How Does Investment Arbitration Affect “Third Parties”?

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Dr Zoe Phillips Williams, LSE

14 November 2018

Today, the international investment protection regime – comprised of investment treaties and investor-state arbitration – is facing sustained calls for reform. One of the most fundamental criticisms of the system is that it is inherently undemocratic.

What does it mean to say that a regime made up of treaties, signed and ratified by states, is undemocratic? Underlying concerns about the impact of arbitration on democracy is an understanding that the investment regime has an impact on “third parties” – for the purposes of this article meaning individuals or groups who are neither the treaty signatories nor legally parties to a specific dispute, as opposed to parties that fund arbitral proceedings.

To understand the relationship between the regime and third parties, it is necessary to consider the impact investment may have on domestic groups. Subsequently, it is useful to evaluate how investment arbitration may shape states’ responsiveness to these groups.

Investment has an impact on third parties

Investment treaties have often been justified on the grounds that they help host states attract foreign investment, which is understood as an important driver of development. And indeed, investment can increase the demand for employment, contribute to technology transfer and provide much needed contributions to infrastructure.

However, not all investment is created equal, and some projects generate significant negative externalities which affect host state populations.

The clearest example is investment in extractive industries, which contributes to environmental degradation, as well as the depletion of water resources on which nearby communities depend for their livelihood.¹  This in turn often leads affected communities to put pressure on the government to take measures which will avoid or mitigate the negative impacts of these projects.

Indeed, numerous investment claims involving extractive industries might be better characterized as community-investor-state disputes, in which the state, often in response to electoral pressure, takes measures which investors subsequently challenge in arbitration. Recent examples include disputes between investors and El Salvador, Peru, Canada and Colombia.²

Investment in public utilities can also have a negative impact on host state populations and can be quite politically contentious. This is particularly the case if investment as part of a privatization or liberalization process leads to reduced access (because of price increases) or disruption in service. Several high-profile cases have resulted from governments responding to domestic opposition to investment in utilities.³

Beyond regulatory chill

When faced with this pressure from “third parties” policymakers have two options: respond to domestic pressure to prevent or mitigate negative impacts of an investment, or maintain high levels of investment protection to avoid a dispute.

Critics of the regime have been particularly worried about the latter response, which they characterize as investment arbitration’s ‘chilling effect” on domestic regulation. And the fear is not misplaced. While regulatory chill is difficult to measure systematically, increasing amounts of anecdotal evidence suggest that this mechanism is at work in many cases.⁴

On the other hand, as the case record indicates, states are continuing to respond to domestic interest groups and take measures to which investors object. However, this does not necessarily mean that third parties are unaffected by the resulting arbitration.

As I’ve argued elsewhere, Pacific Rim v El Salvador is particularly illustrative.⁵

At the heart of this dispute was a “de facto ban” on mining, announced during an election campaign in which mining had become a central issue. While this ban appeared to be a victory for El Salvador’s anti-mining movement, it fell short of their stated goal, which was a legislative ban on metallic mining in the country. While the arbitration was ongoing, the de facto ban was upheld, but no legislation was passed. A number of observers and government officials attributed this to the government’s fear of provoking further investment claims from other affected miners.

It was only following the dismissal of Pacific Rim’s claims by the tribunal that anti-mining legislation was finally passed in 2017. It is easy to imagine that if the tribunal had found in favour of the investor, the barriers to the passage of this legislation would have been greater.

Pathways to reform

Some of the more extensive calls for reform acknowledge the impact that investment and investment arbitration can have on third parties and suggest possible solutions. For example, requiring that states’ right to regulate and investors’ obligations to respect human rights are enshrined in treaties would be a positive step. More far-reaching calls for reform have focused on ensuring that investment-affected third parties have access to remedy similar to that which has been granted to investors.⁶

However, the effectiveness of these suggestions ultimately depends on the will of the host state to be responsive to the political demands of its citizens.

For decades, investment has been touted by international organizations and developed states as the most effective tool for economic development. Thus, national governments have a clear incentive to attract investment and are often more than willing to defend the interests of foreign investors against the demands of their own citizens. In political contexts in which development is conceived of only as economic growth, reform of the investment system can only go so far toward ensuring third parties affected by investment have adequate protection.

 *Dr Zoe Phillips Williams is an LSE Fellow in International Political Economy in the Department of International Relations. Her research focuses on the impact of domestic politics on the incidence of investor-state disputes, although her research interests branch out to include non-judicial mechanisms for dispute resolution between citizens and the private sector and corporate social responsibility.

1. Anne-Emanuelle Birn, Leah Shipton and Ted Schrecker. ‘Canadian mining and ill health in Latin America: a call to action’ [2018] Canadian Journal of Public Health

2. Pacific Rim Cayman LLC v El Salvador ICSID Case No ARB/09/12; Bear Creek Mining Corporation v Peru ICSID Case No ARB/14/21; Clayton and others v Canada PCA Case No 2009-04; Eco Oro Minerals Corporation v Colombia ICSID Case No ARB/16/41

3. Aguas del Tunari SA v Bolivia, ICSID Case No ARB/02/3; Biwater Guaff (Tanzania) Limited v Tanzania ICSID Case No ARB/5/22

4. Gus Van Harten and Dayna Nadine Scott. ‘Investment treaties and the internal vetting of regulatory proposals: a case study from Canada.’ (2016) Osgoode Legal Studies Research Paper Series.

5. Zoe Phillips Williams. ‘Investor-state arbitration in domestic mining conflicts’ (2016) 16 (4) Global Environmental Politics <https://www.mitpressjournals.org/doi/abs/10.1162/GLEP_a_00380?journalCode=glep>

6. IISD ‘Developing a progressive agenda for reform of international investment law: Canadian perspectives’ (2018) <https://www.iisd.org/library/developing-progressive-agenda-reform-international-investment-law-canadian-perspectives>