Investor State Dispute Settlement in the banking and finance sector

Investment arbitration is becoming increasingly popular amongst banks and financial institutions. This was the conclusion of an ICC Task Force investigating arbitration use amongst financial institutions and other players in the finance sector that reported at the end of last year. Financial institutions, which have traditionally tended to resolve disputes by litigation in jurisdictions hosting recognised financial centres, are turning their attention to international commercial arbitration, and, in appropriate cases, to investment arbitration or Investor State Dispute Settlement (ISDS). In this article, we analyse the relevance of ISDS for financial institutions and seek to identify trends from ISDS cases in the financial sector.

Our blog with commentary on the ICC Task Force’s Report can be found here. For an FAQ on ISDS see our article.

Investment treaties are agreements between states in which they each agree to provide certain minimum standards of protection to investors from the other state when they make investments in the host state jurisdiction. There are over 3,000 such treaties in place globally, and they frequently provide for a range of protections materially beneficial to financial institutions and/or the project companies or investment vehicles through which they may invest.

Investment treaties typically prohibit bias on grounds of nationality, guarantee fair and equitable treatment (FET) and the free transfer of funds, and grant rights to compensation in the event of state expropriation of assets. Protection against state actions that undermine ownership or economic interests are of particular importance to banks and financial institutions. Critically, claims for breach of these protections arise under the treaty in accordance with principles of international law, independently of any contractual claims, and often give rise to a direct right to arbitrate such claims against the host state in a neutral forum. There are a number of procedural frameworks for investment treaty arbitration including

• The International Centre for Settlement of Investment Disputes (ICSID) Arbitration Rules or ICSID Additional Facility Rules
• Ad hoc arbitration (most commonly under the UNCITRAL Rules) or
• Less commonly, proceedings under the rules of a specific arbitration centre such as the International Chamber of Commerce Court of Arbitration (ICC).

There are three substantial reasons for the growing relevance of ISDS to financial institutions.

Substantive investment treaty protection

Firstly, financial institutions and their advisers are increasingly aware of, and structuring their foreign investments or financial instruments in such a way as to avail themselves of, substantive protections available to foreign investors under investment treaties.

Advantages of arbitration

Secondly, investor-state arbitration and arbitration generally are increasingly attractive to financial institutions, with recent reforms addressing some of the disadvantages. For a discussion of international commercial arbitration and its increasing relevance to financial institutions, see Financial institutions and international arbitration in the February 2017 Banking and finance disputes review.

In particular, arbitration offers a neutral forum for dispute resolution. This is particularly attractive in emerging markets where local courts might be perceived as unreliable or susceptible to bias. Such risks become more acute where the host state is a counterparty.

In an ISDS context, there is the additional advantage that whilst proceedings generally take place in private and share many of the procedural advantages of commercial arbitration, such as parties’ involvement in choosing the constitution of the tribunal for example, final awards are generally made public. The risk to the host state’s reputation as a recipient of foreign investment may give an investor negotiating leverage.

Furthermore, arbitral awards are often more readily enforced than court judgments. ICSID awards are subject to the enforcement regime under the ICSID Convention, with compliance linked to access to World Bank funding.

Increased regulation

Thirdly, following the sub-prime and Eurozone crises, many states moved to a more interventionist approach to regulation, including concerted efforts to tighten regulatory frameworks. Typical policy changes include austerity measures, sovereign debt restructuring, regulatory intervention and bank bailouts. This has resulted in significant change in the legal environment for many foreign investors, with financial institutions being amongst the entities most sensitive to increased regulation.

Many of these measures have been taken by states in order to protect global economic stability, in a way not contemplated by the negotiators of investment treaties. Nevertheless, the unprecedented level of state intervention in the financial sector has provided and may yet further provide banks and financial institutions with claims under investment treaties that they would not be able to pursue outside of the ISDS framework.

The three factors set out above can be seen emerging as trends in recent investment arbitrations involving financial institutions.

Most recently, in September 2017, two claims by Austrian banks have been registered by ICSID (Raiffeisen Bank International AG & Raiffeisenbank Austria d.d. v Croatia (ICSID Case No. ARB/17/34) and Addiko Bank AG v Montenegro (ICSID Case No. ARB/17/35)) in the wake of the fallout from the Swiss central bank’s decision to abandon exchange rate controls in 2015. That decision briefly caused turmoil in financial markets by removing caps on the value of the Swiss franc and prompting both Croatia and Montenegro to pass legislation compelling the conversion of franc-denominated loans into Euros. UniCredit has also brought claims.

A decided case stemming from the fall-out and changing regulatory landscape in the wake of the global financial crisis is Poštová banka, a.s. and ISTROKAPITAL SE v. Hellenic Republic (ICSID Case ARB/13/8, Award April 9, 2015). The dispute arose from downgrading of Greek debt from 2009 and the adoption by the Greek government of austerity measures and sovereign debt restructuring, including an exchange of outstanding government bonds for new titles. The claimants brought a claim against Greece for expropriation and breach of the fair and equitable treatment standard in the Slovakia-Greece bilateral investment treaty (BIT).

State bailouts and compulsory administration of banks have also led to a number of investment protection cases. In Bank Melli Iran and Bank Saderat Iran v Bahrain for example, Future Bank was placed into administration by Bahraini authorities in order to “protect the rights of depositors and policyholders”. This led to a claim by the banks under the Bahrain-Iran BIT. Similarly in Hesham Talaat M. Al-Warraq v Republic of Indonesia (Award December 15, 2014) and Rafat Ali Rizvi v Republic of Indonesia (ICSID Case ARB/11/13) claims arose out of the Indonesian government’s bailout of a bank in which the claimants had allegedly invested (involving a similar fact pattern).

A proliferation of investor-state claims has also been triggered by state debt default, the most notable example being those brought against Argentina following that country’s default and debt restructuring including Abaclat and others v Argentine Republic (ICSID Case ARB/07/5, Decision on Jurisdiction and Admissibility August 4, 2011), Ambiente Ufficio S.p.A and others v Argentine Republic (ICSID Case ARB/08/9, Decision on Jurisdiction and Admissibility February 8, 2013) and Giovanni Alemanni and others v Argentine Republic (ICSID Case ARB/07/8, Decision on Jurisdiction and Admissibility November 17, 2014) brought under the Argentina-Italy BIT.

State actions arising out of political instability or transformation have led to recent claims by banks and financial institutions. A recent example of this is PJSC CB PrivatBank and Finance Company Finilon LLC v The Russian Federation (PCA Case No. 2015-21), a case brought before the Permanent Court of Arbitration (PCA) under the Russia-Ukraine BIT. The claimants alleged that Russia had breached its obligations under the BIT by preventing them from operating their banking business in Crimea. Another example is Indorama International Finance Limited v Arab Republic of Egypt (ICSID Case No. ARB/11/32), brought under the Egypt- UK BIT, seeking compensation for a foreign investment in the Shebin al-Kom textile factory, which had been privatised in 2007 during the Mubarak regime. In the wake of the protests that ousted Mubarak in 2011, factory workers occupied the site to protest against working conditions and redundancies. A Cairo administrative court then ruled that the privatisation had been unlawful. Similarly, in Saluka Investments v Czech Republic (UNCITRAL Arbitration Rules, Partial Award March 17, 2006), the dispute arose out of the re-organisation and privatisation of the Czech banking sector to replace the centralised banking system of the Communist period.

In many of these claims, the primary allegation of state liability under the investment treaty is for expropriation without payment of fair compensation. Expropriation can be direct (formal takeover of investment) or indirect (actions equivalent to depriving the investor of the benefit of the investment).

Expropriation claims have also arisen from policies of nationalisation and compulsory acquisition rather than political transformation and reorganisation of the financial sector or restructuring of public debt. Swissbourgh Diamond Mines (Pty) Limited, Josias Van Zyl, The Josias Van Zyl Family Trust and others v The Kingdom of Lesotho (PCA Case No. 2013-29) concerned expropriation of the claimants’ mining leases and KT Asia Investment Group B.V. v Republic of Kazakhstan (ICSID Case ARB/09/8), concerned forced nationalisation of the BTA Bank. In Fireman’s Fund Insurance Company v United Mexican States (ICSID Case ARB(AF)/02/1, award July 17, 2006), brought under the North American Free Trade Agreement (NAFTA), the claimant alleged that the Government of Mexico had expropriated its investment in Grupo Financiero BanCrecer. Similarly, British Caribbean Bank Ltd v Government of Belize (PCA Case 2010-18, Award December 19, 2014) concerned the Government’s compulsory acquisition of the claimant’s interest in certain loan and security agreements.

Recent political change and the growth of nationalistic policies in a number of emerging markets, such as East Africa, as well as in Western markets, suggest treaty expropriation claims will continue to proliferate.

Investment treaties provide crucial substantive protections for banks and financial institutions investing in applicable foreign jurisdictions. ISDS is the mechanism which gives those protections teeth. It is a potential direct route to redress where host states fail to protect foreign investments in accordance with their treaty obligations.

Financial institutions are increasingly availing themselves of ISDS mechanisms to bring high-value claims that would not be available outside the investment protection system. ISDS claims also carry many of the advantages of arbitration as means of resolving disputes. Despite significant current political controversy and calls to reform existing ISDS models, it is likely that this area will continue to grow in importance and that banks and financial institutions will bring an increasing number of claims.