25 May 2017
One Belt One Road: Protecting your investment on China's new pan-continental superhighway
By King & Wood Mallesons
China’s One Belt One Road policy represents a renewed and strengthened push to connect Chinese investors with investment opportunities along the historical Silk Road trade route and a new maritime route. Whilst the increased investment by China along this route presents clear opportunities for domestic Chinese companies and their OBOR investment counter-parties the road is likely to be a bumpy one.
Challenges will be as diverse as the OBOR countries themselves which range from Singapore to Syria and contain significant divergences in operational and investment risks. However, a web of investment treaty protections overlay the route and provide a crucial means of reducing the risks involved in investment. We set out in this article the policy details, investment protections and detail some of the key considerations for OBOR investors.
Section 1 – Journeying along the bumpy OBOR superhighway
The OBOR policy, which was unveiled by Chinese leader Xi Jinping in late 2013 focuses on economic connectivity and cooperation along a pan-continental superhighway encompassing a land-based “Silk Road Economic Belt” and an ocean going “Maritime Silk Road”. The initiative promises to deepen an already active Chinese involvement in developed economies in South-East Asia on this route as well as opening up new investment in developing economies in Central and Western Asia and Africa. To stimulate this investment, the Chinese Government has pledged a sizeable amount of its own sovereign wealth including:
- USD 40 billion to establish a Silk Road Fund to focus mainly in infrastructure and resources, as well as in industrial and financial cooperation between the countries along the OBOR route; and
- USD 50 billion to a new Asian Infrastructure Investment Bank (the “AIIB”) which, as the name suggests, is to act as a regional fund for infrastructure projects across its now 57 members in the Asian region.
It is expected that the bulk of the funds in the Silk Road Fund and the AIIB will be spent on infrastructure, construction and energy and resources projects which will take OBOR investors along a sometimes bumpy route. Whilst the OBOR route may begin in more traditional and developed “Chinese Commonwealth” trading partners in Asia it continues through less traditional, Central and Western Asian nations such as Afghanistan, Armenia, Kazakhstan, Turkmenistan and Georgia as well as African and European nations.
Many of these countries will prove difficult territory for investors to navigate through and will pose serious operational risks. Afghanistan, Iraq and Syria continue to be beset by conflicts; Central Asian nations such as Uzbekistan and Kazakhstan contain potential political and economic risks; whereas OBOR countries from Africa and parts of Asia, continue to suffer from undeveloped legal and operational infrastructures and a lack of funding. These risks and the other legal, regulatory and sovereign risks in the countries through which the route passes militate careful planning by OBOR investors journeying along this highway.
Aside from the usual awareness of risk and prudent contracting and investment structuring, Chinese investors and their contracting partners on the OBOR route should also be aware of their rights under the web of investment treaties covering the route.
Section 2 – Investigating investor protections covering the OBOR route
More than 50 separate bilateral investment treaties (“BITs”) and several multilateral investment treaties (“MITs”) criss-cross the OBOR superhighway and provide a robust source of potential investor protections. Such protections, however, must be understood and carefully planned for by OBOR investors.
BITs and MITs are agreements between countries encouraging investment and setting out the protections each will afford each other and their investors. With the inclusion of Investor State Dispute Settlement (“ISDS”) mechanisms in these investment treaties, corporate and individual investors may be able to bring claims against OBOR governments for breaches of the substantive investor rights set out in those treaties without recourse to the host state’s domestic legal system. The independence of this process from domestic legal systems means that MIT and BIT protections are a crucial bulwark against the political and legal risks that OBOR investors are likely to face.
Arbitration mechanisms, whether under contract or treaty, are powerful rights for OBOR investors because they permit investors to enforce their rights without reliance on local procedures or diplomatic means. Notably, the usual dispute resolution method under Chinese BITs and MITs, ICSID arbitration, allows investors to rely on simplified enforcement mechanisms under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the “Washington Convention”). Host states that are party to the Washington Convention are required to enforce arbitral awards made under that Convention, making enforcement of awards an international law obligation. 55 countries along the OBOR route are party to the Washington Convention and voluntary compliance is the norm, although not always the rule.
Nevertheless, concerns surrounding reputation and creditworthiness are likely to continue to encourage OBOR governments’ compliance with enforcement.
What kind of investment protections are offered under investment treaties?
Typically, the protections offered in MITs are similar to the protections offered in BITs. The scope of guaranteed protection offered by each treaty will be set by the wording of a particular treaty. Common forms of guaranteed protection include:
- compensation for expropriation or nationalization of investor’s assets by a state. Typically, this guarantee covers both direct and indirect expropriation, and additionally prohibits expropriation unless it is for a public purpose;
- fair and equitable treatment, as well as protection and security afforded to investments. Clauses setting out these protections are designed to create a standard of treatment independent of the standard of treatment afforded to domestic investments which can vary dramatically from state to state; and
- treatment of foreign investments in a manner no less favourable than that provided to domestic investments.
Even though the scope of guaranteed protections offered under each treaty is set by the wording of that particular treaty, investment treaties often also contain a Most Favoured Nation (“MFN”) clause. MFN clauses allow investments covered by a particular treaty to be afforded the same treatment that the host state would give to any other third state’s investments. This allows an OBOR investor to rely on guaranteed protections set out not only in treaties to which China and the OBOR countries are parties but potentially also any other, better substantive protections that any third party country enjoys under its treaty with the OBOR investment host state in which the investor is investing.
How to make use of investment treaties?
In order to fall within the scope of a particular treaty, the investment needs to fall within the definition of ‘investment’ under that treaty. Typically, the definition of ‘investment’ under treaties is broad and non-exhaustive, in the hopes of capturing evolving types of investments. The broad definition is often followed by a list of non-exhaustive examples such as tangible and intangible property, capital investments in local ventures (regardless of form through which they are invested), financing obligations, infrastructure contracts, etc. Often, the definition of ‘investment’ encapsulates not only the primary investment, but also its collateral elements such as loans – which may themselves be considered distinct investments. While treaty definitions of investment are often broad, each treaty may also set out requirements that an investment must comply with in order to be afforded protection under the treaty, for example: compliance with national law. The definition of investment has been subject to significant arbitral scrutiny: tribunals have found that in order to be considered an investment, the investment must assume risk and make contributions to the state, and contain a certain degree of longevity.
Depending on the scope of application of the treaty, it is possible that guaranteed protections in treaties which did not exist at the time of investment may nonetheless apply to those investments. Typically, guaranteed protections survive for a certain period of time after termination of a treaty.
It is also necessary that investors are viewed as such for the purposes of the treaty. Typically, natural and legal persons must be nationals of a contracting state in order to rely on benefits set out in a treaty, but such persons cannot be nationals of the host state. Often, the question of nationality of the investor is difficult to answer when complex holding structures are used to invest. Under some treaties, place of incorporation is relevant whereas under other treaties, the place from which substantial control of the investments is directed determines who the investor is, and accordingly what is the investor’s nationality.
OBOR investors therefore need to be aware not only of the existence of BIT/MIT rights but the impact that structuring an investment on the OBOR route can have on the protections available to them.
Section 3 –MIT/BIT planning on the OBOR route
1. Know your treaty rights: forewarned is forearmed on the OBOR superhighway and OBOR investors should carefully check the BITs and MITs between China and the OBOR country where an investment is being made and their specific provisions. OBOR investors should also check that any treaties are still in force and verify the OBOR country’s history in dealing with ISDS claims.
For example, although a Chinese company seeking to benefit from OBOR investment might consider taking advantage of the China-Jordan BIT, which incorporates a fair and equitable treatment and no expropriation without due compensation clauses, as of the date of writing that treaty is not in force. OBOR investors from Chinese Special Administrative Regions, Hong Kong and Macau should take care to ensure that their residency in an SAR qualifies them as a “national” of China for the purposes of any treaty. Although a Hong Kong investor has already successfully brought a case before ICSID as a Chinese “national” on the basis of the China-Peru BIT some treaties expressly exclude the SAR territories from treaty definitions.
Finally, careful attention should be paid to an OBOR government’s attitudes to ISDS: an OBOR investor in Poland would be prudent to take heed of its government’s recent pronouncement that it is considering cancelling all of its BITs and an OBOR investor in Russia might consider the fraught recent history Russia has had with enforcing treaty claims against it.
2. Contracting for treaty rights: to the extent possible, drafting of contracts governing the investment should: (i) set out the parties’ intention that OBOR investors and their investment vehicles are understood to be “nationals” for the purpose of the relevant treaties which apply; (ii) make it clear that the investment itself is agreed to be an “investment” for the purposes of the contract. Similarly, where contracting or dealing directly with OBOR governments, ISDS clauses of relevant BITs and MITs should additionally be incorporated into contracts to ensure that the host state is contractually obliged to comply with any specific treaty obligations.
3. Consider structuring an investment to take advantage of OBOR ISDS: OBOR investors should consider structuring or restructuring their investments to ensure that they qualify for ISDS protections. When structuring investments, parties ought to give similar weight to considerations regarding ISDS and falling within the scope of investment treaty protections, as they do to the usual tax, funding and corporate governance considerations.
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