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ISDS can be fixed

28 Aug 2015

What is ISDS?

Investor-state dispute settlement, or ISDS, is a way of settling disputes between investors and states.

It most often happens in the form of an arbitration, so some people call it investor-state arbitration, or ISA. ISDS provisions have traditionally been inserted in bilateral investment treaties, which are negotiated between two states and provide for certain benefits and protections when an investor located in one of the states invests in the other state.

One of the problems investment treaties try to solve is that the host state could seize the investment outright, or might introduce limits on currency convertibility that make it difficult to patriate profits, or introduce regulations that discriminate against foreign investors. These concerns loom particularly large in countries with an ineffective legal system or weak rule of law, but even countries that we might think would know better will sometimes discriminate against foreign companies.

When the foreign investor can’t get justice in domestic courts, the traditional remedy has been to get the investor’s home state to try to convince the host state to pay some compensation through diplomacy, or perhaps by threatening retaliation in some other area. In the 19th century, the home state might have sent along some gunboats or even started a full scale war. Today the use of military force to settle commercial disputes is frowned upon.

The first bilateral investment treaty allowing an investor to take a state to arbitration was signed by France and Tunisia in 1969. Since then, hundreds of treaties have included arbitration clauses, and a few multilateral ones have too, notably NAFTA and the Energy Charter Treaty.

ISDS provisions give investors some confidence that if their investment is confiscated or otherwise impaired, they can take their case to an impartial tribunal and receive compensation. While an investor would probably not invest in a state that has a terrible legal system and is certain to ignore property rights, the option of using ISDS can provide a little more assurance and could tip the scales in favor of a particular country, or investing versus not investing.

ISDS provides a way to circumvent weaknesses in the host state’s rule of law and respect for property rights; it might be better to just fix that, but major institutional changes can be challenging to realize.

Even in places where courts work well, arbitration is often seen as a more efficient, faster and cheaper process than a traditional lawsuit that can take years, especially when the state is the defendant.

Most ISDS cases have been brought by European investors against poorer countries. Unsurprisingly, Argentina and Venezuela dominate the league tables of respondent states as a result of their large scale nationalizations of foreign businesses.

ISDS clauses usually say that arbitration has to follow one of two sets of rules, those set out by ICSID, part of the World Bank, or UNCITRAL, a UN institution. UNCITRAL arbitral awards against a state can be enforced in courts around the world like traditional arbitral awards. ICSID awards are easier to enforce because they are supposed to be treated like a domestic court judgment. In most cases, a state that loses will simply pay up.

Why are we talking about ISDS now?

There have been a few high-profile ISDS cases that were widely seen as abuses of the process, which has created anxiety that ISDS, which is ultimately a limitation on a state’s sovereignty, could have a chilling effect on legislation in areas like environmental protection, health and patents, and perhaps undermine democracy itself.

After the Fukushima nuclear incident in 2011, Germany decided to phase out nuclear power by 2022. As part of the phaseout, some older nuclear reactors were shut down. The Swedish state-owned energy company Vattenfall, which owned two of those reactors, decided to sue request arbitration for billions of euros—we don’t know exactly how much because arbitration proceedings are secret—under the ISDS provision of the Energy Charter Treaty.

Even if Vattenfall wins, the reactors will stay closed and Germany will still be nuclear free by 2022. Arbitrators cannot issue an injunction that orders German regulators reopen the reactors and their awards have no direct influence on public policy. Many regulations will end up costing someone money, and if that someone is a foreign investor from a country with an ISDS clause, regulating them in a way that benefits the public—for example by reducing the risk of a nuclear disaster—could end up costing a lot of money.

In most countries, the government has to pay compensation if it confiscates a piece of property and takes it into its own ownership, but usually not when there is a good public policy rationale for the regulation. If the kind of legislation that legislators routinely enact could end up being ruinously expensive because a foreign investor happens to lose out, legislators could be reluctant enact it in the first place. That is alleged to have happened in Canada in 2014 when legislation mandating plain packaging for cigarettes was withdrawn. Australia is currently engaged in an ISDS case on the same issue because Philip Morris Asia, which is nominally a Hong Kong investor, argues that the Australian plain tobacco packaging law expropriates its investment.

Proposed Australian cigarette package

ISDS cases can also be brought when courts reinterpret existing legislation to limit investors’ property rights. The Supreme Court of the United States has sharply limited what can be patented in the US through a series of decisions over the past decade, with the effect of limiting or eliminating those patent owners’ “property” rights. We think of those decisions as simply clarifying what the law always was, but arbitrators may not see it that way. No investor has yet sued requested arbitration over CLS v. Alice or other American patent decisions, but Eli Lilly is doing so over an aspect of Canadian patent law known as the “promise doctrine.” The same could also happen as a result of the new Unified Patent in Europe.

It’s important to note that the chilling effect only exists if legislators, regulators and courts are chilled by it. As long as they are not ruinous, the host state could choose to pay out any arbitral awards and just continue governing as if they never happened. The US Congress and state legislatures would probably not feel very chilled.

ISDS is part of the drafts for both the new Trans-Pacific Partnership deal being negotiated by the US and various Pacific rim countries, and the TTIP deal between the US and the European Union, which makes it very relevant. People who are debating TPP and TTIP spend a lot of time discussing whether ISDS should be part of those deals. It also looks bad that ISDS provisions grant special privileges to foreign companies, because only foreign investors can request arbitration against a state.

[For my 🇺🇸 readers: United States has yet to lose an ISDS case. That might be because American courts are awesomesauce, because the system is rigged, or it might just be luck. Also, check out this hilarious pro-ISDS-argument that invokes the Federal Circuit.]

[For my 🇪🇺 readers: There are some intra-EU ISDS treaties. The European Commission requested their termination a few months ago because they’re not really compatible with EU law.]

How can ISDS be fixed?

The intentions behind ISDS are good: ISDS can help attract investment by protecting property rights, and by circumventing ineffectual legal systems. With some fixes—some small, some radical—I think ISDS can be cut down to size and be made palatable, while still achieving the goals it was created for.

Countries with good legal systems

When Vattenfall felt expropriated by the German government, did they really need access to an alternative judicial system to receive the compensation they deserved? Germany has very well-functioning and widely respected courts. I poo-pooed Vattenfall’s claims over its two nuclear reactors, but if they truly have merit, couldn’t German courts have decided that?

In fact, RWE and E.ON, two other energy companies with large investments in Germany, sued in German courts over a nuclear fuel tax, a different provision of the phaseout, and won. Well, the European Court of Justice in Luxembourg later ruled that the tax was legal. In any case, that lawsuit is close to being resolved, while Vattenfall’s case appears to be never-ending. So much for arbitration being faster.

Swedish investors don’t need ISDS to be reassured that it is safe to invest in Germany. Hong Kong investors don’t need ISDS to invest in Australia. American investors don’t need it to invest in Canada.

Vattenfall used the Energy Charter Treaty, which includes countries that at the time did not have great legal systems, and it would probably look bad to only apply ISDS to cases involving those countries. But there is no pressing need for TTIP, which is between the United States and the European Union, to include an ISDS provision. (There is an argument making the rounds that ISDS in TTIP is necessary to get China to agree to ISDS, and it doesn’t quite make sense.)

Stronger public policy exceptions

Most recent ISDS clauses include some recognition that not all losses caused by government action constitute a taking, and many arbitrators accept that. The leaked TPP investment chapter explains in an annex that

Non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health, safety, and the environment, do not constitute indirect expropriations, except in rare circumstances.

These guarantees can be made stronger, so something like the Australian plain tobacco packaging law is understood by everyone to not be expropriation.

Multilateral investment treaties often allow a commission of government representatives to issue interpretations of the treaty that are binding on arbitration panels. NAFTA has one and the TPP draft has one too. These commissions should be used more frequently and aggressively to curb abuses of the arbitration process.

Appeals

Arbitration panels consist of three often not very well selected arbitrators, and they can make mistakes. When a judge in a conventional court makes a system, there is usually an appeals court that can correct the mistake. ISDS awards can amount to billions of dollars and the consequences of an error can be serious to the losing state.

While there are a few narrow ways in which an arbitral award can be set aside, a permanent appeals body, like the WTO has, could do much to curb bad arbitral awards and abuses of the system. Arbitration awards can normally not be appealed because that would increase the potential cost of a system that is supposed to save money. One way to preserve that is to limit appeals to awards over a certain size.

Transparency

Arbitration is secret. The arbitration panel has the option of issuing wide-ranging confidentiality orders over the documents in the case, and in-person sessions are usually not open to the public. Opening up the proceedings whenever possible would reduce anxiety about the process.

Alternatives to ISDS

Arbitration is not the only way that investors can be protected against expropriation. MIGA, an agency of the World Bank, sells insurance against breach of contract and political risks such as expropriation. Many countries’ export-import banks offer similar coverage.

An investor with such an insurance policy may be even better protected than with an ISDS clause, because the insurer is less likely than a state to resist paying out a valid claim. MIGA’s capital can be expanded so the $720 million per-country limit can be raised and more investors can take advantage of this kind of insurance.

MIGA has only paid out eight claims so far, and only one of those was for a project in Argentina. According to the agency itself, the number is so low because they are awesome at negotiating an informal solution before a full claim is necessary.


Addendum: Contrary to popular belief, the bilateral investment treaty concluded between Germany and Pakistan in 1959 did not contain an ISDS provision. It was the first such treaty, but the arbitration procedure in Article 11 refers only to disputes between the parties to the treaty, not between a private investor and the host state of the investment.

On finality of payments

25 Mar 2015

(This is cross posted from Ello.)

Izabella Kaminska writes about what she describes as Bitcoin’s lien problem. The “problem” is that although Bitcoin transactions are final and irreversible within the context of the Bitcoin payment system, a court (or a thug) might force you to pay back the Bitcoin you have received. And what’s worse, if the Bitcoin were illegitimately transferred in the first place, an owner down the chain after multiple transfers—who was not complicit in the original disputed transaction—might be forced to hand it over too.

As I’ve said in the past, Bitcoin is not great, but USD is terrible. In the United States, wire transfers with Fedwire are final and irreversible. If you make a payment to someone and believe you are entitled to get your money back, you will have to sue them (or threaten to beat them up). Appealing to your bank or the Federal Reserve will not help.

A lot of payment systems around the world work like this. Cash transactions are irreversible. Payments in the Danish domestic payment system I described in my 2014 post are irreversible. The British Faster Payments Service also has final and irreversible payments.

Most American systems do not work like this. If you charge something to your credit card, you can dispute the transaction and often get an immediate refund. The dispute will be resolved within the payment system, according to opaque standards, without much collection of evidence or a neutral arbiter.

The recipient will get a chargeback and be forced to return the money, so it’s not like an insurance policy. If you have a job and receive your wages through direct deposit, that deposit can be reversed for 60 days after the deposit is made. Already paid your bills with that money? Too bad.

What about PayPal? Venmo? Square Cash? Debit cards? Facebook Messenger payments? All reversible for a terrifying period of time.

There are some benefits to resolving disputes within the payments system. A lot of payments in the US are “debit pull”: the merchant “pulls” the money out of your credit card, your utility company pulls it out of your bank account with ACH. You didn’t explicitly authorize each of these transactions, so there could easily be mistakes. Being able to easily reverse credit card transactions also makes people more comfortable using these cards, whose security is otherwise not that great.

However, I believe the option of final and irreversible payments is an important feature of a modern payment system. If you receive your pay in your bank account, you should be able to count on that money being there. If you received the wrong amount, maybe you should be made to pay it back (possibly in installments if you spent the money by honest mistake), and there is always the option of resorting to the courts, but your money should not just suddenly disappear without notice. If you sold your car to someone you met on Craigslist, and he or she paid you using the payments system, you should also count on that money being available—let them sue you if you sold a lemon.

What’s the point of easy Bitcoin?

12 Mar 2015

(This is cross posted from Ello.)

It’s easy to see the appeal of Bitcoin to drug dealers and nerds like me. I can buy some Bitcoin, or mine it myself, and use it to make instant (well, 10-minute) payments without using the antiquated US dollar payment infrastructure.

Most consumers, however, don’t want to hold Bitcoin, because they might lose all their hard earned savings, and merchants don’t want to bother with that either. That’s why there is a slew of startups that make the Bitcoin payment process much easier. When I buy things from Adafruit, Bitcoin payments are processed by BitPay, who takes care of instantly converting my Bitcoin to US dollars. BitPay will then automatically transfer the converted dollar amount to the merchant using ACH or other national payment systems.

What if, like most consumers, I don’t own any Bitcoin and don’t want to be exposed to the risks of holding any? A company like Coinbase lets me instantly buy Bitcoin and send it to BitPay to pay for an online purchase. How do I pay for that? Coinbase prefers to withdraw the US dollar amount from my bank account using ACH.

Startups like BitPay and Coinbase have made it reasonably convenient for me to pay a merchant using Bitcoin, but it already looks like there are a few redundant steps here. If I pay using ACH, and Adafruit is paid using ACH, why can’t there just be a single ACH transaction? That way we could save half of the ACH fees (on one of the two ACH transactions) as well as the Bitcoin transaction fee.

So what’s the point of using Bitcoin here? Why not just use ACH payments? BitPay and Coinbase both comply with all the relevant laws and are registered with the regulators, so there’s not even any regulatory arbitrage to be had. In some ways, the easier you make Bitcoin as a payment system for regular folks, the less you actually need Bitcoin as part of that system.

Bitcoin has also been touted as revolutionizing small cross-border payments, such as remittances. But to make it easy to use, remittance solutions for Bitcoin have to interface with a “normal” payment system, whether it is dispensing cash at a retail store or domestic payment systems like ACH or the European SEPA. Companies like TransferWise and XE Trade have already disrupted the market for international payments the old-fashioned way, by maintaining bank accounts in each country and making domestic payments in and out of those.

The main advantage I can think of, for this type of consumer, is that Bitcoin can decentralize the centralized component of the payment flow. This allows each consumer and each merchant to use different providers at the endpoint. If I pay with a credit card, the endpoint providers are my card issuer and the bank that provides the merchant account. There is a lot of competition in the market for card issuance and merchant accounts, but a centralized network connects all the card issuers and merchant accounts. (Indeed, operating such a network is very profitable.) I don’t have to use Coinbase, or any particular card issuer in the case of debit and credit cards: I can use some other company. And I can still make easy payments to Adafruit.

For domestic payments, we can cut out Visa or MasterCard as a middleman, but we cannot cut out ACH. At each end, we could, however, replace ACH with something else.

For international payments, TransferWise is easy and cheap enough. But what if I want to make a payment to a country that TransferWise doesn’t support? I can use a provider in my country to convert dollars to Bitcoin, and the recipient can use a provider in a different country to convert Bitcoin to local currency that is transferred to his or her bank account. I think this is a minor improvement: if we both live in countries supported by either TransferWise or XE Trade, it would be easier and faster to just use a single provider for the whole transaction.

The real problem with sticky navigation, illustrated

10 Feb 2015

There are many reasons to hate sticky nav bars, explained by Felix. They are annoying. They take up valuable screen space on mobile devices. They are often pointless, for example the Slate mobile one that only shows you the title of the article. I wrote a Safari extension that kills them on a view sites.

Felix mentions the real reason sticky nav is super evil: it hides content.

I often read articles by using the spacebar or page-down button to scroll. Almost all browsers implement this function, and it simply scrolls down a page. But because sticky nav is layered on top of content, instead of being separate from the page like frames used to be, it hides whatever is under it. That is not a problem when you scroll in tiny increments. It is a problem when you want to scroll a page at a time, which is much faster.

Here’s an example from Fusion.net, a site that recently relaunched and has sticky nav. I’m innocently consuming some content:

stickynav

That last line ends with “they always”. Now I hit the spacebar:

stickynav

Does that say “They came home the way they always of-date one”? Should I submit this to Language Log?

No, it turns out that a line is being hidden under the sticky nav. Here is the missing text:

stickynav

Kill sticky nav!

Is the US government funded?

19 Nov 2014

Yes!

The US government is funded through September 30, 2015.

H. R. 83/Public Law 113–235

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