No More BITs and Pieces
1 December 2013Without Prejudice
The legal framework governing foreign investments in South Africa
On 1 November 2013 the Promotion and Protection of Investment Bill was published for public comment. The Bill is aimed at consolidating the regulation of all foreign investment into a codified framework as opposed to a plural system of bilateral investment treaties (BITs).
The Bill has received immediate attention from the market, with a number of critics speedily voicing their concerns and suggesting that its promulgation will result in a decrease in foreign direct investment (FDI). While the Bill should not come as a surprise to investors, who have been warned of it for three years now, its provisions contain potentially widespread ramifications for South Africa's status as the "go to" investment destination on the African continent.
What has confused both market commentators and investors is that South Africa has already begun the process of withdrawing itself from a number of important bi-lateral investment treaties (BITs) entered into since apartheid. While most BITs provide for extended protection beyond unilateral termination, it remains perplexing why these have been cancelled before the Bill has even overcome public scrutiny, let alone being passed into law.
This article aims to evaluate South Africa's foreign trade position under a centralised governing scheme as the successor regime to that of a plethora of separate bilateral agreements.
BITs and their Context
A BIT creates a form of protection for foreign investors by ensuring that their respective investments will be regulated and governed in accordance with international rules on investments. Among other things, BITs ensure that host countries' governments do not expropriate investments without fair and adequate compensation, usually market-related, as well as granting foreign investors treatment that is no less favourable than that accorded to domestic investors.
Perhaps the most critical aspect of a BIT is its provision for international dispute resolution, usually through the International Centre for Settlement of Investment Disputes (ICSID), which allows private investors to sue national governments in an international arbitration forum. The use of the ICSID eases investors' concerns of being subject to an unknown and uncertain judicial system.
However, from a host country perspective, BITs invoke a number of undesired complications. The sheer multitude of agreements results in an uncertain and fragmented legislative regime, with different interpretations arising in respect of similar provisions on a constant basis. The confusion that this multifaceted governance framework creates has led the Department of Trade and Industry (DTI) to pursue a more standardised system.
There are currently 36 BITs to which South Africa is a signatory, though only 16 of these have been promulgated into South African law. These numbers were higher before the Minister of Trade and Industries, Rob Davies, announced the withdrawal of treaties with certain European Union countries — Belgium-Luxembourg (October 2012), Spain (August 2013), Germany (October 2013), Switzerland (October 2013) and the Netherlands (November 2013) — a trend that is set to continue until all BITs are eventually terminated.
The EU, through trade commissioner Karel de Gucht, has expressed its unhappiness at this state of affairs. De Gucht recently met with Davies, supposedly in an attempt to retain BITs with EU countries. The EU's concern may well be based on South Africa's current policy of pursuing closer relations with Brazil, Russia, India and China, which suggests a greater reason to establish a comprehensive and uniform legal framework.
It is, however, noteworthy that South Africa is not alone in this trend — Australia, Brazil, Canada, Norway, the USA and Sweden have expressed their intention to review and amend their existing BITs in favour of the host country's interests.
BITs and their Purpose
The purpose of a BIT, especially in the context of a developing country, is to draw in Foreign Direct Investments (FDI). It is argued that multinationals view BITs as a central pillar to their FDI policy owing to the inevitable reduction in transaction costs brought by the strengthening of the legal environment to which their investments are subject.
Confirmation that their investments will not be expropriated without due compensation is seen as a major comfort. This seems to be supported by the negative sentiment that has been expressed by the EU, where De Gucht has been reported as saying the unilateral change of the investment regime was "not good, and is not good for SA".
However, there is empirical evidence against the contention that BITs result in increased FDI. Indeed, in a review of South Africa's BITs conducted from 2007 to 2010, it was confirmed that there was "no clear relationship between BITs and increased FDI inflows" with the review going on to suggest that FDI comes from a number of countries with whom we do not have a BIT (for example, Japan, the USA and India).
It is also argued that BITs are established by countries as the groundwork required for the more influential preferential trade agreements (PTA) to follow suit. However, an examination of South Africa's current PTA network also refutes this contention as there doesn't appear to be any significant correlation between BITs that are enforceable and PTAs that are in places.
The two different schools of thought leave us at a stalemate on whether the alleged economic value of BITs is enough to compensate for the complications which they bring.
The Promotion and Protection of Investment Bill
First, an issue that must be answered by the DTI is how South African investors, who have interests in foreign countries that are counterparties to a current BIT, are to be protected in respect of their investments. For companies such as South African Breweries (SAB), Naspers and others, which have large investment portfolios with signatories to a BIT, does this replacement of BITs with domestic legislation diminish their protection?
Cognisance should particularly be taken in respect of investments by South African companies within Africa. It is very likely that the inbuilt legal protections of countries such as Mauritius and Mozambique offer far less protection to the private investor than the respective BITs that are currently in place. Further clarity from the DTI on this issue should be requested.
Moreover, the Bill includes the following contentious provisions and aspects that are to be considered:
- An investment may not be expropriated without just and equitable compensation;
- The concept of expropriation is defined narrowly;
- Investment disputes may only be referred to South African arbitration or courts;
- Government is entitled to take a number of measures in favour of public interest, which may have a detrimental impact on an investment.
In light of the importance of BITs to multi-nationals, as suggested by De Gucht, it is no surprise that the Bill has already been the subject of market outcry. The concept of "just and equitable" compensation for expropriation will be evaluated against the considerations of the public interest, invoking a firm belief that this amount will inevitably fall below the market value of the investment.
Though this is in line with the Constitutional protection afforded to property rights, foreign investors will require some form of assurance that their investments will receive a reasonable compensation.
Furthermore, the concept of "expropriation" is limited, and excludes, among others, instances where a government measure has an indirect adverse impact on an investment or is introduced to protect public welfare objectives. It is contended that the uncertainty, coupled with the lack of adequate compensation this provision contains, calls for a compromise that must be reached between the legislators and investors.
Critically, the removal of foreign investors' rights to seek relief on a dispute through international arbitration is said to be of major concern to the foreign market.
However, it must be noted that the South African government has only once been taken to the ICSID for an investment dispute — the matter involved the change from old order rights to new order rights brought about by the Minerals Petroleum Resources Development Act, which was greatly attenuated and eventually resulted in an argument in The Hague over costs.*
The submission of this single dispute to arbitration begs the question — is the removal of BITs's such a grave danger? According to Minister Davies, both South African courts and the Arbitration Foundation of South African (AFSA) are considered efficient and well capacitated dispute resolution systems and will certainly provide litigants with a legitimate and credible judiciary.
While it is acknowledged that a neutral territory will always be comforting to a foreign investor, South Africa's judiciary has developed and progressed extensively over the years and should not be seen in the same light as that of many other African states. For these reasons, the removal of an international arbitration mechanism should not act as a deal breaker for investors.
Finally, a degree of uncertainty is created through the entitlement of government to take any measures in favour of public interest. This provision, which is drafted widely, may be read with government's rights of expropriation for the benefit of the public interest. Again, the failure to appropriately compensate investors for expropriation will no doubt act as a deterrent to multi-nationals considering the establishment of their businesses in South Africa.
Notwithstanding Davies' assurances that the Constitution will provide investors with extensive protection of their property, they need to be directly comforted that their investments will be protected to the best degree possible, and that they will be treated fairly and reasonably.
Too soon to panic?
There is no doubt that these contentious provisions will result in a protracted negotiation process between the public and legislators, further delaying the promulgation of the Bill. While this delay will be of concern to investors who are protected by BITs that are already in the process of termination, it must be acknowledged that most BITs provide for an extended protection of investments for 10 to 20 years after termination of the treaty, notwithstanding the provision for retrospective application of the Act. So though new investors may not be so lucky, foreign investors currently established in South Africa will have continued protection under their BITs for some time to come,.
Furthermore the Bill is currently open for public comment until 1 February 2014. Foreign investors are encouraged to use this opportunity to propose alternative mechanisms, which provide a sustainable compromise between government's needs and foreign investors' concerns.
In line with market commentators, it is suggested that two aspects of the Bill need to be addressed:
- The lack of adequate compensation for expropriation — an element of objectivity needs to be instilled in the valuation of "just and equitable";
- The lack of certainty of an investment's security — despite s7 of the Bill (Security of Investment) government needs to make a concerted effort to ensure investors will be treated fairly and reasonably and not unduly deprived of their investment.
When all is said and done, both investors and government require certainty. Switzerland, a non-EU country, though regretting the recent cancellation of its BIT with South Africa, has confirmed that it will continue trade relations provided government establishes a "reliable and equivalent national legal framework for the promotion and protection of investments". The Bill has the opportunity to deliver a well-rounded and balanced governing framework in place of a number of BITs and pieces.
* The International arbitration case was brought in 2007 in terms of the bilateral investment treaties entered into by the SA government with the governments of Belgium, Italy and Luxembourg. Marlin Holdings, Marlin Corporation and Red Graniti (SA) (owned by Italian investors through Finstone, a Luxembourg-based holding company), claimed €266 million compensation for the effective expropriation of their granite mining operations under the MPRDA. The companies had not originally applied to convert their existing "old order" mining rights to "new order" rights as Finstone had not been an investor in the country before 1993 and was not a signatory to the Mining Charter. In 2009, following a settlement with the Department of Mineral Resources (DMR), the DMR converted all the companies' old order rights as the applications "fully met the requirements of the law." Under the settlement, the companies initiated an employee share ownership scheme for 5% BEE ownership and a 21% offset against the Charter's 26% target on the basis of their beneficiation activities, as provided for in the Charter. As a result of this, the companies withdrew their claim. The case heard in The Hague in 2010 thus became one to resolve the issue of costs — Editor