although such clauses seek to prevent the state parties from weakening their environmental standards, one can argue that these provisions do not create obligations for the states, especially where the term “should” (instead of “shall”) is used in the clause to encourage state parties to avoid lowering their standards, as it is often the case. Furthermore, even if they are phrased in a more rigid manner, non-regression clauses often cannot be enforced for the lack of an enforcement mechanism for such commitments. More recent IIAs have recognized this drawback of the non-regression clauses and sought to provide for enforcement. For instance, the United States-Mexico-Canada Agreement (USCMA) has moved away from the NAFTA reliance on the term “should” in non-regression clauses. Instead, it introduced the term “shall” and provided for the enforcement of the non-regression provision through “binding state-state dispute settlement procedures . . . that permit economic countermeasures in the event of a violation.”
Other proposals may include the enhancements of the enforcement mechanism of investment treaties, where the rights to enforce treaty commitments are granted to the non-disputing state parties, who could get involved not only in instances of treaty interpretation, but also in cases of breach of treaty commitments by the host state, e.g., by lowering the regulatory standards to attract foreign investors. In some way, at least with regard to the lowering of environmental, sustainable development, human rights, and CSR standards, this would remove investment treaties from the pool of agreements concluded only for the benefit of third parties. Yet, as the prisoner’s dilemma suggests, this would allow the state parties, in addition to providing foreign investor protections, to agree in IIAs on the strategy of cooperation in the market for foreign investments. In other words, sovereign states could use BITs and other IIAs to coordinate their actions with regard to foreign investors, thereby reducing the incentives to defect from the regulatory commitments in international investment law. Alternatively, the right to enforce such commitments can be granted to non-state actors, such as environmental NGOs, tasked with monitoring the state parties’ compliance with regulatory commitments included in investor protection treaties.
V. Conclusion
The ongoing reform efforts to modernize international investment law and dispute settlement focus on safeguarding the state right to regulate and imposing obligations on foreign investors to ensure responsible investment. Such rebalancing of international investment law is to be achieved through uniform modernization of international investment treaties. Yet, as this article argues, in view of the high fragmentation of the current system of international investment law based largely on bilateral treaties, the reliance on traditional treaty-making will not bring the desired uniformity in international investment law. As long as sovereign states remain interested in and compete for foreign investments, they will be willing to compromise on their rights and risk investment arbitrations in order to gain competitive advantage in the market for foreign investments. In the classic prisoner’s dilemma fashion, driven by self-interests, sovereign states will not cooperate globally, although such cooperation appears to be in their best interest. To rebalance international investment law, we need to explore further solutions that provide for enforcement of investment treaties outside of the ISDS mechanism and rely on incentives for sovereign states, foreign investors, and investment tribunals to take into account and avoid lowering of SDG and CSR regulatory commitments of investment treaties.
