UPDATES ON POTENTIAL EU-CHINA COMPREHENSIVE AGREEMENT ON INVESTMENT (WITH A FOCUS ON INVESTMENT PROTECTION AND ISDS) – NEW WINE IN NEW BOTTLES?

On 30 December 2020, the European Union and China announced their Agreement in Principle for the EU-China Comprehensive Agreement on Investment (CAI). This is a landmark development for both parties in these long-running negotiations which began in 2012. On 22 January 2021, in the interest of transparency, Brussels published certain draft sections (here) of the CAI that are still under negotiation between China and the EU (Draft CAI). The Draft CAI provides helpful insight into how the final legal text of the treaty may look. Following the relevant procedure, the CAI will now need to be further negotiated and finalised between the parties, before the Chinese government, EU Council and European Parliament can approve it.

There has been considerable media focus on the market access commitments in the deal, and the stated ambitions of both parties in upholding standards relating to labour, the environment and sustainability. This note focuses on the dispute resolution provisions. Inevitably, there is a considerable degree of uncertainty as to how the final dispute resolution and investment protection mechanisms will look. However, the Agreement in Principle and sections of the Draft CAI reveal the direction of travel in these areas.

At a high level, both sides appear to have agreed to adopt some of the key features of recent EU investment treaties, so far as State-State dispute resolution is concerned. However, it seems likely that a treaty on investor protection and investor-State dispute settlement (ISDS) will be agreed separately at a later stage. In this regard, the EU seems to be pushing for formalised dispute resolution institutions, in line with its wider efforts to establish a Multilateral Investment Court. How China will respond to this initiative remains to be seen, but it seems likely that any new agreement once in force will replace the bilateral investment treaties (BIT) between China and various EU member States.

State-State Disputes

Section V of the Draft CAI sets out State- State dispute resolution mechanisms to resolve “any dispute concerning the interpretation and application of the provisions” of the CAI. They would be used between China and the EU to enforce commitments under the CAI, such as market access or countering climate change.

These draft articles are very similar to the WTO rules and to the State-State dispute settlements in other agreements reached by the EU with Singapore, Vietnam and Canada and the UK over recent years. They also reflect the key principles applicable to the State-to-State dispute settlement disclosed in the Agreement in Principle. These principles include:

• “An effective, efficient and transparent mechanism for avoiding and settling disputes between the Parties in relation to violation complaints.
• A two steps approach based on consultations (and the possibility of mediation) to try to reach a mutually agreed solution and, in the absence of a solution, the recourse to an arbitration panel procedure.
• Specific rules for the establishment and composition of the arbitration panel, including requirements for highly qualified, experienced and independent panellists subject to high ethical standards.
• Streamlined and clearly defined compliance and post-compliance stages of the proceedings (including retaliation).
• Rules of Procedure for the Panel, which contain detailed rules on the panel proceedings and an elaborated Code of Conduct for the panellists (under discussions) in order to ensure their full independence and impartiality.”

Notable details in Section V of the Draft CAI include:

• A mandatory process of consultation within a defined period of time before any party is able to commence arbitration. Parties may at any time attempt to settle the disputes by mediation, although the use of mediation is entirely voluntary.
• Where arbitration is commenced, the arbitration panel shall be composed of three members. Parties shall endeavour to agree on all three. If such an agreement cannot be reached, the arbitrators will be picked from individuals contained in three sub-lists.
• Consistent with the EU’s recent treaties, the Draft CAI also contains compliance review procedures and provision for countermeasures to ensure compliance with the decision of the panel.
• The draft Rules of Procedure for the Panel have been published as Annex I of Section V. They cover a wide range of matters from commencement of arbitration to the costs of the proceedings. This marks a move towards “institutionalising” the procedure for State-State arbitration. It stands in contrast with China’s past bilateral treaties with various EU member States (where applicable). The China-Germany BIT for instance, does not contain any agreed procedural rules, stating instead that the arbitral tribunal shall determine its own procedure.
• The negotiations around the Code of Conduct for the arbitrators are on-going, although the EU has promised to publish a draft in February 2021. The EU has previously made a number of proposals of this kind in other fora and this is an important area to watch.

Investor-State Dispute Settlement

The Draft CAI contains no ISDS provisions. Instead, in the Agreement in Principle, there is an expression of commitment by both parties to seek to reach agreement on this topic in future. The Agreement in Principle states that:

“The package deal reached today includes a commitment by both sides to try to complete negotiations on investment protection and investment dispute settlement within 2 years of the signature of the CAI. The common objective is to work towards modernised protection standards and a dispute settlement that takes into account the work undertaken in the context of UNCITRAL on a Multilateral Investment Court. The EU's objective remains to modernise and replace the existing Member States' Bilateral Investment Treaties with China.” (emphasis added)

Substantive investment protection standards

There are currently 25 BITs between China and EU member States, each of which contains varying degrees of investment protection. As the Agreement in Principle suggests, standardising the level of protection will be a focus of negotiation for both the EU and China. It will be interesting to see how the objective to “modernise” the investment protection levels and replace existing BITs will be interpreted by each side. Many of the BITs between China and the EU member States are decades old and are based on an assumption that investment flows were from the EU into China rather than vice versa.

The Draft CAI has revealed some interesting evidence as to what the parties consider to be the “modernised standards of protection” that, according to the Agreement in Principle, may be reflected in a future investment protection treaty. This includes:

• National Treatment - National treatment for foreign investors has been an issue of focus in these negotiations. Draft article 4 of Section II (Investment liberalisation) now provides that “[e]ach Party shall accord to investors of the other Party and to covered enterprises treatment no less favourable than the treatment it accords, in like situations, to its own investors and to their enterprises, with respect to establishment and operation in its territory”. This is a significant development, particularly given that many of the older BITs between China and EU member States do not contain provisions concerning post-establishment national treatment. This shift should be read in conjunction with recent developments in Chinese domestic legislation. For instance, the Chinese Foreign Investment Law (CFIL), which came into force in early 2020, has established a nationwide "pre-establishment national treatment and negative list" management system. The implementing regulation to the CFIL also requires national treatment for enterprises with foreign investors in many important areas.
• Most Favoured Nation Treatment - Draft article 5 of Section II lays down the principle of most favoured nation treatment, with a clear exclusion to its application in ISDS procedural or jurisdictional issues.
• Right to Regulate - The inclusion of a detailed section entitled “Regulatory Framework” at Section III of the Draft CAI suggests that the parties may seek to agree provisions which aim to protect States’ so-called “right to regulate”, for example in relation to environmental or social matters.

ISDS Mechanism

The Agreement in Principle indicates that the EU and China have reached a consensus that the investor-State dispute resolution process that results from any final agreement on investment protection should “tak[e] into account” the work undertaken by UNCITRAL on a Multilateral Investment Court.

UNCITRAL’s Working Group III has been mandated to consider reforms to existing ISDS frameworks and practices since 2017. One potential direction of reform, supported by the EU, is to establish a permanent Multilateral Investment Court to replace the current ISDS provisions set out in various individual BITs or other treaties or chapters containing investment protections. The EU has negotiated modernised dispute settlement mechanisms in its most recent investment protection treaties (Canada, Singapore and Vietnam), with the traditional ISDS model of investor-State arbitration being replaced by a new two-instance investment court system, with agreement in those treaties to work towards the use of a multilateral investment court in future.

Chinese support for a permanent Multilateral Investment Court has historically been relatively limited. China supports the idea of a permanent appeal body within the wider ISDS mechanism, but has so far not indicated support for the EU’s proposal to establish a first instance multilateral court. Further, when it comes to the appointment of the tribunal, the EU advocates for “a standing mechanism with the same body of adjudicators appointed for long and staggered (i.e. their terms of office do not expire at the same time) terms” who will form panels for individual cases on a randomised basis. China in contrast, takes the more traditional position, emphasising party autonomy in selecting and nominating arbitrators, at least at a first instance level.

There appear to be some other areas of agreement or potential convergence. For example, both China and the EU seem to share the objective of strengthening ethical rules to avoid conflicts of interest for arbitrators. China has also proposed the inclusion of alternative dispute resolution provisions, and suggests that the establishment of a more effective investment conciliation mechanism be actively explored. The EU also proposes increased institutional support for the conciliation and mediation of investment disputes.

For more information on the EU’s approach to its recent treaty negotiations and its proposals for an Investment Court system, please see our earlier blog posts here and here.

Conclusion

Investment protection and dispute resolution mechanisms in the upcoming CAI and its Agreement in Principle may not yet have been subject to the same degree of media attention as some of the other topical issues the CAI has raised. However, these remain critical aspects of the treaty between two of the world’s largest economies. The Draft CAI has drawn a relatively clear picture on State-State dispute resolution. The Agreement in Principle and certain articles of the Draft CAI also offer some guidance to the positions both sides are likely to take in their negotiations about investment protection and ISDS. The modernisation of investment protections and the move towards a multilateral investment court seem, for the EU at least, to be front and centre of that agenda.

For more information, please contact Andrew Cannon, Partner, Antony Crockett, Senior Consultant, Peter Chen, Associate, or your usual Herbert Smith Freehills contact.