EU - Japan Economic Partnership Agreement announced

On 6 July 2017 the EU and Japan announced an agreement in principle on their Economic Partnership Agreement ("EPA").  The scale of this agreement is eye-popping: once in effect the EPA will cover nearly 40 percent of all goods exports, 10 percent of the Earth's population, and about 30 percent of global GDP.  The breadth of goods covered by the EPA will be similarly substantial and includes agricultural and food products, the forestry sector, industrial products, the automotive sector, electronics, and services.  While some tariffs, such as those on wine, will disappear from the moment the EPA enters into force, other tariffs – including those on imports of Japanese automobiles to Europe and imports of European chocolates to Japan – will disappear over a number of years.  The net effect will be to remove tariffs from 99 per cent of all goods traded between the EU and Japan with one study suggesting consequent increases in EU exports to Japan of 34% and Japanese exports to the EU of 29%. 

Getting to the point of agreement, even in principle, was not easy.  Within the EU the European Commission ("EC") held dozens of meetings including more than 40 meetings held with EU governments since 2016 alone.  Negotiations with Japan have also been extensive: 4 years and 18 rounds of negotiations have elapsed since talks began.  Perhaps in light of strengthening protectionist sentiment elsewhere and in an effort to maintain a sense of legitimacy, the EC also has taken pains to document these meetings and those held with citizens and civil society.  Despite these extensive efforts, key issues remain unaddressed including – most prominently – how to address the rights of investors and how to settle investor-state disputes.

Approach to investor-state dispute settlement ("ISDS") in the draft EU-Japan EPA

The EC-published draft negotiating text of the EPA concerning investment and investment liberalisation sets out several immediately recognisable standards for the treatment of investors by states and in some ways reflects the basic approach to investment protection visible in thousands of other investment treaties.  It provides, for example, certain obligations to ensure market access for investors of one party in the territory of the other party, as well as commonly found provisions such as National Treatment and Most-Favoured-Nation-Treatment ("MFN").  Even these basic provisions, however, foreshadow a key gap in the in principle agreement: the draft negotiation text expressly carves out from the definition of 'treatment' in the MFN provision "investor-to-state disputes settlement procedures provided for in other international agreements."  In other words, the draft negotiation text expressly attempts to prevent investors from claiming the benefit of standard ISDS procedures (i.e. binding arbitration) found in other investment agreements, and leaves wholly unresolved the question of what procedures exactly to include.

The EU's Proposed Investment Court System

Perhaps encouraged by the successful exclusion of traditional ISDS procedures from the EU-Canada Comprehensive Economic Trade Agreement and EU-Vietnam Free Trade Agreement, the public statements of the European Commission concerning ISDS procedures and the EPA demonstrate some inflexibility on the issue of investor protection provisions.  It seems that an investment court system ("ICS"), as part of the EC's drive towards a multilateral investment court, is the only option as "[u]nder no conditions can old-style ISDS provisions be included in the agreement". Simply put, "[f]or the EU ISDS is dead".  The reasons offered by the European Commission, against a background of some civil society campaigns against ISDS, include that:

1. An investment court system would create a more predictable environment for investors;
2. An investment court system would have highly qualified judges, appointed by the state parties to the agreement; and
3. An investment court system would have public oversight and transparent working methods.

This proposal, as evidenced by its exclusion from the draft negotiation text and the lack of any agreement, has not been welcomed with open arms by Japan.  Whether or not the claimed benefits would indeed materialize as described also remains unclear.

Japan's Recent Approach to ISDS

Japan, in recent years, has tended to conclude free trade agreements of a broad scope and with a detailed investment chapter that provides for standard investor-state arbitration.  Government pronouncements have made clear on several occasions that Japan expects its investors to use these tools to protect their investments and to resolve disputes.  Japan's approach to ISDS provisions and protections do, however, demonstrate some diversity.  This is likely in part because Japan lacks a model bilateral investment treaty upon which to base negotiations – evolution or drift therefore become natural.  The rules and institutions applicable to investor-state arbitration contained within Japan's international investment agreements are similarly diverse: Japan has frequently agreed to the use of ICSID arbitration but has also agreed in the past to allow the use of other rules or institutions including the Kuala Lumpur Regional Centre for Arbitration and the Arbitration Institute of the Stockholm Chamber of Commerce.  Despite Japan's past flexibility on dispute resolution provisions, however, there remains the risk that ICS may yet prove unpalatable.

Next Steps

Over the coming months Japanese and EC negotiators will meet to try to hammer out several remaining points, including the issue of investor state dispute resolution, with an eye on bringing the EPA into force in 2019.  Recent media reports have suggested that one option under consideration is to simply not include provisions on this issue in the final text of the EPA.  Whether an EPA lacking investor protection is attractive to the parties remains to be seen. What is clear is that challenges arising from the proposed ICS system remain, including:

1. a lack of detail as to how this system would work in practice, including the appointment of judges;
2. the potential for national or regional parliaments to hold hostage the ratification of any EPA including the ICS system, following the Court of Justice of the European Union's 16 May 2017 ruling that the approval of the (nearly 40) national and regional EU parliaments is required to ratify the EU-Singapore FTA;
3. the potential cost of the ICS system to Japan in circumstances where Japanese investors rarely bring investment claims against states; and
4. the uncertain future of the ICS system and its potential impact on future trade agreements.

For more information, please contact Colin Trehearne, Associate, or your usual Herbert Smith Freehills contact.