Does the draft investment bill threaten foreign investors’ rights?

The JSE Stock Exchange Investment Index last week. If the draft Investment Bill is approved as is, there are concerns that foreign investors will be spooked.
The JSE Stock Exchange Investment Index last week. If the draft Investment Bill is approved as is, there are concerns that foreign investors will be spooked.

South Africa’s approach to regulating the protection of foreign investments and investors has become controversial. It has centered on the future of bilateral investment treaties (BITs), pitting the European Union (EU) against the South African government.

The debate was precipitated by the SA government’s decision to terminate or not renew BITs. Now it is refocusing on the Promotion and Protection of Investment Bill, released on 1 November 2013. A three-month window for public comments on the bill has recently closed.

Regarding BITs the SA government makes several arguments. First, that they afford foreign investors more rights in the SA market than domestic investors who have no recourse to international arbitration. Second, that international arbitration favours corporate interests at the expense of host nation policy space. Since Black Economic Empowerment (BEE) is a core redress policy for inequalities bequeathed by apartheid, and it was challenged in the International Centre for the Settlement of Investment Disputes by a group of Italian investors, it is easy to see why government is concerned.

Third, the SA government argues that the South African Constitution provides sufficient protection against arbitrary expropriation. It also notes that other significant countries have similar concerns: Brazil, which has not implemented its BITs; India, which is reviewing theirs; and Australia which eschewed investor-state dispute settlement in its free trade agreement with the United States (US). Finally, the SA government notes that a number of countries such as the US, Canada, and Australia operate inward investment-screening agencies.

Foreign government concerns over the cancellation of South Africa’s BITs centre on the implications for the legal rights of their companies in the possible event of expropriation. Many foreign investors around the world favour international dispute settlement panels that remove disputes from the host nation’s political and legal systems, offering the prospect of a neutral hearing.

Notwithstanding SA’s succesful transition to democracy in 1994, it is clear some foreign investors retain concerns about SA’s long-term political stability. They point to SA’s domestic politics, particularly the debate over nationalisation that raged within the governing tripartite alliance between 2009 and 2012. That debate coincided with the SA government’s decision to revoke BITs, sparking suspicions that the revocation was a prelude to expropriation.

In the same timeframe, the SA government intervened in Walmart’s planned acquisition of Massmart, obliging Walmart to set up a fund to promote local procurement. During the course of the legal proceedings, revolving around ‘public interest’ concerns, key government ministers made the case for establishing a screening agency that would be empowered to review incoming foreign direct investment (FDI).

This argument reinforced a more general drift towards inward-looking trade and industrial policies, underpinned by BEE policies with their emphasis on increasing black ownership and management control in the economy, and local beneficiation. In the minds of some foreign investors these policies are the thin edge of an expropriation wedge.

The SA government, for the reasons outlined above, does not see the matter the same way. So what trajectory does the Investment Bill take?

Key provisions have to be analysed in order to form a balanced assessment: expropriation, compensation, national treatment, rights of establishment, and dispute settlement. Overall the Bill reflects a government in need of expansive regulatory space for its transformation agenda. However, it is not sufficient to assert key national prerogatives; the way they are framed has to be consistent with domestic and international laws.

The Bill emphasises the principle of ‘public interest’. The SA legal community is divided over what constitutes ‘public interest’.

The South African Institute of International Affairs last month made a submission to the Department of Trade and Industry on the Bill. Since the definition is so elusive, and this principle features centrally in the Bill, our submission recommended that should the SA government insist on using it they should offer a statutory definition in the final legislation. This will give foreign investors more certainty. However, we recommended that the SA government replace this principle with a sounder, internationally acceptable basis on which to screen incoming investments, namely ‘national security’. This would also require careful definition.

Click here to download the full SAIIA submission to the Department of Trade and Industry on the draft Promotion and Protection of Investment Bill.

The Bill states that it should be interpreted in line with customary international law consistent with the Constitution, implying that some customary international law is not consistent with the Constitution. Considering that most customary international investment law principles will run counter to this Bill, SA might find the statute can be challenged at international courts for denial of justice.

In a major diminution of existing rights the Bill removes the right to establishment from foreign investors. Rather than impose a blanket prohibition it better promote investment if the government established a negative list proscribing right to establishment in designated sectors bearing on national security. The presumption should be that FDI is generally beneficial and therefore to be promoted; but in certain cases, closer scrutiny is required. The ‘public interest’ review could be reserved for exceptional cases, rather than as currently framed whereby the Bill appears to license government to screen all incoming investment.

Furthermore, the Bill neglects to explain the procedural dimensions of the screening examination, in particular which state institution(s) would conduct it. Nor is it clear which investments would be screened. The bill specifies very broad criteria against which the investment will be examined, giving some insight into the intentions of the drafters. Unfortunately, they are so broad that one could drive a bus through them. Clearly the framers intended to leave wide scope for government discretion. However that could fuel concerns over the government’s intentions rather than allay fears.

The most important proviso relates to expropriation; especially in SA where proprietary rights occupy politically contested terrain. The Bill codifies customary international law by providing that expropriation is lawful if pursued for a public purpose or interest. It then derogates from customary international law by providing that compensation must be ‘just and equitable’. This standard is in line with the South African Constitution and essentially means compensation the state can afford. Nonetheless, ‘just and equitable’ is a minefield of legal interpretation.

The best compensation standard which now occupies customary international law status, states that compensation must be ‘prompt, adequate and effective’, or market value. This is aimed at eliminating the consequences of the expropriation (restitution). In practice arbitration tribunals and most BITs use market value. Efforts are underway in the international investment arena to find a middle path. Until that path is found it would be prudent to adhere to the market value standard.

Overall, the Bill provides South Africa with a good opportunity to reconfirm its commitment to protecting foreign investment in line with both domestic priorities as well as international obligations. However, we think that the current draft does not do so and requires amendment in a number of areas, as proposed above.

This article is based on SAIIA’s submission to the Department of Trade and Industry on the Draft Promotion and Protection of Investment Bill.