EU Commission issues "Concept Paper" on ISDS in the TTIP and beyond: proposals for "profound reform"

Further to its report on the outcome of the consultation on investment protection and investor-state dispute settlement in the TTIP, the EU Commission has issued a "Concept Paper" which envisages a very different future for resolution of investor-state disputes.

The Concept Paper builds on the four key areas which the Commission previously identified as requiring further consideration, explaining that there is opportunity for "profound reform" of the investment protection and ISDS systems. It also elaborates on the steps it has already taken in the EU-Canada FTA (the CETA) and the EU-Singapore FTA to improve the systems, and makes proposals which it considers will offer further progress towards its goal of protecting and encouraging investment without affecting the ability of the EU and its Member States to pursue policy objectives.

The Commission has proposed what it terms "concrete ideas" and a "concrete solution" (as summarised below). The Concept Paper is not binding and the Commission states that the content is without prejudice to its final position. However, the Concept Paper is a clear indication of the evolving thinking of the Commission in these areas. In particular, the Concept Paper contains two clear messages:

• Despite the outcome of last year's consultation and the apparent weight of opinion in the European Parliament, the Commission is not minded to remove substantive investment protections or investor-state arbitration from the TTIP.
• The Commission envisages major changes in the future for ISDS which, if adopted in the TTIP and accepted more broadly in other free trade and investment agreements, would have significant implications for the way in which investors are able to protect their investments and resolve disputes with host states.

Summary of Commission's Proposals:

Right to regulate:

• A provision enshrining the right of states to take measures to achieve legitimate public policy objectives, "on the basis of the level of protection that they deem appropriate" (i.e. an article addressing the right to regulate)

Arbitral tribunals and legitimacy:

• Arbitrators on investment tribunals established under the TTIP to be chosen from a pre-established roster agreed by the parties to the TTIP
• Arbitrators to have certain qualifications (including qualification to hold judicial office in their home state) and expert knowledge on how to apply international law
• A right to intervene for third parties with a direct and existing interest in the outcome of a dispute

Appellate mechanism:

• A bilateral appellate mechanism for ISDS modelled on the institutional set-up of the WTO Appellate Body, with 7 permanent members, to review awards as regards errors of law and manifest errors in the assessment of facts (including incorrect factual treatment of domestic law)
• To be included in TTIP and future trade and investment agreements made by the EU

Relationship between ISDS and Domestic Courts:

• Prohibit parallel proceedings
• Include a fork in the road provision, or a "no u-turn" provision, or both, to make sure that investors make a definitive choice between ISDS and domestic court proceedings
• Clarify the relevance of domestic law - i.e. that domestic law can be taken into account by ISDS tribunals only as a factual matter and any interpretations are not binding on domestic courts

Build a multilateral system:

• An appellate mechanism with tenured judges to apply to multiple agreements and between different third parties
• Pursue the creation of a single permanent court, either as a self-standing international body or embedded in an existing multilateral body

Some brief comments on the Concept Paper

Some of the issues dealt with in the Concept Paper are not new: for example, the Commission already made clear in its original consultation that it favoured the inclusion of an appellate mechanism in the TTIP, although it has elaborated on this in the Concept Paper, including further detail on what the mechanism may look like.

However, the Concept Paper includes a number of more radical proposals as to reform of the ISDS system in the TTIP and beyond. It bases these on certain fundamental assumptions about the investment protection system and ISDS, which themselves bear further scrutiny.

(i)                 Does the right to regulate need additional protection? How would tribunals balance the right to regulate and, for example, the Fair and Equitable Treatment standard?  

A frequent criticism made of the current ISDS system is that it threatens the ability of states to legislate to achieve legitimate public policy objectives. The Concept Paper proceeds from the premise that the decided cases under existing BITs and MITs suggest that the international law right of governments to regulate is not adequately upheld by ISDS tribunals, whose broad interpretation of the substantive protections in investment treaties undermines that right.   The Commission has drawn attention to the Micula case, as being an example of where it considers a tribunal has wrongfully upheld the investor's claim to breach of the fair and equitable treatment (FET) standard, in the face of EU law prohibiting state aid.

To the extent that the Commission considers that right to regulate should be elevated in the TTIP, it makes sense to include it in the body of the treaty (rather than in the preamble as previously suggested by the Commission and as has been done in the CETA).

However, key issues are (i) whether the EU intends to enshrine in the TTIP the international law standard right to regulate or something broader; and (ii) what further clarification will be included as to how conflicts should be resolved between investment protections and the regulatory interests of states. It is not yet clear how an express right to regulate would be interpreted by tribunals (in the short term) and potentially by an investment court (in the longer term) and balanced with, in particular, the right afforded to the investor to receive fair and equitable treatment. Indeed, inclusion of an express right to regulate in the TTIP may not make much difference to how tribunals assess whether there has been a breach of the standard, as they may draw on the aspects historically considered in assessing whether or not there has been a breach  – for example, by considering whether the state's action was proportionate in the context of the public policy objectives it was purporting to achieve.

A more detailed elucidation of the relationship between the right to regulate and the substantive protections offered to investors may be welcomed by the US. Whilst historically, BITs entered into by EU Member States have been very short documents, with little in the way of detailed explanation as to the scope of the protections granted, the US approach demonstrated by the 2012 US Model BIT is to include extensive statements and clarifications as to the scope of the substantive protections.

(ii)               What are the concerns over the current system of party nomination of arbitrators? Would the Commission's proposal for a Code of Conduct address perceived problems with arbitrators?

Implicit in the Commission's proposal that parties to a dispute will select arbitrators from rosters pre-established by the parties to the agreement, is the suggestion that the current system of party nomination (i.e. nomination of one arbitrator each by the investor and the state) is flawed. This bears further scrutiny. The current system of party nomination of arbitrators is accepted across the commercial world as a fair and equal basis for settlement of disputes – should it be different for investor-state cases? One criticism of the current system, acknowledged by the Commission, is that it does not preclude the same individuals who act as arbitrators from acting as counsel in other ISDS cases. It is not clear, however, that the Commission's proposal would change the status quo or that it would be beneficial to states or investors if it did. Some of the most experienced public international lawyers are appointed as arbitrators and advise as counsel in investor-state disputes. It is likely that, not only would the parties to the TTIP want to benefit from this experience and expertise on the pre-established roster, but that some (albeit not all) of the most experienced arbitrators would not be willing to join the roster if it precluded them from advising on other investor-state disputes (or, for example, acting as counsel on state to state disputes).

Of course, potential conflict issues are raised by an individual acting as an arbitrator on one case and as counsel in another. These concerns are generally self-regulated through the broad acceptance of codes and guidelines, such as the IBA Guidelines on Conflicts of Interest in International Arbitration and the IBA Guidelines on Party Representation in International Arbitration, as well as adherence to domestic professional and regulatory obligations applicable to the legal profession. The Commission had initially proposed including in TTIP a code of conduct for arbitrators which would bind those who are appointed to tribunals in investor-state disputes (as it has included in the CETA). Few arbitrators would complain about adhering to such a code providing that it offered clear guidance to those seeking to rely upon and apply it. It is not explained in the Concept Paper why any perceived concern about arbitrator conduct and conflict would not be resolved by the Commission's earlier proposals.

Also included in the Commission's commentary is the suggestion that arbitrators appointed in investor-state arbitrations (either by the parties or by the institution) may lack sufficient expertise in international law. Again, it is not clear what evidence supports this proposition. The vast majority of the approximately 300 decided cases under investment treaties have been decided by arbitrators with considerable international law expertise.

(iii)             Towards an international investment court

Perhaps the most radical of the Commission's proposals is to suggest the creation of a permanent investment court, with tenured judges, to apply to agreements between different trading partners on the basis of an opt-in system. This proposal is embryonic: the costs and functioning of the court have not been explored, and the relationship between the permanent court and other institutions such as ICSID is not explained. But this would certainly constitute a dramatic change to the current ISDS system, if it were to be embraced by the negotiators going forward.

Do the Commission's proposals offer any positives for investors between the US and EU?

What both investors and states need from the investment chapter in the TTIP is clarity. For example, the suggestion that the international law right of governments to regulate should be codified in the body of the treaty is not problematic in itself. However, everything will turn on the detail – and broad or subjective language which leaves doubt as to how a tribunal (howsoever composed) should interpret the right as against the investor's right to receive fair and equitable treatment will fuel uncertainty and potentially inconsistent decision-making.

It also cannot be ignored that the US will also have its own negotiating aims for the investment chapter of the TTIP, no doubt informed by the 2012 US Model BIT (which itself was the product of several years of consultation with a broad spectrum of stakeholders). Since the TTIP seems likely to provide a blueprint for the future in terms of both substantive protections and investor-state dispute resolution mechanisms, the US will clearly be considering the implications of TTIP for its developing trade and investment relationships with other states, most notably China.

For more information, please contact Andrew Cannon, Partner, or Hannah Ambrose, Professional Support Consultant, or your usual Herbert Smith Freehills contact.