This essay has been authored by Adeeba Akhlaq and Samidha Shekhar from Symbiosis Law School, Pune. This essay was one of the Top 7 Honorable Mentions in the 2nd RGNUL Arbitration Essay Writing Competition, 2023 organized in collaboration with Centre for Trade and Investment Law (CTIL), Ministry of Commerce and Industry, Government of India.
Introduction
The Intertwined Dynamics of Sovereign Wealth Funds and Investment
In an era marked by unrelenting globalisation and the inexorable march of capital across borders, the junction of Sovereign Wealth Funds and foreign investment has emerged as a critical theatre of economic diplomacy. These companies termed the “titans of global finance,” have enormous financial weight, crossing national boundaries and serving as virtual ambassadors for their host countries. Management and protection of SWFs and foreign investments have become high-stakes diplomatic manoeuvres as governments compete for their place in the new international order.
Complications in this vast narrative of financial globalisation have resulted in a volatile environment where promises of wealth mix with the possibility of disagreements.
Changing Global Landscape and The Emergence of ADR
In a world where the dichotomy between law, economics, and geopolitics is increasingly blurred, alternative dispute resolution is more than just a tool for conflict resolution. It is the core of diplomacy. Our attention goes beyond the simple existence of SWFs and foreign investments internationally. The field of ADR, which is vibrant and constantly transforming, calls to us with its catalytic potential. ADR serves as the silent diplomat, the link-maker, and the peacemaker in a world where conventional norms struggle to restrain the ambitions of global capital.
The Quest to Balance Sovereignty and Global Capital through Innovative ADR
The delicate art of integrating national sovereignty with the ravenous cravings of global capital is a fluid enterprise. Within this dynamic crucible, we are confronted with the need for a more robust, inventive ADR framework, as old procedures may no longer be sufficient in the face of increasingly complicated financial disputes. To cater to the changed environment’s needs, the conventional investment treaty arbitration must change, adapt, and push the boundaries.
The essay delves into the complicated connection between SWFs, foreign investment, and the dynamic world of Alternative Dispute Resolution. It seeks to identify the methods, innovations, and solutions that will create the diplomatic arsenal of the future—a future in which sovereignty and global capital coexist.
Shortcomings of the current Investment Arbitration techniques: The Need for Evolution
In the past few years, though it may seem that parties are largely relying on third-party dispute resolution to resolve international investment disputes, the amount of cases going to ADR is minuscule compared to the ever-rising foreign direct investments. The UNCTAD has identified around 318 disputes which have arisen out of investment treaties in the past five years, whereas there are around 80,000 MNCs with 100,000 affiliates acting as foreign direct investors.[1]
These figures show the true picture of the parties’ reliance on the existing international investment arbitration and the need to innovate ADR techniques to instil confidence in the parties. In the prevailing international investment arbitration, there is inconsistency in the Tribunal’s awards with respect to issues on jurisdiction, procedural requirements and costs owing to the diversity of these tribunals. This inconsistency often results in uncertainty and a disruption of the cost-benefit analysis with which the parties entered the investment arbitration treaty agreement. Lack of mutual expectations of parties often leads to apprehension of bias and loss of confidence in the dispute resolution mechanisms.
On the other hand, the traditional ADR mechanisms lack the capacity to navigate disputes revolving around global capital as these disputes involve complex financial instruments, nuanced regulatory frameworks, and multifaceted geopolitical considerations. Further, in a plethora of cases, there is an inherent power imbalance between foreign investors and sovereign wealth funds/host states. This power asymmetry often compromises the fairness and impartiality of ADR proceedings, which exhibit a systemic bias towards the state’s sovereignty while undermining the interests of the foreign investor. In instances where the sovereign states have a weak rule of law, the foreign investors have to face the repercussions of the inadeptness of state to resolve the dispute fairly. For instance, it might be the case where the domestic law of a state fails to provide the dichotomy between the adjudicators and investigators and the foreign investors maybe wrongly accused even though the government officials are at fault. Likewise, the sovereign state may unilaterally breach the terms of a BIT on public policy grounds[2], change in laws or administrative action in wake of an economic crisis which is not only manifestly unjust to the interests of the foreign investor but will also cause detrimental losses to their business. Consequently, in the case of ADC Affiliates Ltd. vs. Hungary[3], it was ruled that a sovereign state has power to secure its sovereignty rights and state of domestic affairs but this power is not unfettered and has to be implemented in consideration with the international obligations of the state with respect to the investment agreement entered with the foreign investor. Hence, the need for neutral experts is paramount to balance the division of power between the states and foreign investors [4]There is an urgent need to innovate ADR techniques in order to overcome the flaws of the conventional investment treaty arbitration and this can only be made possible by building the capacity of traditional ADR mechanisms to handle complex investment disputes. The States and investors cannot have confidence in the legitimacy of investment arbitration and other dispute resolution techniques unless it produces fair and reasonable outcomes. The parties can be incentivized to utilize dispute resolution mechanisms only when the risks associated with foreign investment are eliminated by Stakeholders.
The Political Agenda of SWFs undermining the Company’s Interests
Sovereign Wealth Funds (SWFs) account for $9 trillion in assets[5] and have gained significant attention in the business press owing to its growing size. The only difference between traditional investors and SWFs is not that the latter is owned and controlled by the State, but there exists a clandestine difference between the objective of the investment. When it comes to SWFs, their objective is not only seeking exorbitant financial returns but also catering to political agendas. This additional objective of SWFs results in them having a detrimental effect on the efficiency and corporate value of the company with SWF ownership. However, plethora of findings indicate that existence of healthy political ties between host countries and SWF countries have alleviated the ramifications arising from political interference as the host countries perceive low risks associated with such SWFs. Bilateral ties are a reflection of the trust that has been established through prior dialogues between the SWF states and the host countries. This perceived notion of trust has the potential to minimize the difficulties in establishing the SWF's moral legitimacy in the host nation and providing the framework for a positive assessment of the SWF investment due to the commonality between the political objectives and goals of the countries. [6]
As the SWFs are majorly controlled by the Government, they give rise to several concerns such as political interference, lack of transparency, coercive diplomacy and obscure intentions. In the recent years, there has been low-return on SWFs investments on government due to which they have begun investing in equities. The ulterior motive of SWFs of political considerations gives rise to the looming threat of destabilizing global financial markets. There have been several accounts of SWFs utilizing their portfolios in order to accomplish their political and social objectives at the expense of the growth and the performance of the company they invest in. One such example is Abu Dhabi’s Mubadla Development company which stated in its annual report that their partnership with computer chip-maker AMD shall deliver “social value to Abu Dhabi”[7] which implies that SWFs can influence the technologies and locations of companies to further their social objectives.
SWFs do not disclose their investment strategies, intentions, and decision-making processes which leads to a lack of transparency. They harbour obscure intentions of breaching “national” security through “pseudo-government” ownership and buying of strategic assets. For instance, the attempt of Chinese Oil Company CNOOC to acquire the US Oil company Unocal was blocked due to concerns raised on “national security and strategic interests” [8] Though, SWFs has tremendously contributed to the increasing the market share of companies, it has also led to disputes in which the companies were disadvantaged due to the existing ADR mechanisms favouring the host state and undermining the interests of the foreign investor.
Multinational Diplomacy at Play: Role in resolving disputes arising out of Foreign Investment
Multinational diplomacy is paramount in resolving disputes arising out of Sovereign Wealth Funds (SWFs) and foreign investments because it encourages open communication and negotiation between states, fosters collaboration, and prevents escalations that could endanger investor companies and the stability of the global economy.
Multilateral diplomacy offers a platform for states to interact positively when national security issues are at stake. Diplomatic channels can allow negotiations on risk mitigation strategies and protections that combine security concerns with economic reasons rather than resorting to unilateral moves that may disrupt investor enterprises. To reach amicable resolutions and to avert drawn-out legal disputes, non-adversarial ADR techniques such as mediation can be employed.
Issues of political interference can be resolved diplomatically by pressuring governments to uphold the rules prohibiting meddling in investor businesses' affairs. Multinational forums like ICSID, UNCTAD, and UNCITRAL can be leveraged to develop standards and regulations that forbid undue political influence on SWFs. When diplomacy is unsuccessful in resolving these disputes, investment arbitration can be used as a last resort by investor companies to seek redress. Moreover, investment treaties and arbitration rules frequently call for the establishment of impartial, unbiased arbitral tribunals, ensuring a fair mechanism for resolving disputes.
Lastly, international collaboration and information-sharing channels can be used to address the lack of transparency in SWF activities. Global initiatives such as the Santiago Principles for SWF governance can be urged to promote increased accountability and transparency.
Reshaping The Horizons Through Case Studies
SWFs, affiliated SOEs, their States of nationality, or their central banks may participate in bilaterally univocal international and domestic investment-related issues. On the one hand, an SWF and SOE may act as claimants before international investment tribunals and, thus, before a domestic court, seeking execution of an arbitral award in its favour, on par with any successful foreign investor claimant. On the other hand, an SWF and SOE may merely act as an applicant invoking a breach of some domestic law for breach of contract or other. In contrast, SWFs, associated SOEs, States of nationality, or central banks may face legal action in domestic and foreign courts for the exact causes. Practise demonstrates that various domestic legal systems adopt different responses under both scenarios[9].
The 2018 battle between the government of United States and the Chinese telecommunication company Huawei, highlighted the lessons of national security concerns, legal framework and multilateral democracy as the US questioned the potential ties of the agglomerate to the Chinese government and raised the espionage concerns, ultimately ‘banning’ their products to balance national sovereignty and global capital[10]. The General Data Protection Regulation (GDPR), introduced by the European Union on the other hand with its extraterritorial application and cross border cooperation regulates the intersection of national sovereignty and global capital in the digital era[11]. These two incidents highlight and emphasizes on the significance of having legal and diplomatic tools that can address the complex challenges arising in the increasingly interconnected world of the 21st century.
Examining models of successful application of ADR mechanisms
The Al Kharafi award in the case of Mohamed Abdulmohsen Al-Kharafi & Sons Co v the Government of the State of Libya and Others[12], has attested to the competency of ADR mechanisms in resolving investment disputes arising between SWFs and foreign investors by balancing global interests and sovereignty. The dispute arose when arbitration proceedings were filed by the Claimant, Kharafi, a Kuwaiti investor company, over a lease contract for a piece of land in Libya, that the Libyan Tourism Development Authority had leased out to establish a tourism investment project. The parties had ratified the Unified Agreement for the Investment of Arab Capital in the Arab States (UAIACAS) by virtue of which they had to seek recourse in the Arab Investment Court in the case of any disputes arising out of in connection to the arbitration agreement. However, the parties had mutually agreed upon to refer the dispute to both the Libyan Law and the UAIACAS. Therefore, the Claimant initially brought a breach of contract claim against the Government of the State of Libya and the Ministry of Economy of Libya and sought a joinder to include the Libyan Investment Authority (LIA) as a party. [13]
The Tribunal applied the Kompetenz - Kompetenz principle to rule that any contradictory elements of the domestic law were superseded by the UAIACAS as it formed an integral component of Libyan law.[14] With regards to the question joinder of LIA, the tribunal held that The Libyan Investment Authority though not a party to the arbitration case, irrespective of whether its investments are located—inside or outside of Libya, was a crucial part of the State of Libya, to which the arbitral award was applicable.
The Norwegian Sovereign Wealth Fund or the Norway’s Government Pension Fund Global (GPFC),one of the largest SWFs in the world with its total assets roughly amounting to US $ 0.5 trillion[15], manages global investments and revenues of the country’s oil and gas.[16] The fund is governed by the Ministry of Finance which not only rebalances the fund but also implements investment strategies, benchmarks portfolios, limits tracking errors and minimizes risk by enforcing risk control measures along with quarterly reporting.[17]
The fund’s success can be attributed to its innovative internal mechanisms for dispute resolution which encompasses adherence to the prescribed ethical guidelines, risk management practices and organizational structure ensuring transparency and accountability. Thus, these mechanisms effectively address potential conflicts while ensuring swift and fair modes to resolve disputes which further bolster the credibility of the fund.
Pitfalls to avoid: Lessons from Failed avenues
The 1MDB controversy featured corruption charges and misuse of billions of dollars from a Malaysian government-owned investment fund.[18] The 1MDB incident demonstrated the value of transparency in SWF operations. Because of the fund's lack of openness, corrupt practices went unnoticed. Inadequate control and accountability procedures within the Malaysian government and the fund aided asset mismanagement and corruption. The scandal encompassed transnational transactions, emphasising the difficulties of coordinating investigations and taking legal actions across borders.[19]
The Future of ADR for SWFs and Foreign Investment Pioneering The New Frontiers
Anticipating Changes and the Digital Age Adaptions
The growth of Alternative Dispute Resolution practises in the twenty-first century must embrace digital transformation. Create cutting-edge digital ADR platforms incorporating blockchain technology for safe data storage and smart contracts for automated dispute settlement. Investments in specialised ADR training for technologists provide real-time translation services to bridge linguistic gaps, and advocating for SWF and foreign investment-specific global investment treaty arbitration standards will be pathbreaking. These twenty-first-century solutions prioritise efficiency, accessibility, transparency, and adaptation, resulting in a more robust and inventive ADR framework for our ever-changing global scene.
Piercing of Veil: SWF and State treated as a single entity
With the advent of SWF-State disputes, enforcement issues in Investor-State arbitration and Commercial arbitration have become rampant, wherein when an attempt is made to enforce an arbitral award or judgment against a SWF holding state assets, they end up claiming state immunity. Though the position on enforcement of an arbitral award against a State with a SWF possessing a distinct legal identity than the State is unclear, the court of enforcement may order to execute a piercing of veil between the SWF and the State entity. [20]
Currently, no internationally binding rules provide for a definitive criterion for piercing the veil. Nevertheless, implementing such a mechanism would mitigate the chances of a SWF from claiming state immunity and would bring enforcement of an award against the state assets held by SWF at an equal footing with the enforcement against a private investor, making the enforcement of awards and judgements much easier.
Alleviating Uncertainties: The Legal and Regulatory Frameworks
Internationally, investment treaty arbitration should be harmonised with prospective effect so that SWFs and foreign investors benefit from consistent and predictable ADR processes across jurisdictions, as well as the promotion of the negotiation of investment treaty arbitration-specific agreements between host governments and foreign investors or SWFs. These agreements can describe dispute settlement methods, increasing legal certainty.
States and investors should be encouraged to invest in developing global efforts that include uniform disclosure and reporting standards for dispute resolution outcomes to ensure transparency and accountability.
The host governments should regularly examine and change their regulatory structures to accommodate emerging alternative dispute resolution practices and technology. Legislative flexibility would stimulate innovation in ADR while protecting sovereignty and autonomy.
Conclusion
A new dawn for investment treaty arbitration
The reinvention of the international investment arbitration for SWFs and foreign investment has emerged as a fundamental issue in our quest for a more efficient diplomatic arsenal. We investigated the concept of ADR 2.0, emphasising the significance of bespoke solutions for complex disputes, adapted to the specific demands of SWFs and adaptable to address sovereignty issues. Collaborative ADR efforts, such as international ADR tribunals and SWF-specific platforms, should be the cornerstone of the new means of global diplomacy. Furthermore, improvements to the legislative environment, particularly transparency, accountability, and the promotion of fair and equitable processes, are critical building blocks for successful ADR in the context of SWFs and foreign investment.
Embracing the Innovations to harmonize Global Capital and SWFs
As we consider the future of ADR for SWFs and foreign investment, we must recognise the constantly changing landscape in which it functions. Anticipating change, using technology, and navigating legal and regulatory developments will be critical as ADR in SWFs and foreign investment enters a new phase. The awareness of ADR's vital role in this evolving global scene emphasises its importance as a powerful diplomatic instrument. We can change the worldwide financial arena. To summarise, the ultimate goal remains the harmonisation of sovereignty and global capital, as we must strive for a balance that respects national autonomy while promoting the adequate circulation of capital.
The intricacies of SWFs, foreign investment, and ADR have been explored in this essay, along with the potential and problems they pose. We all take responsibility for taking note of the lessons discovered, embracing innovation, and paving the way for a world where national sovereignty and global capitalism coexist. The future requires innovation, flexibility, and a firm commitment to the delicate art of balancing sovereignty and global capital—a challenge that, while difficult, bears the promise of a more affluent and harmonious global financial landscape.
ENDNOTES
[1] UNCTAD, “Investor-State Disputes: Prevention and Alternatives to Arbitration II”, 23 https://unctad.org/system/files/official-document/webdiaeia20108_en.pdf
[2] Murtinu S. et al., 2021., Cross-border acquisitions by sovereign wealth funds: A legitimacy-based view., Wiley., pp 888-926.
[3] ADC Affiliates Ltd. vs. Hungary, ICSID Case No. ARB/03/16
[4] Yarik Kryvoi., 2020. Three Dimensions of Inequality in International Investment Law., British Institute of International and Comparative Law., pp 7
[5] Sovereign Wealth Fund Institute, Sovereign Wealth Funds Surpass $9 Trillion in Assets (Sept. 9, 2021) https://www.swfinstitute.org/news/88265/sovereign-wealth-funds-surpass-9-trillion-in-assets
[6] Supra note 2.
[7] Sana Anjum, AMD Announces $622m Investment by Mubadala Development Company, MUBADALA (Nov.16, 2007) https://www.mubadala.com/en/news/amd-announces-622m-investment-mubadala-development-company
[8] Leslie Hook et. al, Cnooc heeds lessons of failed Unocal bid, THE FINANCIAL TIMES (Jul. 24, 2012) https://www.ft.com/content/bd0bc91a-d4e1-11e1-9444-00144feabdc0.
[9]D Gaukrodger, ‘Foreign State Immunity and Foreign Government Controlled Investors’ (2010) 2 OECD Working Papers on International Investment.
[10] Czerwiec, J., 2021. Reprograming Geopolitical Firewalls: Technological Non-Proliferation and the Future of Investor-State Dispute Settlement. ITA Rev., 3, p.57.
[11] Bendiek, A. and Römer, M., 2019. Externalizing Europe: the global effects of European data protection. Digital Policy, Regulation and Governance, 21(1), pp.32-43.
[12] Mohamed Abdulmohsen Al-Kharafi & Sons Co v the Government of the State of Libya and others, CRCICA, Final Arbitral Award, 22 March 2013
[13] Hussein H., et al., 2021. Sovereign Wealth Funds: Transnational Regulation and Dispute Resolution. British Institute of International and Comparative Law, pp. 63.
[14] Ghouri A., 2015. Case Commentary on Mohamed Abdulmohsen Al-Kharafi & Sons Co v the Government of the State of Libya and Others. The Journal of World Investment and Trade, 16(1), pp. 325-333.
[15] Ekeli T. & Amadou SY., The Economics of Sovereign Wealth Fund, International Monetary Fund., pp 107-115.
[16] Clark, G.L. and Monk, A.H., 2010. The legitimacy and governance of Norway's sovereign wealth fund: the ethics of global investment. Environment and Planning A, 42(7), pp.1723-1738.
[17] Id
[18] Kulamadayil, L., 2022. Grand theft in international law. London Review of International Law, 10(3), pp.427-457.
[19] Gomez, E.T., Cheong, K.C. and Wong, C.Y., 2021. Regime changes, state-business ties and remaining in the middle-income trap: the case of Malaysia. Journal of Contemporary Asia, 51(5), pp.782-802.
[20] Hahn A.C., 2012. State immunity and Veil Piercing in the Age of Sovereign Wealth Funds Revue Suisse de Droit des Affaires et du Marché Financier (2), pp. 101-108