Jay Newman is an author and former senior portfolio manager at Elliott Management, where he led its Argentina campaign. Nick Kumleben is energy director at Greenmantle. Richard Carty was Managing Director of Morgan Stanley Principal Strategies and CEO of Bonanza Creek Energy.
Bilateral investment treaties aren’t dead yet, but they need to go. The sooner the better.
BITs once held great promise as a means of attracting foreign direct investment by providing a framework for protecting investors from capricious (or corrupt) decisions by host governments, and fairly, efficiently adjudicating disputes.
They have failed decisively. Countries that are deserving destinations for FDI need to break free from the clutches of a rapacious arbitration-litigation complex. There is a better way.
It began in good faith, in 1959, with a single treaty between West Germany and Pakistan. The original premise made sense. In recognition of the need for foreign investment in long-term projects, host countries would agree to protect investors from a wide range of legal and political risks. Notably: expropriation or assertion of eminent domain (because politicians can be short-sighted and greedy), equitable treatment (because well-connected national champions can be jealous), inconvertibility and repatriation of profits (because cash is king), change of law (because governments can be fickle and regimes change), and denial of justice (because judges are corruptible).
Those treaties — there are now some 2,500 — codified a utopian mechanism for the resolution of disputes: arbitration. It was widely touted that arbitration would be quicker and cheaper than pursuing redress through conventional legal systems like American or English courts. Instead of going to court, claimants would appear, in private, before panels of professional arbitrators (professors, lawyers, retired judges). Arbitrations would be conducted under rules established by tribunals such as the ICC, the ICSID, the LCIA and the SIAC.
The notion of arbitration sounds nice, mutually respectful and kind of friendly — at least, friendlier than suing sovereign states and dragging them into Western courts. Right? In practice, not so much. Rather than being governed by well-established rules of civil procedure, arbitrations came to be governed by increasingly complex and arcane rules established by the tribunals themselves. They are just as partisan, hard fought, slow-moving, and vicious as court battles, but without the public scrutiny, jury trials, or the robust and transparent procedural and ethical protections provided by competent judicial systems.
From the get go, the premise that arbitration would save time and money was false. Arbitrations routinely take years — often a decade — to complete, replete with extensive briefing, frivolous motion practice, and endless opportunities to delay. Even when arbitrations end, they’re not done. Participants can move for reconsideration and ask actual judges at the “seat” to set aside awards. Six, eight, or 10 years after the start, you might end up with a final, non-appealable judgment, but if the sovereign refuses to pay, you could be in for years of expensive litigation to enforce an award — and, as you attempt to domesticate even a “final non-appealable” judgment, end up re-litigating merits questions that had been decided previously.
Worse: denizens of the arbitration industry are motivated to draw the process out as long as possible. For many large law firms, mostly paid by the chronograph, international arbitration is a money-spinner. And it’s not just the lawyers who milk the system: arbitrators are on the clock and have no interest in speedy resolution. Then you’ve got expert witnesses, accountants, investigators, scholars who opine on whatnot — and litigation funders that profit from financing massive bills. All in all: it’s a captive, cosy, insular ecosystem programmed to fleece investors.
It’s no surprise that investors are now passing on projects in some countries, rather than risk ending up in interminable disputes. But where does that leave countries that are on the move? Countries like Argentina that have an extraordinarily negative record for investor protection, but (we hope) show promise.
For sovereigns that are willing to put their money where their mouths are, there is an alternative model. It’s based on an old idea: political risk insurance — but with a couple of contemporary twists.
We call it the Investment Insurance Initiative (3i), and it would work for any country that needs to overcome a chequered past, but has a strong story to tell today about why it should be a trusted destination for FDI.
There are many candidates, but let’s focus on Argentina as a case in point. Except for weak historical adherence to the rule of law, Argentina would be a perfect candidate for massive new foreign direct investment in energy and mining. It has cobalt, copper, nickel, vast reserves of lithium, over 300tn cubic feet of shale gas, and billions of barrels of oil. Until Javier Milei’s government lost decisively in recent provincial elections, foreign investors had been rushing in. One company alone rushed to submit applications for $13bn mining investment over a decade, and investment in the Argentine shale patch has surged.
But it is far from clear whether Argentina will be able to turn its back on inconsistent policies and political corruption. On the plus side, it took over a decade, but Cristina Kirchner was convicted of corruption. And against all odds, Javier Milei has been trying to adhere to orthodox economic policies and abide by a rule of law. Argentina might — or might not — be ready to turn its back on its past: given the recent resurgence of Peronism at the ballot box, change in Argentina’s political culture won’t follow a straight line.
If Milei is intent on keeping investment flowing, he needs to try new ideas — and continue to challenge conventional wisdom.
Here’s one way to keep FDI flowing:
In partnership with a credible economic development finance institution and private investors, Argentina could co-sponsor the creation of a new kind of political risk insurance company: a company dedicated exclusively to fostering new investment in designated sectors of the Argentine economy. Let’s call it A3i.
To prove its seriousness, Argentina would invest a significant chunk of hard currency reserves in A3i — we’re pencilling Milei in for $1bn. An institution such as the US International Development Finance Corporation (DFC) would co-invest alongside Argentina, as would private sector investors.
Here’s the key to A3i’s credibility: Argentina would not be in control of the purse.
The company would be structured as a conventional political risk insurance company, professionally managed, and domiciled in a jurisdiction with deep experience and credibility in insurance, like Bermuda. While control would be vested in a Board of Directors elected by the DFC and private sector investors, as an investor and implicit guarantor, Argentina would have the final say on the types of risks that could be insured against, and the investment sectors that would be covered. Protection against expropriation, change of law or regulation, denial of justice, convertibility and repatriability of capital and profits are high on the list of protections required by foreign investors.
The benefits to Argentina would come in several forms. The availability of political risk insurance coverage would enhance its attractiveness as a destination for new, larger foreign direct investments. Argentina would also earn a higher return on its reserves. If A3i has good loss experience — remember, Argentina controls whether the company incurs losses — A3i will be able to tap capital markets for additional equity, borrow, and perhaps go public. Argentina also benefits by proving that it can be a consistent, reliable destination for FDI. Argentina will see a significant decline in its country risk premium: that will lower its cost of borrowing across the board.
The DFC benefits by helping to stand up a commercial vehicle that can promote long-term US-aligned investments in energy, critical minerals, mineral infrastructure, and technology. Instead of offering gifts or grants, the DFC can leverage its capital by owning equity in a fractional reserve vehicle designed to succeed — a company that will return capital and profits to investors.
For investors, fast-tracking the payout of liquidated damages could take some of the sting out of a breach. That would be a significant improvement over arbitration, which incentivises sovereigns to delay liability and enforcement. As the ongoing refusal by the Kingdom of Spain to satisfy arbitration awards has demonstrated, domestic political considerations trump probity and respect for contractual rights.
Participation by an institution like a DFC should also go a long way towards avoiding denial of justice claims, making the PRI structure even more attractive to investors. The DFC would not only provide its imprimatur by investing, but could help define the direction of A3i by participating in the design of the insurance coverage on offer.
Of course, this is no small “ask” for a sovereign state without a lot of spare cash to apply scarce reserves to a novel plan.
The only way A3i can lose money is if Argentina fails to keep its word. Argentina would be the perfect test case, but our contemporary twist on the political risk insurance model has much broader potential. 3i companies could retake the field from China’s Belt & Road. Many jurisdictions deserving of increased investment would benefit. Why not Chile, the Democratic Republic of Congo, Vietnam, the Philippines, Madagascar, Bolivia, and Guinea? A 3i for each country would increase Western strategic investments and provide much-needed jobs, growth, and opportunity.
Political risk insurance was an important risk mitigation tool before BITs took root. Perhaps it’s time to offer foreign direct investors an opportunity to travel back to the future.
