My opinion: dispute resolution becomes a speculative financial asset


Investor-State Dispute Settlement (ISDS) provisions in Bilateral Investment Treaties (BITs) and Free Trade Agreements (FTAs) have effectively created a powerful and privileged system of protection for foreign investors that undermines national legislation and institutions.

ISDS allows foreign companies to sue host governments for allegedly causing them losses due to policy or regulatory changes that reduce the expected return on their investments. Very significantly, the provisions of ISDS have been and can be invoked, even where the rules are non-discriminatory or the profits are derived from public harm. ISDS will thus reinforce perverse incentives for foreign investors to the detriment of local businesses and the public interest.

New speculation opportunity

In recent years, the ISDS provisions of investment treaties and free trade agreements and the like have increasingly provided an investment opportunity to earn money by speculating on suits, winning huge rewards and forcing foreign governments and taxpayers to pay. Financial speculators have increasingly bought up companies deemed able to profitably bring winnable ISDS claims, sometimes using front companies.

Some hedge funds and private equity firms even fund ISDS cases as a third party, with ISDS itself being the raison d’être for these investments. This third-party funding of ISDS claims has grown rapidly as funding such claims has proven to be very lucrative.

Third-party funding reduces legal costs for companies themselves, making it easier and therefore encouraging for them to take legal action. Foreign companies are generally not required to report receiving third-party funding for an ISDS filing. It is therefore not surprising that the ISDS claims funding industry is booming, as different types of investors have been lured and drawn into financial lawsuits, treating ISDS claims as speculative assets.

The International Council for Commercial Arbitration estimates that at least three-fifths of those considering ISDS claims have inquired about possible third-party funding before pursuing them. Finance companies provide clients with litigation packages upfront, advising them on which treaties to pursue and which law firms to hire, even recommending arbitrators.

Although bondholders do not actually develop production capacity or sell services in a host country, they too can use ISDS arbitrage to maximize returns from their debt purchases. Thus, bondholders who have lost value can use the ISDS backdoor to sue countries for compensation, encouraging a new speculative investment option for ‘vultures’. Therefore, ISDS allows investors with few ties to the original “damaged” investment to also benefit financially.

Ripe for picking

ISDS advocates say the outcome of cases remains uncertain, with foreign companies winning only around a quarter of the cases they initiate. But this proportion does not include settlements agreed before the conclusion of arbitration proceedings when foreign companies obtain huge gains. ISDS arbitration is very attractive, even tempting, to foreign investors who otherwise would not bring claims in domestic courts against host governments.

Recent ISDS arbitrations have seen greater delegation of authority to arbitrators in the interpretation and enforcement of agreements, with no ability to appeal or otherwise challenge the arbitrators’ decisions. There is no way to ensure that arbitral tribunals will interpret and apply treaty provisions in a manner consistent with governments’ understanding of what treaty obligations entail.

Investors in ISDS cases recognize that the most vulnerable governments that investors could sue are usually those that are already in trouble. For example, when a country resorts to emergency economic measures to protect its citizens, investors can easily argue that these undermine previous understanding of international agreements. The ensuing lawsuits generally damage the country’s credit rating, increase investment costs and undermine its ability to attract investment.

Jomo Kwame Sundaram was the United Nations Under-Secretary-General for Economic Development and received the Wassily Leontief Award for Advancing the Frontiers of Economic Thought in 2007.


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