- Investment — Debts — Loans — Investor
All international investment treaties focus on two subjects: (1) investments, particularly international or ‘foreign investments’; and (2) investors, especially international or ‘foreign investors’. An understanding of both of these phenomena is fundamental to understanding the growing role and significance of investment treaties in international economic life. The purpose of this chapter is to explain the nature and significance of international investments and investors.
The meaning of the term ‘investment’ at its most basic level is the commitment of resources by a physical or legal person to a specific purpose in order to earn a profit or to gain a return. Etymologically, the word ‘invest’ is derived from the Latin investire, which means ‘to clothe’.1 An investor is in effect ‘clothing’ an enterprise with capital through the process of investment. In economic terms, investment, a form of savings, is the opposite of consumption. Investment is fundamental to economic growth and to the provision of needed goods and services in any society.
The term ‘investment’ is generally used in two senses. One sense is the process by which a person or legal entity makes an investment. Thus, the act of purchasing a hundred shares of stock on an exchange or buying a shop in which to sell goods is an investment. The second meaning refers to the asset acquired as a result of investing. Thus, the shares purchased by the shareholder and the shop acquired by the shopkeeper are both considered investments. Discussions of investment and foreign investment sometimes emphasize its process dimensions (p. 27) and sometimes its asset dimensions.2 As we shall see, the term ‘investment’ is a basic concept used in any investment treaty, and it is therefore important to understand its ramifications. Most such treaties, as shown in Chapter 7, adopt an asset-based, rather than a process-based, definition of investment. It is also important to recognize at the outset that lawyers, arbitrators, economists, financiers, and business executives may define investment in different ways. As a result, a transaction that an entrepreneur may consider as an ‘investment’ may not qualify as such under relevant legislation or treaties. For example, in one case that arose in Congo in 1999, the country’s armed forces closed down a thriving law firm established by an American in Kinshasa, thereby effecting a total deprivation of the American’s enterprise. When the American lawyer sought to bring a claim against the Congolese government before an international tribunal under the United States–Congo BIT, the arbitrators rejected his claim on the grounds that his firm did not constitute an ‘investment’ under the treaty.3
Investments can take many forms. Indeed, the great diversity of individual investment forms seems to be limited only by the creativity of investors seeking to meet their interests and those of the enterprise in which they are investing. As a result, new types and forms of investments are continually developing to meet new economic situations and achieve evolving financial objectives. An understanding of these diverse forms is important because the form an investment takes may influence the legal rights to which it and the investor are entitled under domestic legislation and international treaties. Three attributes of any investment form are particularly important: (1) the property and contractual rights resulting from the investment; (2) the control attributes of the investment; and (3) the enterprise form in which the investment is made.
References(p. 28) (a) Property and contractual rights resulting from investments
Legally, when an investor makes an investment in an enterprise, the investor gains certain specified property and contractual rights in the investment as a result. Generally speaking, an investor’s rights with respect to an investment fall into two basic categories: equity or debt. An equity investment, like shares of stock in a company or a fixed asset like a shop, gives the investor an ownership interest. As an ownership interest, equity in company shares or a fixed asset entitles the investor to share in the profits (if any) of the enterprise, to participate to a greater or lesser extent in its management, and to hold that property interest until that investor transfers its interest to another person. On the other hand, an investment in the form of debt, like a loan or a bond, gives the investor a claim to be repaid, entitles the investor to fixed payments of principal and interest at specified times according to the investment agreement, and normally provides for a maturity date on which the investor’s claim will end. In most legal systems, debt has priority over equity in the event of the enterprise’s bankruptcy and liquidation, which means that holders of debt are paid before holders of equity from whatever enterprise assets remain.
Whether an investment in a given enterprise takes the form of debt or equity and the specific nature of the rights and liabilities attached to a particular equity or debt investment will depend on a host of variables. These include the prevailing law, projected interest rates, the financial goals and intentions of the parties involved in the enterprise, evaluations of the risks to be encountered, the projected revenues of the enterprise, and many other factors. In most instances, investments in specific enterprises will consist of a mixture of equity and debt, and that mixture is referred to by financial analysts as the enterprise’s capital structure.4
An important element of the capital structure of any enterprise is its debt-to-equity ratio. In many investment projects, the amount of debt invested may far exceed the amount of equity. For instance, in 1995 the capital structure of the first phase of the Dabhol Power Company, then the largest foreign investment undertaken in India, amounted to US$932 million, which consisted of US$289 million in equity contributed by the three project partners and US$643 million in debt provided by a variety of foreign and domestic banks and financial institutions. The debt–equity ratio of the Dabhol Power Company was therefore more than 2 to 1.5
In most industries, it is generally believed that the higher the debt–equity ratio, the greater the risk faced by the enterprise. This is because the greater the amount of debt assumed by an enterprise, the greater its burden to make regular debt servicing payments to its creditors in order to meet its fixed obligation as required by its loan agreements. The failure to make such required payments because of insufficient earnings will entitle its creditors to take various legally authorized (p. 29) remedies, including forcing the enterprise into bankruptcy or some form of judicial reorganization. The precise debt–equity ratio in a specific enterprise usually depends on the relative cost of debt and equity to the investors seeking to establish the enterprise, as well as the legal or regulatory requirements of the specific industries or countries. Indeed, the usual investment to establish or rehabilitate an enterprise rarely takes the form of a contribution of equity or debt alone but often also involves a host of other complex legal arrangements, including loans (both short-term and long-term), credit arrangements to finance equipment purchases, loan guaranties, licensing agreements, management contracts, and long-term sales and supply arrangements. Moreover, in addition to the more common forms of equity and debt, there are hybrid investments, such as preferred shares and convertible debentures, which possess some of the characteristics of both debt and equity securities.6
(b) Control attributes of the investment
A second important question concerning an investment relates to the extent of the investor’s legal rights to control the underlying enterprise or assets in which the investment is made. ‘Control’ in this context means the ability of the investor to determine the actions and policies of that enterprise. An investor may have an ownership interest in an enterprise from which it gains certain financial benefits but still may not be able to control it because that ownership interest is not large enough. Thus, to take an extreme example, an investor who purchases a hundred shares of Microsoft Corporation or Barclays plc gains an equity interest in those enterprises but that interest is not large enough to allow the investor to determine the policies and actions of either company. On the other hand, if two companies form a joint venture to manufacture software and each elects members of the venture’s board of directors, they each have an equity interest that allows them to participate in the control of the enterprise. Thus, it is by having rights to select members of an enterprise’s governing board that an investor is able to influence the actions and policies of that enterprise.
Whether or not an investor has control of the enterprise in which it invests is a matter of importance both for the investor and for the government of the country in which the enterprise is located. For the investor, control not only enables the investor to determine the actions and policies of the enterprise, and therefore to pursue actions that will bring benefits to the investor, but also allows individual investors to protect themselves from the potentially negative and self-serving actions of other investors, creditors, and managers. Since governments are also concerned about the actions of enterprises taken on their territories, they too are often vitally interested in who controls those enterprises. For example, if foreign (p. 30) persons seek to buy a controlling interest in certain enterprises, local law may require prior government approval or even forbid such foreign control altogether.
The issue of enterprise control requires a second categorization of investment forms that distinguishes direct investment from portfolio investment. A direct investment establishes or purchases some form of permanent enterprise or facility, such as a factory, mine, plantation, hotel, or power station, in whose control and management the investor will participate. A portfolio investment is one which gives the investor no right to participate in the control and management of the underlying enterprise. Whether an investor has such control, and whether the investment therefore qualifies as direct or portfolio investment, will depend, of course, on the specifics of the investment. For statistical purposes, governments and international organizations classify an equity investment of 10 per cent or more as a direct investment.7 An investment that gives the investor less than a 10 per cent voting interest is considered a portfolio investment.
The International Monetary Fund distinguishes between direct and portfolio investments in similar terms. It provides that a direct investment consists of either equity capital or retained earning between ‘affiliated enterprises’. One enterprise is affiliated with another enterprise if the former has a voting interest of 10 per cent or more in the latter.8 The key difference between these two categories of investment is the right of the investor to exert control over the investment. Thus, as a general rule, a direct investment is an equity interest in an enterprise that gives the investor 10 per cent or more voting power.
(c) Enterprise form
Yet a third way of categorizing investments relates to the legal form of the enterprise in which the investment is made. An enterprise is usually enclosed within a particular legal form of enterprise organization. Here, a fundamental distinction is whether the enterprise or asset is owned directly by the investor or owned by (p. 31) a separate legal entity in which the investor has an equity interest. If the asset is owned directly by the investor, it is considered a branch of the investor. On the other hand, the asset or enterprise might be owned by a separate legal entity all of whose shares are in turn owned by the investor. In this case, the investment would take the form of a subsidiary of the investor. For example, a refrigerator manufacturer that wants to establish a factory to produce air conditioners might make the factory a branch of its existing operations or alternatively create a separate subsidiary to own the factory and produce the air conditioners. The decision on whether to make an international investment in the form of a branch or a subsidiary involves numerous factors. For example, from the point of view of the investor, a branch may make the efficient management of a foreign investment easier than would a subsidiary. On the other hand, a subsidiary in the form of a separate company or corporation enjoying limited liability will protect the parent company from liabilities incurred by the subsidiary.9 The choice of whether to make a foreign investment in the form of a branch or a subsidiary is not always a matter to be decided by the investor alone. Host country laws may require that any direct investment take the form of a subsidiary organized under and subject to host country company laws and regulations.
Whether an enterprise is a branch or a subsidiary can have significant legal consequences for the investor and the operation of the enterprise. When the enterprise has a separate entity, other investors may take part through the contribution of capital. In such cases, the investment, instead of being a wholly-owned subsidiary, will take the form of a joint venture or consortium. If the investment receives capital from numerous shareholders who do not participate actively in the business of the enterprise, the enterprise may take the form of a publicly traded corporation. Depending on the legal system of the country concerned, the law may provide a variety of enterprise forms such as a sole proprietorship, partnership, limited partnership, closely held corporation, or publicly traded corporation. Each form has different legal attributes and is subject to different legal requirements. And if a state invests in an enterprise, that enterprise may take the form of a government corporation subject to laws and rules separate from those governing private companies.
Investment treaties govern not only investments but also investors: the persons and organizations that make investments. There are many kinds and types of investors. Depending on the nature of their owners, one can divide them into four basic categories: (1) private investors; (2) state investors; (3) international organizations; and (4) mixed enterprises.
The first category consists of private investors, physical and legal persons who are not part of any government or state apparatus. Among private investors, the most important are those that take the form of corporations or companies.
It has been said that ‘[t]he most important organization in the world is the company: the basis of the prosperity in the West and the best hope for the rest of the world’.10 Companies and corporations are the world’s most significant depositories of assets and technology and a primary force for wealth creation and allocation. Although companies and corporations are generally created under the domestic law of a particular country,11 they share many common features and have all been designed to encourage investment. For example:
1. Companies and corporations are legal entities that exist separate and distinct from their investors and shareholders. Thus, they are said to have ‘legal personality’. As a result, they may hold, acquire, and transfer property in their own names, make contracts, sue and be sued in their individual capacity, and engage in legal transactions just as physical persons can.
2. Shareholders in companies and corporations enjoy ‘limited liability’. That is, they are not liable for the debts and obligations of the company in which they have invested—a factor that encourages investment by reducing investor risk. Since investors in the shares of corporations risk only their initial investment and are not personally liable for the debts and obligations incurred by the corporation itself, they are generally more willing to make investments than they would be if they were liable for such corporate obligations as well.
3. As entities existing apart from their investors, companies and corporations usually have an unlimited life under most domestic legal systems. This factor gives stability to enterprises in corporate form, since their existence is unaffected by the entry and departure of individual managers or investors.
4. The corporate structure allows centralized control and management by a few managers of the assets and operations of potentially diverse, vast, and widely dispersed enterprises. A company’s usual organizational structure provides that the shareholders, based on the voting rights of the shares they own, elect a board of directors that is legally responsible for the management of the company. This structure facilitates the development of easily controlled groups of corporations, often located in many different countries. Indeed the much discussed ‘multinational corporation’ is legally not a single References(p. 33) corporation but many corporations and companies linked together by share ownership and contractual rights.
5. The domestic law of the country concerned usually allows ownership interest in the form of shares of stock to be transferred from one investor to another without affecting the legal structure of the underlying enterprise. This factor encourages investment by giving liquidity to investments in companies and allows for the easy entry and exit of shareholders.
The vast majority of the world’s corporations are private corporations, since their ownership and control are in the hands of private individuals and organizations. Nevertheless, they are each creatures of national law and are subject to the differing laws and regulations of the countries of their creation and their operation.
(b) State investors
A second large and important category of investors consists of governments and governmental entities, known variously as ‘state-owned enterprises’ (SOEs), ‘government corporations’, or ‘state-controlled entities’ (SCEs). Virtually all governments, to a greater or lesser extent, invest in enterprises designed to provide services or goods to the inhabitants of their countries. Thus, states may establish corporations to provide air and maritime transportation, telecommunications, mining, and steel production, to mention just a few. Such state entities are usually subject to a separate legal regime that is distinct from that governing private companies and corporations. Traditionally, governments created them to serve the local economy; however, more recently they have begun to act as significant international investors.
State entities may choose to invest at home or abroad for myriad financial or political reasons. The extent to which a government becomes an investor depends on a variety of factors, including the existence or lack of private investors in a particular economic field or sector, the quality and cost of needed goods and services provided by such private enterprise, the existing political situation, and the prevailing ideology in that country. Indeed, in many countries whether private enterprise or government should invest in a particular economic sector is an important public policy question having strong ideological and political implications. For instance, since 2004, China’s strategy of state intervention through private investment in Africa has raised questions over the geopolitical impact of the scale of such investments.12
The question of who invests in what is not a purely economic one. The identity of who owns and controls a country’s enterprises has important political implications because assets and enterprises endow their owners with political power. As (p. 34) a result, the subject of investment by foreigners, as will be seen, has significant ideological and political overtones in most countries.
The prevailing ideology in a country may significantly influence the respective roles accorded to private and state investors. For example, countries with a strong socialist orientation may choose to reserve to the state important areas of economic activity, such as the production of electricity, the provision of air and land transportation, and the pursuit of mineral development, and to exclude private enterprise from these economic sectors. A government’s nationalist ideology may exclude foreigners from investing in economic sectors considered vital to preserving a country’s sovereignty, economic independence, or national security. One of the consequences of the end of communism in eastern Europe and the former Soviet Union and the elimination of socialism in many other countries was ‘privatization’, or the transfer of state enterprises and assets to private hands and the reduction of barriers to private investment throughout the economy.13
Today, despite the end of communism and the widespread and massive privatization of state assets throughout the world, governments remain important investors both domestically and internationally and often prohibit private investment in specific sectors and industries. In the field of international investment, one may distinguish between state-owned multinational corporations whose purpose is to undertake and conduct business activities in specific economic sectors, usually through direct foreign investments, and sovereign wealth funds (SWFs) whose purpose is to invest a state’s monetary reserves in order to gain a return to finance state activities, often through portfolio investments.
(c) International organizations
A third important category of investors consists of international institutions and organizations created and owned by states. These international institutions and organizations have international legal personalities and are subject to international law, primarily the treaties that created them. The World Bank, its affiliates (such as the International Finance Corporation), and regional development banks (such as the Asian Development Bank and the InterAmerican Development Bank) are all international institutions whose purpose is to invest funds secured from states and from private capital markets in order to promote economic development.14 (p. 35) They invest billions of dollars each year through both loans and equity participations in order simultaneously to support economic development and earn a return on their invested capital. One distinguishing characteristic of loans from international organizations is that they often impose severe conditions on the governmental policies of debtor countries, a process known as ‘conditionality’.15
(d) Mixed enterprises
Frequently, the various types of investors mentioned earlier invest together in particular enterprises. For example, it is common for private companies to form joint ventures with state corporations to undertake productive enterprises, such as the manufacture of machines or the operation of an airline. In some countries, such mixed enterprises may be subject to a distinct legal regime. Often, an international organization such as the World Bank or the International Finance Corporation is included as a party. Thus, a large infrastructure project such as an electrical generation and transmission system or a telecommunications network may involve a state corporation, a private company, and an international organization as investors within a single legal entity.
With the possible exception of certain subsidized government enterprises, investors are concerned primarily about two factors in making and managing their investments: return and risk. Indeed, one can say that return and risk are the driving factors behind all investment decisions. The reason investors invest is to gain a return, to make a profit. The ways in which an investor will gain a return from a particular investment will depend on the nature of the enterprise and the investment made in it. Investors may gain a return through sharing in the profits of the enterprise, through the receipt of interest paid on debt obligations, through capital gains made on the sale of an investment to a third party, as well as by a variety of other transactions, such as technology transfers and management contracts, associated with the investment.
At the same time, all investors are also concerned about the risks affecting their proposed investments. One may define risk as the probability that expected returns from an investment will not be realized. Investors evaluate potential investments not in terms of the absolute returns to be expected from a particular investment but on the basis of the expected returns measured against the projected levels of risk. In the calculation of most investors, a greater risk requires a higher rate of return to justify an investment.
(p. 36) Investors analyse risk in various ways, but a basic distinction made by most investors is between commercial risk and political risk. Commercial risks are those possible negative effects derived from ordinary commercial activities affecting the enterprise. For example, market sales may be less than expected, management may be inefficient, or the enterprise’s technology may prove more costly or less effective than planned. Political risks are negative events that derive from political actions, such as the expropriation of an enterprise by the government, the establishment of price controls by a regulatory authority, or riots that damage investment assets. A fundamental purpose of investment treaties is to provide foreign investors and their investments with a level of protection against political risk.
All investors, private, state, and international, seek to structure and operate their investments in ways that will enhance their returns and minimize their risks. To achieve this result, they use a variety of devices, including contracts, legislative provisions, and, as will be seen later in this volume, international treaties. From the point of view of the investor, the primary utility of an investment treaty is that it reduces the political risks of investing in a foreign country. Similarly, countries and communities seeking to attract or encourage investment will try to find ways to increase returns to potential investors, perhaps by building roads or granting tax exemptions, or to reduce risk, possibly by lessening governmental corruption or guaranteeing to purchase the product produced by the investment. In general, actions that increase return or reduce risk encourage investment. Conversely, actions that threaten returns or increase risk discourage investment. Thus, from the point of view of many states, a primary utility of an investment treaty is to promote investment from another signatory country. Reflecting these two goals, the title of most investment treaties states that they are ‘agreements to protect and promote investment’.
Historically, investors and entrepreneurs have sought economic gain not only in their home countries but in other countries as well. Originally, the primary mechanism for seeking such gains was through foreign trade. Trade eventually led to early forms of international investment. Indeed, such international investment was originally focused on financing trade with other countries. Thus, for example, during the Renaissance, individual merchants formed limited partnerships or commenda with a ship’s owners or sea captains to finance the shipment of goods or trade in goods with other countries.16 Later, in connection with trade, merchants might acquire buildings or property within foreign countries to create trading establishments. For example, in AD 991, the Byzantine Emperors Basil II and Constantine VIII, in a document known in Latin as a chrysobul, granted (p. 37) the merchants of Venice the right to trade in the ports and other places of the Byzantine Empire without paying customs duties, as well as the right to a quarter in Constantinople, known as an embolum, for dwelling and trading.17 The acquisition and development of such a trading and dwelling quarter in Constantinople was a form of direct foreign investment by the Venice merchants. In time, investors would undertake investments in other countries for other purposes, including acquiring natural resources and conducting manufacturing.
In most cases, an international investment is international because it has two defining attributes: (1) the person or entity undertaking the investment is not a citizen, or at least not a resident, of the country in which the investment is made; and (2) the investment process includes the transfer of funds or capital from a foreign country to the country of investment, which results in a continuing legal relationship between the investor and the foreign enterprise. Thus, most ‘foreign investments’ in a particular country are made by a foreign corporation or foreign individual and involve the transfer of money or capital from one country to another. For example, a corporation with headquarters in France wishing to establish a factory in Malaysia that manufactures refrigerators or computers would establish a wholly-owned subsidiary in Malaysia and transfer to that subsidiary the necessary capital and technology to build and operate the factory. In that situation, France would be considered the ‘home country’ of the investor and Malaysia would be considered the ‘host country’.
On the other hand, while the previous description is the basic model for many direct foreign investment transactions, an investor of foreign nationality or residence and a physical transfer of capital from one country to another may not necessarily be present in all international investment transactions. For example, a foreign company could undertake an investment by mobilizing capital within a host country by borrowing from local banks or raising funds on the local capital market.
On the other hand, indigenous entrepreneurs may mobilize capital from abroad for investment in their home countries. For example, they might borrow from foreign banks or issue corporate bonds abroad. Does either of the transactions just described qualify as ‘international’ or ‘foreign’ investment? The answer depends upon who is characterizing the transaction and for what purpose. Economists and economic institutions may use one definition of foreign investment to gather statistics or analyse financial trends, but lawyers, regulatory authorities, and arbitration tribunals might use another when applying laws and treaties. Without engaging in a detailed discussion of this issue, it is worth noting that the definitions of foreign investor and foreign investment are important starting points (p. 38) in analysing the coverage of foreign investment treaties and foreign investment legislation, a subject discussed in Chapter 7.
While foreign investment is often associated with international trade or has trade as its objective, investment transactions and trade transactions are conceptually distinct. For one thing, the typical trade transaction is basically an exchange of goods or services for money. Once that exchange is made, the transaction is complete and usually no further legal relationship exists between buyer and seller. Investment transactions, on the other hand, are of a longer duration and once made result in a continuing legal relationship between the investor and the enterprise in which the investor has invested. Foreign investment also results in a continuing relationship between the investor and the foreign country where the investment occurred because the investor’s capital is now subject to the sovereignty of that country. Because an asset owned by the investor is subject to the jurisdiction of a foreign sovereign, the investor and its investment is subject to that sovereign’s future actions. To the extent that those future actions have a negative impact on the investment, the investor and its investment are subject to the political risk emanating from that country. Normal trade transactions do not result in similar continuing relationships and so are not subject to the same kinds of political risks as foreign investment transactions.
While they are conceptually distinct, trade and investment are nonetheless often interrelated. Many foreign investments are undertaken to facilitate and foster trade. For example, the French company mentioned earlier may have established a subsidiary to manufacture refrigerators in Malaysia specifically in order to take account of lower production costs and gain the ability to sell its product throughout Asia. Because of the close connection between investment and trade activities, the World Trade Organization (WTO) has adopted various rules through binding treaties that govern investments that have an impact on trade. One such treaty, to be discussed later in this volume, is the Agreement on Trade-Related Investment Measures (TRIMs).18
Like purely domestic investment, foreign investment can take a variety of forms. The following are some of the most common.
Foreign direct investment (FDI), sometimes also called direct foreign investment (DFI), is an equity or ownership investment of more than 10 per cent by References(p. 39) an investor in one country (known as ‘the home country’ or ‘capital-exporting country’) in an enterprise located in another country (the ‘host country’ or ‘capital-importing country’).19 FDI is a vitally important feature of modern economic life. In 2013, UNCTAD estimated that the total stock of FDI in the world was US$25.5 trillion, of which US$16 trillion was invested in developed economies, US$9.4 trillion in developing countries, and US$940 billion in ‘transition economies’, a group composed of South-East Europe, the Commonwealth of Independent States, and Georgia.20 The total FDI invested in that year was US$1.45 trillion, of which US$566 billion (39%) went to developed countries, US$788 billion (54%) went to developing countries, and the remainder, US$108 billion, went to transition economies. 2013 was the first year in which investment to developing countries exceeded the amount invested in developed economies. By comparison, in 2007, total FDIs reached a record amount of US$1.833 trillion.21 Of that amount, US$1.248 trillion was invested in developed countries, approximately US$500 billion was invested in developing countries, and US$86 billion was invested in South-East Europe and the Commonwealth of Independent States.22
FDI has the effect of giving investors in one country ownership rights in and control over economic assets in another country. As a result, FDI is a powerful force for integrating national economies and fostering the phenomenon of globalization. As governments and populations in host countries become concerned about the influence of foreigners on domestic politics, local economies, national security, and indigenous culture as a result of their direct investments, these same factors give FDI important political overtones. In this regard, it is important to recognize that FDI in most instances involves more than the transfer of money or assets from one country to another. Its purpose is to create productive capacity. To achieve that goal, the foreign direct investor usually must also transfer know-how, skills, and management capability along with money, capital, and technology. Thus, in most cases, an FDI, like the one to create a factory to manufacture air conditioners, consists of a package of money, equipment, human skills, technology, and know-how.
A foreign portfolio investment is an investment by a resident of one country in a company based in another country with shares equaling less than 10 per cent of the overall voting power. Here, too, the fundamental distinction between FDI and foreign portfolio investment lies not in the form of the investment (ie shares) (p. 40) but in the amount of control transferred. A DFI is large enough to enable the investor to participate in control of the enterprise, while a portfolio investment is not large enough to give such control.
The purchase of shares of one country’s companies by another country’s persons has also grown significantly in recent years. The total value of portfolio investments of this type amounts to trillions of US dollars, and that total seems to be growing rapidly.23 A variety of factors have driven this phenomenon, including the development of stock markets in many countries, the emergence of technologies to facilitate cross-border portfolio investment, the removal or reduction of legal restriction on the investment by foreigners in local companies, and improved knowledge and information about foreign stock markets and foreign companies. Another factor has been the recognition by institutional investors throughout the world that exposure to foreign markets is an important element in increasing the returns earned by such institutions as mutual funds, pension funds, and endowment funds.
Loans by banks and other financial institutions based in one country to enterprises located in another country constitute yet another form of foreign investment. In many cases, in order to spread the risk, especially large loans are provided not by a single financial institution but by a syndicate of several banks located in different countries. International loans are also not only made between unrelated entities; corporations often make them to their subsidiaries and affiliates as a means of financing the latter’s operations. In some cases, loans are often a substitute for an equity investment.
Both governments and corporations raise some of the needed capital for their activities by issuing bonds, notes, and other negotiable instruments to investors in other countries. Once issued, such bonds, notes, and other negotiable instruments are often traded among investors on capital markets. The value of new international bonds issued during 2013 was equivalent to US$3,966.2 billion.24(p. 41) Normally, such loans are denominated in dollars, euros, yen, and other readily convertible international currencies. However, with the development of local credit markets, foreign investors are increasingly investing in bonds and notes of foreign issuers denominated in other local currencies that are less easily convertible.
Companies in one country will often sell goods on credit to a company in another country. In many situations, that credit is supported by a guarantee from a financial or governmental institution. Such credit is also a type of investment by the supplier and often accrues interest until the amount of the purchase is fully paid. In such a transaction, unlike a loan or the purchase of a bond from a foreign issuer, no money crosses borders. Nevertheless, it is an investment because the supplier has committed capital in the form of goods to the transaction, and it expects a return in the form of repayment of the purchase price, plus an agreed amount of interest, for financing the sale.
A variety of other contractual arrangements, particularly long-term arrangements between persons in different countries, may also qualify as investments to the extent that they require one party to commit capital or money to a venture with the expectation of receiving a return at a later time. Thus, concession contracts between persons and entities based in different countries to run public services, mineral exploration and development agreements, construction contracts, land purchase agreements, and innumerable other contractual devices may all be considered international investments.
International investment transactions and forms have been growing rapidly in size, frequency, and variety in recent decades as a result of the economic imperatives of globalization. The continuing drive for economic efficiency will propel this trend in the decades ahead. Globalization is both a cause and a result of the movement to conclude international investment treaties among nations.
The forms of international investment indicated earlier are by no means an exclusive list. They are offered as illustrations of the principal ways in which international or foreign investments are made. In response to business and economic necessity, and the creativity of business and financial entrepreneurs, new forms will no doubt arise in the future. Foreseeing this, investment treaties have generally avoided giving an exclusive listing of covered investments and have instead opted to provide an open-ended definition to allow for the future evolution of investment transactions. Nonetheless, as will also be seen, definitions of international (p. 42) investment are important in applying treaties. A transaction will be protected by a treaty if it meets the treaty’s definition of investment. It will not be protected if it fails to meet that definition.
Who exactly are international investors? Simply put, an international investor is a physical or legal person in one country who invests funds or capital in another country in an investment transaction, such as those listed earlier. That bland definition masks the great diversity of individuals and organizations engaged in international investment and the broad variations in their economic objectives and activities. One of the principal types of foreign investor is the ‘multinational corporation’ (MNC), also known as the ‘multinational enterprise’ (MNE) and the ‘transnational corporation’ (TNC). Basically, an MNC is an enterprise that owns or has control over income-producing facilities in at least two countries.25 Applying that definition, the United Nations Conference on Trade and Development (UNCTAD) estimated that in 2006 there were 77,000 multinational corporations with 770,000 affiliates in the world.26 That definition covers an extremely wide variety of enterprises, from global companies like Shell or General Motors with hundreds of subsidiaries around the world to small specialized enterprises with a single subsidiary in another country. MNCs are by no means found exclusively in developed countries. Increasingly, emerging market countries like China, India, and certain Arabian Gulf states are developing their own MNEs, which are becoming active investors around the globe. In addition, important MNEs are owned or controlled by states. In 2013, UNCTAD estimated that there were at least 550 state-owned MNCs, from both developed and developing countries, with more than 15,000 foreign affiliates and foreign assets valued at over US$2 trillion. In that year alone, FDI by state-controlled MNCs was more than US$160 billion. At that level, although their number constitutes less than 1 per cent of the MNCs in the world, they accounted for over 11 per cent of global FDI flows.27
MNCs include a wide variety of business enterprises pursuing a diverse set of objectives. One way of trying to understand MNCs is by the objectives they pursue. Companies invest abroad for different reasons. Some, which might be called ‘market seekers’, invest in order to find and develop new markets for their products. Others, like petroleum or mineral companies, invest in order to find and obtain raw materials. They might therefore be called ‘raw-material seekers’. Still others searching to reduce costs and improve efficiency of production by finding (p. 43) lower cost factors of production, like cheap labour or low-cost energy, might be called ‘efficiency seekers’. Some companies, particularly in high technology areas, invest abroad in order to obtain knowledge and might therefore be called ‘knowledge seekers’. And yet others acquire or establish new operations in countries that are considered unlikely to expropriate or interfere with private enterprise, and might be called ‘political safety seekers’.28
Regardless of their aim, for many years MNCs have been the subject of intense study and commentary by both scholars and the public and have engendered strong and opposing views. For some people, MNCs are important engines of economic development. For others, they are exploiters of labour and destroyers of the environment.29 For some, their potential for economic development needs to be released from the strictures of onerous government policies and laws. For others, their potential for self-enrichment at the expense of national sovereignty, human rights, and the environment needs to be controlled by strict legislation and international agreements. As a result, the role of MNCs is central in international development, and they are important subjects of all international investment treaties.
New types of MNEs seem to be evolving constantly. Traditionally, multinational corporate investors have been engaged in manufacturing and production activities, but non-manufacturing firms have also become important direct investors. Thus, private equity firms are now actively engaged in DFI in foreign enterprises. Their goal is to take control of those enterprises, reorganize them to make them more efficient, and then sell them.
But multinational direct investors are by no means the entire universe of international investors. Banks and financial firms that extend loans and credits to governments, companies, and individuals in other countries are also foreign investors. These banks and firms control significant amounts of capital and devote considerable funds to international investments. Institutional investors, such as pension, endowment, and mutual funds, are increasingly devoting their resources to both debt and equity investments in foreign countries to enhance their returns and manage their risks through diversification. And as a result of the development of capital markets around the world, improved communications, and more readily available financial information on a global scale, individual portfolio investors are also increasingly seeking to invest their funds in shares, credit instruments, and bonds issued by entities outside their home countries.
An increasingly important manifestation of governments as investors is the sovereign wealth fund. SWFs are state agencies holding a portion of a country’s foreign currency reserves. Established by such countries as Kuwait, Norway, Singapore, and China with the goal of maximizing returns, they are authorized to (p. 44) invest their assets in foreign investments of varying degrees of risk. Their investment capital is derived from their countries’ growing foreign currency reserves resulting from revenues from their commodity exports and expanding international trade. In addition to formally established SWFs, other important sources of state funds for investment abroad are central bank reserves, public pension funds, and state-owned enterprises and development funds.30 In 2013, UNCTAD estimated that there were seventy-three recognized SWFs, 60 per cent of which had been established since 2000, and that they managed US$5.3 trillion in assets.31 Other sovereign investment vehicles held an additional US$6.8 trillion.32 Because of their potential economic power and the fact that they are controlled by governments with various political aims, the activities of these sovereign investors have raised concern in host countries and prompted calls for increased transparency and regulation of their activities.33
As a result of globalization, growing numbers of individuals and organizations invest abroad and are therefore in a general sense to be considered ‘foreign investors’. Thus, the universe of potential foreign investors consists of literally millions of individuals, companies, and organizations, and that number continues to expand steadily. Each of these millions of individuals, companies, and organizations and their trillions of dollars of capital may potentially be affected by international investment treaties.
An international investment is not only a transaction between a foreign investor and the enterprise in which an investment is made, it is also an act of international relations between sovereign states. While investors’ primary interest is protecting their investments from risk and maximizing their returns, national governments and the international community have other, broader interests that need to be considered and accounted for in developing an international regime for investment. Since it is governments, not individuals or corporations, that negotiate investment treaties, they will normally seek to pursue their interests through the treaty-making process. As a result, officials, executives, and lawyers engaged in making and managing foreign investments must take account of these interests in order to understand and interpret investment legislation and treaties appropriately.
(p. 45) National governments are concerned with achieving prosperity, economic development, and security, and improving the general welfare of their people. To the extent that international investment in their territory facilitates the achievement of those goals, national governments will foster and encourage foreign investment. To the extent that a government perceives the goals of foreign investors as contrary to its aims, its response will be less favourable. Indeed, it is in that circumstance of perceived conflicting interests and goals that investor–state disputes arise.
States view foreign investment as a form of international economic cooperation. As seen by states, its purpose is not just to assure legal rights to investors but to achieve broader societal goals that individual investors often forget or ignore. Investment treaties are a mechanism to concretize and advance the economic cooperation between states that advances their individual economic development and prosperity. States often make their intentions clear in that regard in the preambles to their international investment agreements. Thus, they express such goals as ‘[d]esiring to develop economic cooperation between the two States’,34 ‘anxious to give formal expression to this new desire for a European-wide and global cooperation based on mutual respect and confidence’,35 and ‘wishing to strengthen their partnership and promote mutually advantageous economic relations’.36 In the end, it is important to remember that international investment treaties are not just instruments to grant rights to investors. They are above all instruments of international economic relations among states. Government officials, corporate executives, and lawyers must approach them not just within the framework of narrow investor interests but within the broader framework of international economic cooperation.
1 The Oxford English Dictionary defines ‘to invest’ as ‘to employ (money) in the purchase of anything from which a profit is expected’. The Oxford English Dictionary (2nd edn, 1989) vol 8, p 46. Webster’s Third New International Dictionary of the English Language, Unabridged defines the term as ‘to commit money for a long period in order to gain a return’. Webster’s Third New International Dictionary of the English Language, Unabridged (3rd edn, 1981) 1189.
2 eg the Encyclopedia of Public International Law in defining foreign investment as ‘a transfer of funds or materials from one country (called capital exporting country) to another country (called host country) in return for a direct or indirect participation in the profits of that enterprise’ focuses on the process of making the investment. Encyclopedia of Public International Law (North-Holland, 1985) vol 8, p 246. On the other hand, E Graham and P Krugman, in their Foreign Investment in the United States, focus primarily on the result of that process when they define foreign investment in the following terms: ‘Foreign direct investment is formally defined as ownership of assets by foreign residents for purpose of controlling the use of those assets.’ E Graham and P Krugman, Foreign Investment in the United States (2nd edn, Institute for International Economics, 1991) 7.
3 JD Mortenson, ‘The Meaning of “Investment”: ICSID’s Travaux and the Domain of International Investment Law’ (2010) 51 Harv Int’l LJ 257. See also Mihaly International Corp v The Democratic Socialist Republic of Sri Lanka (ICSID Case no ARB/00/02) (2002) 17 ICSID Rev—FILJ 142, in which the tribunal determined that expenses incurred in the preparation of an investment project that never materialized did not constitute an ‘investment’ either under the ICSID Convention or the United States–Sri Lanka BIT and that therefore the tribunal had no jurisdiction over the claim.
a direct investment enterprise is defined in this Manual as an incorporated or unincorporated enterprise in which a direct investor, who is resident in another economy, owns 10 percent or more of the ordinary shares or voting power (for an incorporated enterprise) or the equivalent (for an unincorporated enterprise). Direct investment enterprises comprise those entities that are subsidiaries (a nonresident investor owns more than 50 percent), associates (an investor owns 50 percent or less) and branches (wholly or jointly owned unincorporated enterprises) either directly or indirectly owned by the direct investor. Subsidiaries in this connotation also may be identified as majority owned affiliates. Foreign-controlled enterprises include subsidiaries and branches, but associates may be included or excluded by individual countries according to their qualitative assessments of foreign control. Also, a public enterprise may in some instances be a direct investment enterprise, as defined in this paragraph.
International Monetary Fund, IMF Balance of Payments Manual (5th edn, 2010) ¶ 362, available at <https://www.imf.org/external/pubs/ft/bopman/bopman.pdf > accessed on 19 September 2014.
9 See J Fiechter et al, ‘Subsidiaries or Branches: Does One Size Fit All’, IMF Staff Discussion Note, SDN 11/04, 7 March 2011, available at <http://www.imf.org/external/pubs/ft/sdn/2011/sdn1104.pdf> accessed 18 September 2014.
11 Certain international organizations, such as the World Bank and the various regional development banks, that adopt the corporate form, are created by treaty. See generally, Articles of Agreement, International Bank for Reconstruction and Development, available at <http://web.worldbank.org/WBSITE/EXTERNAL/EXTABOUTUS/0,,contentMDK:20049557~menuPK:63000601~pagePK:34542~piPK:36600~theSitePK:29708,00.html> accessed 20 September 2014.
14 RD Fraser, The World Financial System (1st edn, Longman, 1987) 363–450. See also statements about the mission of selected international financial institutions at <http://www.worldbank.org/en/about/what-we-do> accessed 22 April 2015 (for the World Bank); <http://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corporate_site/home> accessed 19 September 2014 (for International Financial Corporation); <http://www.adb.org/site/business-opportunities/mission> accessed 19 September 2014 (for Asian Development Bank); and <http://www.iadb.org/en/topics/transparency/support-for-countries/mission-vision-and-values,1178.html> accessed 22 April 2015 (for Inter-American Development Bank).
15 eg S Koerberle et al (eds), Conditionality Revisited (World Bank, 2005); K Elborgh-Woytek and M Lewis, ‘Privatization in Ukraine: Challenges of Assessment and Coverage in Fund Conditionality’, IMF Policy Discussion Paper (2002) available at <https://www.imf.org/external/pubs/ft/pdp/2002/pdp07.pdf> accessed 19 September 2014.
17 P Fischer, ‘Some Recent Trends and Developments in the Law of Foreign Investment’ in K-H Boeckstiegel et al (eds), Völkerrecht, Recht der internationalen Organisationen, Weltwirtschafatsrecht: Festschrift für Ignaz Seidl-Hohenveldern (Carl Heymanns Verlag, 1988) 97. See also ‘Concessions Granted to the Merchants of Venice, by the Byzantine Emperors Basilius and Costantinus, Executed in March 991’ in P Fischer, A Collection of International Concessions and Related Instruments (Oceana Publications, 1976) vol 1, pp 15–18.
18 ‘Uruguay Round Agreement on Trade-Related Investment Measures’ in The Results of the Uruguay Round of Multilateral Trade Negotiations: The Legal Texts (1994) 163 (TRIMs Agreement). Also available at the WTO website <http://www.wto.org/english/docs_e/legal_e/18-trims.pdf> accessed 18 September 2014.
19 Cohen states: ‘Quantitatively, the nearly universally accepted definition of FDI is ownership of at least 10 percent of common (voting) stock of a business enterprise operating in a country other than one in which the investing company is headquartered.’ SD Cohen, Multinational Corporations and Foreign Direct Investment: Avoiding Simplicity, Embracing Complexity (OUP, 2007) 38. For the definition used by the IMF, see also n 8 above.
22 ibid 8–9.
23 eg foreign holdings of US securities as of 30 June 2013 were measured at US$14,410 billion, of which US$13,532 billion were holdings of US long-term securities (original term-to-maturity in excess of one year) and US$878 billion were holdings of US short-term securities. As of 30 June 2012, total foreign holdings amounted to US$12,451 billion. US Department of the Treasury, ‘Report on Foreign Portfolio Holdings of U.S. Securities as of June 30, 2013’ (April 2014), available at <http://www.treasury.gov/ticdata/Publish/shla2013r.pdf> accessed 19 September 2014.
US holdings of foreign securities as of 31 December 2012 totalled US$7,941 billion, of which holdings of foreign equities amounted to US$5,312 billion and holdings of foreign debt US$2,630 billion. US Department of the Treasury, ‘Report on U.S. Portfolio Holdings of Foreign Securities as of December 31, 2012’ (October 2013), available at <http://www.treasury.gov/ticdata/Publish/shc2012r.pdf> accessed 19 September 2014.
24 The International Capital Market Association (ICMA) has found that the total of new international bond market issues for the first half of 2014 is US$2,447.8 billion. This figure shows a 13% increase in the value of new issuance compared with the figure for the first half of 2013. Total market size in terms of outstanding international bonds stood at over US$22 trillion as at 30 June 2014. For more information, see the ICMA website, at <http://icmagroup.org/resources/market-data/Market-Data-Dealogic/#8> accessed 19 September 2014.
25 ‘The nearly universally accepted definition of multinational corporation is one that owns outright, controls, or has direct managerial influence in income-generating, value-added facilities in at least two countries.’ Cohen (n 19 above) 39.
28 D Eiteman, A Stonehill, and M Moffett, Multinational Business Finance (12th edn, Prentice Hall, 2014) 9. Eiteman and Stonehill have thus categorized investors into five types: market seekers, raw-material seekers, production-efficiency seekers, knowledge seekers, and political safety seekers.
29 For a discussion of the history of MNCs and the various views concerning their role in the international economy, see generally Cohen (n 19 above).
33 E Truman, Sovereign Wealth Funds: Threat or Salvation? (Peterson Institute for International Economics, 2010), available at <http://bookstore.piie.com/book-store/4983.html> accessed 15 September 2014. See also M Sornarajah, ‘Sovereign Wealth Funds and the Existing Structure of the Regulation of Investments’ (2011) 1 Asian J Int’l L 267; YCL Lee, ‘The Governance of Contemporary Sovereign Wealth Funds’ (2010) 6 Hast Bus LJ 197.
36 United States–Morocco Free Trade Agreement (signed 15 June 2004, entered into force 1 January 2006) preamble, available at <http://www.ustr.gov/trade-agreements/free-trade-agreements/morocco-fta/final-text> accessed 20 September 2014.