CETA’s watershed moment

The Comprehensive Economic and Trade Agreement’s (CETA) novel investment protection provisions provide a measured – and timely – response to criticisms directed at the ISDS system. The bargain struck in CETA between the interests of investors and those of the host state will undoubtedly inform the negotiation of the Transatlantic Trade and Investment Partnership (TTIP).

The Treaty on the Functioning of the European Union conferred exclusive competence to the EU over foreign direct investment. The European Commission has – not without controversy – taken this to extend beyond investment liberalisation to investment protection and Investor-State Dispute Settlement (ISDS).

This is of no small importance since it gives the EU the mandate to negotiate at a supranational level EU-wide agreements – over and above the 1400 or so bilateral investment treaties (BITs) between individual EU Member States and third countries.

The Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada is the first of the EU’s new generation of free trade agreements (FTAs) negotiated by the EU in the exercise of its new competence.

However, CETA must first overcome the hurdle of an eagerly anticipated judgment of the European Court of Justice. The ECJ has been asked by the European Commission to opine on whether an analogous FTA between the EU and Singapore may be ratified at EU level or if it also requires individual ratification by each of the 28 EU Member States. The latter would prompt debate in multiple national parliaments, making it likely that CETA would take significantly longer to come into force, if ever.

If it does enter into force, CETA’s investment protection and ISDS provisions will replace eight existing BITs between Canada and individual EU Member States. However, the ramifications of this new, unified regime will reach far beyond the Canada–EU trade relationship. As part of the first wave of FTAs to be negotiated by the EU, CETA has laid the groundwork for future FTAs and BITs to be negotiated and potentially concluded by the EU, including the all-important Transatlantic Trade and Investment Partnership (TTIP) with the US.

“CETA has laid the groundwork for future FTAs and BITs to be negotiated and potentially concluded by the EU, including the all-important Transatlantic Trade and Investment Partnership (TTIP) with the US.”

CETA also comes at a critical time in the public discourse over investment protection, with a particular focus on ISDS, a system that has been criticised by  influential publications and governments alike. Many question why ISDS is necessary where both state parties have robust legal systems, while others would prefer to do away with the system entirely. One polemicist has gone so far as to qualify TTIP as a ‘monstrous assault on democracy’. It is no surprise that the debate should be so fierce given that ISDS touches on the ability of states to regulate in the public interest and may result in significant monetary awards being paid out of the public purse.

An overview of some of CETA’s features indicates a measured response to the array of critics.

“CETA challenges the assertion that ISDS is a secretive forum lacking in transparency.”

CETA challenges the assertion that ISDS is a secretive forum lacking in transparency by adopting the ground breaking UNCITRAL Transparency Rules. These provide for:

• public hearings
• online access to submissions and arbitral decisions
• access for interested parties, such as NGOs and trade unions, who may seek leave to file amicus curiae submissions.

This signals a significant change since, of the approximately 3000 BITs containing ISDS, only those to which the US or Canada are party contain transparency provisions.

CETA addresses the issue of ‘treaty shopping’ with provisions designed to avoid the circumvention of jurisdictional conditions through ‘mailbox’ subsidiaries.

Investors often structure investments through corporate entities in states that have advantageous BITs with the host state, to gain optimal protection. These corporate intermediaries may be ‘shells’ with no business operations of their own. For example, investors often choose an intermediate corporation in the Netherlands to benefit from the 90-plus investor-friendly BITs to which it is a party (hence the expression the ‘Dutch Gold Standard’), in addition to that country’s favourable tax regime.

CETA’s language makes it clear that one of its underlying objectives is to eliminate this practice.

Under CETA, an enterprise must conduct ‘substantial business activities’ in the territory in which it is constituted, to qualify as an ‘investor’. Thus, only enterprises that have actual business operations in the country in which they are constituted will be able to bring claims under CETA’s ISDS provisions.

BITs typically require that a claimant’s investment falls within the treaty’s definition of ‘investment’ before an arbitral tribunal can have jurisdiction over a claim. Such definitions have traditionally been very broad, encompassing ‘any kind of asset’ and including non-exhaustive lists of specific examples, such as ‘claims to money’ and ‘shares’. Tribunals have often limited their analysis to verifying whether the claimant’s assets in the host state fall within one or more of the categories listed by the treaty.

CETA would narrow the scope of investments afforded protection. Inspired by recent developments in international jurisprudence, CETA has adopted what has been described as the ‘objective’ definition of ‘investment’ in international law, which requires that the claimant’s activities in the host state meet certain inherent characteristics, including:

• a certain duration 
• the commitment of capital or other resources 
• the expectation of gain or profit
• the assumption of risk.

CETA’s MFN clause strikes at another manifestation of treaty shopping, namely the claimant’s ability to invoke MFN protection as a gateway for the protection provided by more advantageous provisions contained in other BITs.

Under CETA, for the purpose of MFN clauses, the scope of the term ‘treatment’ has been narrowed:

• ‘Treatment’ does not include the dispute settlement procedures provided for in other BITs. 
• ‘Treatment’ will generally not include the ‘substantive obligations’ in other BITs; therefore a breach of ‘substantive obligations’ will not give rise to a breach of CETA’s MFN protection (unless ‘measures’ were adopted by a party under ‘substantive obligations’).

While the MFN clause of CETA is more restrictive, it has the benefit of providing clarity on an issue that has divided arbitral tribunals.

CETA draws on awards that have refused to hold states liable to pay compensation to a foreign investor on account of nondiscriminatory, bona fide regulations aimed at public welfare.

Under CETA, there can be no finding of indirect expropriation where measures are ‘designed and applied to protect legitimate public welfare objectives, such as health, safety and the environment’. There is an exception ‘in the rare circumstances where the impact of the measure or series of mesures is so severe in light of its purpose that it appears manifestly excessive’.

This addresses one of the most frequent criticisms of the ISDS system, that it results in a ‘regulatory chill’ that undermines the legitimate right of host states to regulate in the public interest. The provisions also constitute a clear repudiation of the ‘sole effects’ doctrine, under which the effect of the regulation is the only relevant factor that must be analysed.

This approach is consistent with CETA’s preamble, in which Canada and the EU recognise that its provisions ‘preserve the right to regulate within their territories’ and resolve ‘to preserve their flexibility to achieve legitimate policy objectives, such as public health, safety, environment, public morals and the promotion and protection of cultural diversity’.

CETA is the first international investment agreement which seeks specifically to describe the circumstances that constitute a breach of FET. The intent of the CETA parties was to standardise the interpretation of FET and fetter what the European Commission has described as the ‘unwelcome discretion’ of arbitrators.

In contrast with previous generations of BITs, CETA resorts to a closed text that seeks to define FET by reference to a list of five explicit breaches. These measures define a fairly high threshold for breach (e.g. manifest arbitrariness). The list, however, is not definitive; the parties expressly provided that they may review the content of the obligation to provide FET and adopt supplementary elements.

“CETA will mark a watershed moment for the EU as it defines a common approach to investment protection and ISDS for its Member States.”

CETA contains several innovative procedural provisions, including:

• A ‘fast-track’ rejection of unmeritorious claims, providing two distinct mechanisms by which the host state can file preliminary objections to a claim that it considers either manifestly without legal merit or unfounded as a matter of law
• A provision whereby claimants may propose that a dispute be settled by a sole arbitrator. Such a proposal must be given ‘sympathetic consideration’ by the host state, especially ‘where the investor is a small or medium-sized enterprise or the compensation or damages claimed are relatively low’.

If ratified, CETA will mark a watershed moment for the EU as it defines a common approach to investment protection and ISDS for its Member States.

While CETA seeks to make it more difficult for foreign investors to bring successful claims against host states than has been the case with previous generations of BITs, the provisions still afford meaningful protection to foreign investments. This, coupled with the procedural novelties of CETA, should serve to meet some of the criticisms directed at the ISDS system.

“CETA strikes a workable compromise between the views of the defenders of ISDS and those of its most ardent critics.”

While the most passionate on both sides of the debate are likely to remain dissatisfied, CETA strikes a workable compromise between the views of the defenders of ISDS and those of its most ardent critics. This bargain – between the interests of investors and those of host states – will undoubtedly inform the negotiation of the TTIP and will, in our view, increase the likelihood that this next significant EU-wide FTA will include ISDS provisions.

If nothing else, CETA should be put to work to placate the uninformed campaign that is being conducted in certain quarters against ISDS, as part of the wider debate surrounding the TTIP and the Trans-Pacific Partnership (TPP). In this regard, the International Bar Association has recently published a helpful statement designed to identify and correct the misconceptions informing the current public debate about ISDS.

Pierre Bienvenu is an editor-in-chief of International arbitration report and a senior partner and global co-head of international arbitration and Éric-Antoine Ménard is an associate, both in the Montréal office of Norton Rose Fulbright.