Investor-state dispute settlement (ISDS) is — as the term implies — a system of conflict resolution between foreign investors and the state that hosts the investment. Both the foreign investor and the host state must consent to ISDS before a proceeding may commence.
Investor-state dispute settlement (ISDS) is — as the term implies — a system of conflict resolution between foreign investors and the state that hosts the investment. Both the foreign investor and the host state must consent to ISDS before a proceeding may commence.
Usually, this consent is contained in international investment agreements between states. These agreements can be bilateral (between two countries), or multilateral (between more than two countries). There are currently more than 3,300 international agreements providing for ISDS.
Governments and foreign investors often disagree over issues and when these disagreements are not mutually resolved, global arbitration is the main recourse. It is in global arbitration institutions where a judgment is given which is binding on both the parties. Foreign investors naturally want to protect their business interests and manage risks through prescribed and agreed-upon clauses. If conflicts arise, then ISDS is one of the mechanisms resorted to by the parties involved.
This mechanism is often considered a win-win situation for everyone because it allows the countries receiving investment to attract FDI and also assures foreign investors that their investments are protected. It is only when the investment environment changes that bad blood is drawn between the state and the investor.
As of June 2024, over $113 billion has been paid by states to investors under ISDS. The vast majority of this money has gone to fossil fuel interests. There has also been an increase in the number of cases for arbitration, highlighting the deficiencies in a mutually agreed contract between countries and investors.
These flaws, which result in discontentment, have been criticized by those who question the arbitration mechanism and view it as destabilizing otherwise cordial and profitable bilateral relationships. The World Bank’s International Center for Settlement of Investment Disputes (ICSID) provides an independent forum to conciliate and arbitrate these disputes. The ICSID consists of about 70 professionals who administer arbitration and conciliation cases and support other ICSID activities. International jurists from all over the world decide ICSID cases.
In most instances, the tribunals consist of three arbitrators: one appointed by the investor, another appointed by the state, and the third, the presiding arbitrator who is appointed by both parties based on mutual agreement. Arbitration under the ICSID Convention entails a strong enforcement mechanism. An award by an ICSID tribunal is binding on all parties to the proceeding and all member states must recognize and enforce the award.
The ICSID caseload has increased in the last 20 years. This reflects the substantial growth in cross-border investment and the increased number of international investment agreements offering ISDS. In Pakistan, the government often counters the brouhaha created by many individuals and organizations over the issue of IPPs by claiming that sovereign guarantees have been established and there is a risk that the IPPs would approach international arbitrators over non-payment. This would be a blot on the fabric of foreign direct investment and would negatively impact on the goal of attracting future FDI, or so the thinking goes.
Then there was the issue of the Reko Diq copper-gold project that simply unsettled the government. Pakistan has faced such issues no less than a dozen times in the past. Hence, it is normal for any country, more so Pakistan, to be extra careful in amending original policies directed towards foreign investors whenever disputes between the state and investors arise.
According to the United Nations Conference on Trade and Development (UNCTAD), between 2001 and 2022 Pakistan engaged in 12 such cases or disputes. Some, such as the cases involving Al-Tuwairqi Holdings and Swiss company SGS, are notable. Of these 12 cases, one case was discontinued, one remains unsettled, one was decided in favour of neither party, two were mutually settled, another two were decided in favour of the investor, and five were decided in favour of Pakistan. Millions in precious foreign exchange were expended to fight these cases.
In a manner of speaking, Pakistan has become an expert in fighting international arbitration battles. Over time, actions such as these have discouraged many investors. There is an imperative need for the Special Investment Facilitation Council to include the clause of mediation in the agreements and chalk out a mutually beneficial modus operandi in order to attract mega FDI.
The negative ramifications of disputes deter foreign investors, especially when combined with frequent policy changes, unbridled increases in utility rates, overzealousness by tax authorities in creating new rules and regulations, and currency fluctuations that affect the projections and plans of foreign investors. There is no longer any apparent charm in investing in Pakistan.
The Pakistan Business Council recently issued a strong warning that many multinational companies are shifting or will move their back offices to other countries. As it is, multinationals have been selling off their operations in Pakistan or have drastically cut how much they plan to invest in the country going forward. Some of these decisions gathered steam after the installation of a ‘firewall’ system that has wreaked havoc on the internet and generated a severe backlash.
Maybe this system has accelerated MNCs’ plans to move out. It has put the country back by at least two steps. Pakistan and other nations must accept the fact that outcomes in their favour may deter future investors from taking the risk of investing in their economies. Moreover, the rulings may be construed as biased, prejudiced, or unpredictable, despite meeting accepted standards of credibility and consistency. It is then advisable to structure the investment framework such that it offers a comfort zone to the investor and, at the same time, protects the writ of the state.
It is important that both parties understand and mutually accept the enforcement of state and investor obligations. Bad media hype as well as analyses by mostly ignorant armchair experts can result in underpinning the emotions of those who are critics of giving guarantees to foreign investors while denying such facilities to domestic investors. Some naysayers are suspicious about arbitration awards, especially if the ruling is not in accordance with precedents.
However, this is a moot point because the dynamics of each case may not be of the same nature or circumstance and hence consistency may not be as per precedents. Vera Weghmann and David Hall, in their research article, write that “investor–state dispute settlement mechanisms were intended to protect companies from the Global North against expropriation by Global South countries. Social movements and governments alike resisted investor–state dispute settlement mechanisms and, despite the power wielded by multinational companies, the global trend is now to exclude investor–state dispute settlement mechanisms from new investment treaties”.
For Pakistan to secure future inflows of FDI, it must ensure transparency and consistency in policymaking. It must also undertake structural reforms that address the ease of doing business, provide protection, safety, and security of investment, and refrain from using political and administrative pressure. This is because Pakistan needs massive foreign direct investment now more than ever.
The writer is a former president of the Employers Federation of Pakistan.
