- The COVID-19 economic crisis has increased the risk of investment disputes in the banking and financial sector, as the economic effects of the crisis spiral and as governments introduce responsive measures.
- International investment protection can mitigate this risk so long as investors in the banking and finance sectors ensure that their investments are properly protected and satisfy certain basic requirements.
- To receive protection from the investment protection system, investors in this sector must ensure that their assets are held by an entity located in a protected jurisdiction and that those assets qualify as a protected investment.
- Careful consideration of an investment’s international protection is particularly crucial for investments made in the international financial services sector due to their often incorporeal nature.
As the COVID-19 pandemic deepens, so do the financial repercussions for foreign investors in the banking and finance sector. Governments have started implementing new regulatory measures across all industry sectors in response to the rapidly developing economic effects of the COVID-19 pandemic. When governments have implemented measures during past crises that injured investors in the banking and finance sector, qualifying investors were able to seek recourse from the international investment protection system. Having recourse to the international investment protection system can make the difference between losing a multimillion or multibillion dollar investment entirely and receiving monetary compensation for related losses.
The risk of such losses during the COVID-19 economic crisis is real. A prior OnPoint in this series explored the risks that banking and finance sector investments are currently facing by reviewing government actions during past financial crises, such as the 2008 Financial Crisis, the 2012-2013 Cypriot financial crisis, and the 2000-2002 Argentine financial crisis. The COVID-19 economic crisis runs the risk of giving rise to many of the same types of government actions that gave rise to international disputes during these and other past crises. The main categories of government actions taken during those past crises have included:
- Sovereign debt default or forced restructuring;
- Restrictive financial regulations;
- Discriminatory bailouts;
- Obligatory bail-ins;
- Restrictions on bank withdrawals; and
- Exchange rates and currency controls.
When the actions of a government — even if nominally well-intentioned — cause injury to a foreign investor or its investment, international investment law provides protection as well as effective means of recourse against the State (i.e., a sovereign state). This body of law, when applicable, regulates and limits the ways in which governmental actions are allowed to impact foreign investors (and certain domestic investors). When these protections are violated, the investor potentially may bring an international arbitration against the State to vindicate its rights, and may enforce the resulting award against the State’s assets, including assets that are held outside of the country where the investment is located.
This OnPoint addresses the circumstances under which investors in the banking and finance sector are subject to international investment protection for the assets they hold, whether in the form of financial instruments (like loans, bonds, or derivatives) or in the form of equity investments in financial institutions (such as subsidiary banks or insurance companies). It then identifies immediate action items that investors may take in order to assess whether their assets are protected by the international investment system.
Investment Treaties and the Investment Protection System
The international system for investment protection is based on an expansive network of international treaties that offer protections for foreign investors and their investments.1 Almost every sovereign state in the world is party to at least one such treaty, and usually many such treaties — most of which provide important investment protections when they apply. These treaties are most often concluded on a bilateral basis (entered into between two states), although some are multilateral (entered into between multiple states).
To receive protection from the investment protection system, a specific investment treaty in this network must cover an investor and its investment. Regardless of the form, each treaty will offer protection to an investor from one of the states that is party to the treaty (the home state of the investor) when that investor has an investment in the territory of another state party (the host state of the investment). For instance, an investment treaty between the Ukraine and Russia would potentially protect Ukrainian investors from the seizure of a bank held in Russia, but would not protect French investors from such a seizure.
Each investment treaty, in addition to specifying the investors and investments that it protects, sets out a specific set of investment protections — protections usually backed by recourse to international arbitration. These investment protections are broadly worded, but have been given teeth by international arbitral tribunals. The most common protections are guarantees of fair and equitable treatment and prohibitions on expropriation without fair compensation. In practice, these protections may prohibit state regulatory actions in the banking and finance sectors when they cross the line from well-intentioned to abusive.
The Basic Requirements for Investment Treaty Protection
Although the specifics vary, investment treaties protect an investor from one state party to the treaty that holds an investment in the territory of another state party to that same treaty. Thus, they usually require that there is a covered investor and a covered investment in a covered location before they will provide investment protection (and recourse to international arbitration). When these requirements are not satisfied, an investment will be left without treaty protection and the investor without international recourse — even if an abusive action causes millions or billions of dollars in loss.
The main requirements for investments and investors in the banking and finance sectors to receive protection of a typical investment treaty are as follows.
Covered Investor: Most investment treaties extend their protection to individuals as well as business entities from one state party to a given treaty that hold a covered investment in another state party to the treaty. In many cases, the covered investor may hold the investment either directly or indirectly, through one or more layers of intermediary corporate entities.
- Individuals: An individual is usually considered to be an investor from a given State if he or she is a citizen of that State to the treaty.
- Companies or business entities: A corporate entity is usually considered to be an investor from a given State if it is formed under the laws of that State. In many cases, the ownership of the corporate entity will not affect whether it qualifies as an investor from a given State. For example, an entity formed in the Dutch Antilles may qualify as an investor from the Dutch Antilles even if it is a wholly owned subsidiary of a U.S. company (or owned by a U.S. national).
Covered Investment: Most investment treaties extend their protection to a range of assets that are held by a covered investor, including property and property rights, shares or equity in corporate entities, claims to money or performance under contract, intellectual property rights, and business concessions. These categories potentially include many of the common assets held by investors in the banking and finance sectors — such as financial instruments (loans, bonds, derivatives) and equity in financial institutions.
The protection for a banking and finance sector investment may be greater still if the investment also bears the hallmarks of a traditional investment, including a contribution of capital, a minimum duration, and some risk. These characteristics are sometimes considered necessary to access arbitration under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (“ICSID”) — a form of arbitration that offers important procedural benefits. While at least one arbitral tribunal has questioned whether financial instruments such as bonds have these characteristics,2 several others have been more favourably inclined to consider them as investments entitled to treaty protection.3 Such issues might be avoided if the financial instruments are issued through an institution incorporated in the host state, rather than directly by a foreign financial institution.
The qualification as a covered investment may be subject to additional pitfalls as well. Certain investment treaties contain carve-outs for certain categories of financial instruments, such as sovereign debt. Others, especially those that are part of broader Free Trade Agreements, reduce or vary protections for the banking and finance sector as a whole, and thereby offer a less desirable source of protection.
Covered Location: Most investment treaties extend protection only to those investments located in the territory of a state party, other than that of the investor. The location is usually straightforward for an investment in a financial institution like a bank or insurance company — it may well be located where its physical operations are or where it is legally established.
However, the location of investments held in financial instruments is not always obvious. Such investments have been considered to be located in the territory of the State that benefits from the investment: “the relevant question is where the invested funds [were] ultimately made available to the host State and [whether] they support[ed] the latter’s economic development . . . .”4 On such a basis, a number of arbitral tribunals have concluded that bank loans, bonds, and even derivatives were located in the place of the beneficiary — even when they had been bought and sold on the secondary market outside of the host state’s territory.5
How Can Banking and Finance Sector Investors Assess Investment Treaty Protection?
Finance and banking sector investors may have limited recourse before the domestic courts for adverse governmental measures, as those courts may be unwilling or unable to review the actions of the executive and legislative branches of government during an economic crisis. It is thus crucial for such investors to determine, before disputes arise, whether their finance and banking sector investments are subject to adequate protection.
In light of the unfolding COVID-19 economic crisis, we recommend that investors take the following actions:
- Assess risk: Banking and finance sector investors should assess the potential risks to their investments as the COVID-19 economic crisis evolves to put increasing pressure on the global financial system. Investors may consult the previous OnPoint in this series where we outline potential state measures that the COVID-19 crisis could trigger. The second half of 2020 is, based on past examples, likely to be a perilous time for investments in the banking and finance sector in particular.
- Assess current coverage: Banking and finance sector investors should assess which, if any, investment treaties currently protect their major investments. They should consider not only investment treaties in force between the host state of the investment and the home state of the corporate entity that directly holds the investment, but also those in force with the home states of parent companies of such entities. Protection may potentially be available under any of these instruments. It is then essential to determine whether a given investor and investment qualify for the protection of a particular investment treaty, per the terms sets forth in its text.
- Assess potential coverage: Banking and finance sector investors should also assess whether any investment treaties may be able to provide protection even in the absence of current coverage (or in the absence of adequate current coverage). When an investment is not currently protected by an investment treaty, it may be possible to satisfy the requirements for protection set out in one or more investment treaties. If the investment is transferred to another entity in the corporate group that is covered by an investment treaty (in compliance with the applicable requirements), the investment may then receive protection from that treaty.
- Assess alternative coverage: Banking and finance sectors investors should finally consider the availability of alternative sources of investment protection, apart from investment treaties. Some host States will have in place foreign investment laws that provide similar protections to foreign investors (including access to arbitration). Absent that, it may be possible to enter into a contractual investment agreement with the host State, especially in the case of major investment projects.
How Dechert Can Help
Dechert’s International Arbitration, Financial Services, International Insolvency Litigation and Financial Restructuring Groups assist clients in assessing the coverage and exposure provided by the international investment protection system, pursuing their rights in arbitration or litigation as necessary, and assisting in protecting their rights. When clients are faced with a dispute, we assist clients by determining the risks and benefits of international arbitration and, where appropriate, by defending their interests through international arbitration or litigation.
1) In some cases, foreign investors and their investments may receive similar protection from domestic investment laws or from contractual investment agreements concluded with the host state.
2) Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/5, Decision on Jurisdiction and Admissibility (4 Aug. 2011), 364-366; Ambiente Ufficio S.p.A. and others v. Argentine Republic, ICSID Case No. ARB/08/9, Decision on Jurisdiction and Admissibility (8 Feb. 2013), 470-471, 483-487; Theodoros Adamakopoulos and others v. Republic of Cyprus, ICSID Case No. ARB/15/49, Decision on Jurisdiction (7 Feb. 2020), 295; Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka, ICSID Case No. ARB/09/2, Award (31 Oct. 2012), 301-304.
3) Poštová banka, a.s. and ISTROKAPITAL SE v. Hellenic Republic, ICSID Case No. ARB/13/8, Award (9 Apr. 2015), 361, 369-370.
4) Abaclat and Others v. Argentine Republic, ICSID Case No. ARB/07/5, Decision on Jurisdiction and Admissibility (4 Aug. 2011), 374.
5) Fedax N.V. v. Venezuela, ICSID Case No. ARB/96/3, Decision on Jurisdiction (11 July 1997), 40; Ambiente Ufficio S.p.A. and others v. Argentine Republic, ICSID Case No. ARB/08/9, Decision on Jurisdiction and Admissibility (8 Feb. 2013), 498-499, 508-510; British Caribbean Bank Limited v. The Government of Belize, PCA Case No. 2010-18, Award (19 Dec. 2014), 206-207; Deutsche Bank AG v. Democratic Socialist Republic of Sri Lanka, ICSID Case No. ARB/09/2, Award (31 Oct. 2012), 282.