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Australia – FTA with Korea: How Will Investor-State Disputes Be Dealt With?

5 November, 2013

 

Legal News & Analysis – Asia Pacific – Australia – International Trade

 

Australia-Korea FTA Negotiations

 

Speaking at a press conference in Brunei earlier this month, Australian Prime Minister, Tony Abbott, stated that the Australian Government is aiming to conclude free trade agreements (FTAs) with Korea, China and Japan within 12 months.1 The desire to push for a conclusion of these FTAs has been echoed by the new Australia Minister for Foreign Affairs, Julia Bishop, who just last week indicated during a business address in Seoul that the Australia-Korea FTA is expected to be the next FTA to be concluded.2

 

After negotiations in relation to the Australia-Korea FTA, which began back in March 2009, stalled in 2011 as Korea focused on finalising its FTA with the United States and reorganising its trade portfolio following the 2012 Presidential election, the anticipation of new benefits flowing from the FTA is again building among Australian and Korean investors. The FTA is expected to deliver significant gains to both countries, with net GDP gain estimated to be in the order of US$ 42 billion.

 

One matter that is certain to be at the forefront of investors’ minds as the detail of the Australia-Korea FTA is finalised is whether the FTA will include investor-state dispute settlement (ISDS) provisions.

 

Advantages Of ISDS For Investors

 

In contrast to a trade transaction, which is often simply a one-off exchange of goods or services, an investment in a foreign country can span decades, and generally carries with it a medium to long term relationship between the investor and the host country. In many cases, particularly where project-based work such as a mining venture or infrastructure development is involved, significant capital outlay can also be required in the early stages of the investment before any revenue is returned. Accordingly, foreign investment by its nature often involves significant exposure to political risk (i.e. the risk of a change in the position of the host government which would alter the scheme of burdens, risks and benefits underlying the investment).

 

ISDS is an important tool for foreign investors in managing the higher levels of political risk generally associated with foreign investment. FTAs and other investment treaties generally contain substantive protections which the host country agrees will apply in favour of the investor when investing in the host country (e.g. an obligation on the host country to provide an investor with ‘fair and equitable treatment’). If a dispute arises in relation to the host country acting in a manner which is inconsistent with these substantive protections, ISDS provides a mechanism for settlement of the dispute by international arbitration directly between the investor and the host country, often without the need for recourse to the host country’s domestic courts. Without ISDS, these substantive protections have the potential to be illusory, or at least more difficult to enforce.

 

ISDS provisions are also more attractive for many investors because they allow disputes to be settled through the more familiar dispute resolution process of international arbitration, rather than through the courts of the host country.

 

This is of particular relevance to Korean investors which are medium to long term investors, as has been the case in respect of a number of energy and natural resources projects e.g. KOGAS in relation to Prelude LNG and POSCO in relation to the Roy Hill project. Such investments form a significant and growing proportion of Korea / Australia trade. The level of these investments is expected to grow with a Australia-Korea FTA.

 

Australia’s Stance Regarding ISDS Under Former Labor Government

 

Despite the advantages of ISDS for investors, it remains unclear whether the Australia-Korea FTA will include ISDS provisions.

 

During negotiations under the former Australian Labor Government, there were indications that Australia would refuse to include ISDS provisions in the Australia-Korea FTA. For example, in a press release in March 2009, then Minister for Trade, Simon Crean, stated:

 

‘Objections were registered to the designation within the Australia-Korea FTA feasibility study of existing Korean environment and labour standards regulations as impediments to foreign investment. Some contributors also raised concerns regarding the capacity of dispute settlement provisions in FTAs, particularly the Investor-State Dispute Settlement mechanism, to undermine the Australian Government’s capacity to regulate to protect the environment, labour standards or the provision of public services.

 

The Government is conscious of community sensitivity about the important issues of labour standards, environmental standards and the provision of public services and is committed to retaining appropriate control over the setting of domestic policy in these areas.’

 

In April 2011, the former Gillard Labor Government announced a new policy restricting the inclusion of ISDS provisions in FTAs and investment treaties.3 The reasons behind the policy shift were said to be that the Gillard Government would not support provisions that conferred greater legal rights on foreign businesses than those available to domestic businesses, or constrained the ability of the Government to make laws on social, environmental and economic matters. Consistent with that new policy, the first trade agreement with a developing country without ISDS provisions, the Australia-Malaysia Free Trade Agreement, entered into force in January 2013.

 

The table below sets out other FTAs to which Australia is a party, and indicates whether they contain ISDS provisions. As can be seen from this table, only four of Australia’s seven FTAs contain ISDS provisions. The parties to these four FTAs do, however, include a number of Australia’s major trading partners, particularly in Asia. In particular, the ASEAN parties to the ASEAN-Australia-New Zealand FTA are Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.

 

FTA Date of entry into force ISDS provisions? (Yes / No)
Australia-New Zealand Closer Economic Relations 1 January 1983 No
Singapore-Australia FTA 28 July 2003 Yes (see, Chapter 8)
Thailand-Australia FTA 1 January 2005 Yes (see, Chapter 9)
Australia-United States FTA 1 January 2005 No
Australia-Chile FTA 6 March 2009 Yes (see Chapter 10)
ASEAN-Australia-New Zealand FTA 1 January 2010 Yes (see, Chapter 11)
Malaysia-Australia FTA 1 January 2013 No

 

Australia’s Stance Regarding ISDS Under New Coalition Government

 

In contrast to the former Labor Government’s policy with respect to ISDS provisions, there has been some indication that the new Coalition Government is supportive of ISDS provisions. Earlier this year, the new Minister for Foreign Affairs stated that:

 

‘The Coalition would, as a matter of course, put ISDS clauses on the negotiating table and then negotiate ISDS provisions on a case-by-case basis’.4

 

Korea’s Stance Regarding ISDS

 

During negotiations regarding the Australia-Korea FTA under the former Labour Government, the unwillingness of Australia to include ISDS provisions in the Australia-Korea FTA was reported to be the primary hurdle preventing the conclusion of the FTA.5 According to these reports, the Korean Government strongly supports the inclusion of ISDS provisions. This appears to reflect the past practice of Korea, which has included ISDS provisions in all of its FTAs (except with the European Union)6, including the recently negotiated Korea-US FTA, which entered into force on 15 March 2012.

 

Scope And Elements Of ISDS Provisions

 

If the Australia-Korea FTA does include ISDS provisions, it is unclear at this stage what those provisions will entail. The scope and elements of ISDS provisions can vary significantly from agreement to agreement.

 

Having said this, the ISDS provisions in the most recent FTAs to enter into force to which Korea is a party (i.e. the Korea-US FTA (15 March 2012), the Korea-Peru FTA (1 August 2011) and the Korea-India FTA (1 January 2010)) and the most recent FTAs to enter into force to which Australia is a party (i.e. the ASEAN-Australia-New Zealand FTA (1 January 2010) and the Australia-Chile FTA (6 March 2009)) are very similar in many respects. All of these FTAs:

 

  • require an investor and the host country to initially seek to resolve their dispute by consultation and negotiation, which can include non-binding, third party procedures (e.g. mediation),
  • allow an investor to submit a claim to arbitration, provided that:
    • the investor has given the host country at least 90 days’ notice of its intent to submit the claim to arbitration before the claim is submitted, and
    • at least six months have elapsed either from (depending on the particular FTA) the date of request for consultation or negotiation or the events giving rise to the claim, and
    • give investors a choice of arbitration under the ICSID Convention (the generally preferred option for investment treaty arbitration), the ICSID Additional Facility Rules, the UNCITRAL Arbitration Rules or any other arbitral rules agreed upon by the parties.
 
Accordingly, if the Australia-Korea FTA does include ISDS provisions, investors could expect to see similar provisions in that agreement.

 

Key Considerations For Foreign Investors

 

For some investors, particularly those with less exposure to political risk, or those with more experience and comfort in the legal system of the host country, the question of whether or not the Australia-Korea FTA includes ISDS provisions may not be a key concern. There may, in any event, be no need at all for concern among investors if the statements made by the Minister for Foreign Affairs reflect an intention on the part of the Coalition Government to include ISDS provisions in all of Australia’s FTAs.

 

However, for other investors, particularly those with medium to long term investments with a higher degree of exposure to political risk, the question of whether the Australia-Korea FTA includes ISDS provisions is likely to be critical. For those investors, it is important to note that, even if the Australia-Korea FTA does not include ISDS provisions, this does not necessarily prevent investors from having recourse to ISDS as a means of directly resolving disputes with host countries through international arbitration. However, it will mean that investors will need to be more creative in the way that they structure their investments if they wish to take advantage of ISDS provisions. For example:

 

  • instead of investing directly into the host country, Australian investors may be able to invest into Korea through an intermediary country that has a trade agreement with Korea containing ISDS provisions, and
  • instead of investing directly into Australia, Korean investors may be able to invest into Australia through an intermediary country that has a trade agreement with Australia containing ISDS provisions.
 

There are, however, limitations on the circumstances in which an investor will be able to benefit from the advantages of ISDS provisions in this way, and investors should be conscious of these limitations when structuring their investments. In particular, investors will need to ensure that:

 

  • they qualify as an ‘investor’ under the trade agreement between the intermediary country and Australia or Korea,
  • their investment meets the definition of an ‘investment’ under the trade agreement between the intermediary country and Australia or Korea, and
  • any other pre-conditions for treaty protection (e.g. host state approval) are satisfied.
 

Endnotes

 

  1. Prime Minister of Australia, Tony Abbott, Press Conference, Brunei, 10 October 2013 (transcript available here).
  2. Australian Minister for Foreign Affairs, Julia Bishop, Address to AustCham Business Breakfast, Seoul, Republic of Korea (speech available here).
  3. Australian Government Department of Foreign Affairs and Trade, Gillard Government Policy Statement: Trading our way to more jobs and prosperity, April 2011 (available here). This policy shift followed in the wake of an Australian Productivity Commission report which weighed the benefits and risks of including ISDS provisions in trade agreements and concluded that ‘it seems doubtful that the inclusion of ISDS provisions … affords material benefits to Australia or partner countries.’
  4. Julia Bishop, Free Trade Focus, 28 March 2013 (available here).
  5. See, for example, Rowan Callick, The Australian, ‘Arbitration issue delays Korea free trade deal’ 14 June 2012 (available here) and Julia Bishop, Free Trade Focus, 28 March 2013 (available here).
  6. There is no investment chapter or investor-state dispute settlement provisions in the Korea-EU FTA because competency for investment matters rests with individual European Union member states.

 

herbert smith Freehills

 

 

For further information, please contact:

 

Leon Chung, Partner, Herbert Smith Freehills
leon.chung@hsf.com

 

Lewis McDonald, Partner, Herbert Smith Freehills
lewis.mcdonald@hsf.com

 

Donald Robertson, Partner, Herbert Smith Freehills
donald.robertson@hsf.com

 

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