Reforming Investor-State Dispute Settlement (ISDS): Balancing Sovereignty, Investment Protection, and Modern Compliance

The term “international arbitration” has long been associated with cross-border investment, especially in the post-World War II era. Investors sought to seize investment opportunities in other countries, often without having sufficient familiarity with the legal framework of the host state. For this reason, it became necessary to devise a mechanism to settle any future disputes arising from these investments. This mechanism had to be neutral and binding on both parties, and international arbitration emerged as the ideal option for resolving such disputes without undermining the host state’s sovereignty and in accordance with the principles of peaceful dispute resolution in public international law.

On the other hand, some scholars believe that arbitration and state sovereignty can intersect in many situations. Therefore, proponents of this view see the necessity for modern compliance—including environmental, social, and governance (ESG) standards—as a new wave of reform that is both essential and inevitable. In this article, we will highlight the following key points:

• The historical evolution and global context of ISDS.
• Balancing sovereignty with investment protection.
•  Reform Proposals and Inspirations from Global Hubs

The Historical Evolution and Global Context of ISDS

‎The need to establish the International Center for Settlement of Investment Disputes (ICSID) appeared to the middle of the twentieth century when many transcontinental companies obtained investment rights in developing countries, and due to the fact that investment disputes take place between an investor and a host country for investment, and the investor’s mother country if it decides to use diplomatic protection.

Based on the desire of investors to keep this type of dispute away from the political nature, arbitration in investment contracts has been steadily employed, until it has now become the primary means of settling International investment disputes, references indicate that there are now more than 3,000 investment treaties that grant rights to foreign investors and give investors a direct right to claim the host country for any violation of this agreement, and most of these agreements use an arbitration clause. At this stage, the International Centre for Settlement of Investment Disputes (ICSID) was established as a neutral forum for the settlement of investment disputes.

ICSID currently has 153 contracting parties, and ICSID is governed by a Board of Directors consisting of one representative for each Contracting State. It is headed by a chairperson who, among other functions, has the power to appoint an arbitrator if the parties fail to do so. The ICSID does not have a permanent court of arbitration, so a special tribunal must be established for each individual dispute.‎

Reference: Dolzer, R., & Schreuer, C. (2012). Principles of International Investment Law. Oxford University Press.

Balancing Sovereignty and Investment Protection

As mentioned earlier, politics and arbitration can intersect if arbitration mechanisms are not effectively governed to achieve optimal compliance outcomes in accordance with international practices. For example, we cite the case of Philip Morris v. Uruguay, where Philip Morris, a prominent tobacco company headquartered in Switzerland, filed a case in 2010 before the International Centre for Settlement of Investment Disputes (ICSID), claiming that Uruguay’s anti-tobacco laws issued in 2009 violated a bilateral investment treaty between Uruguay and Switzerland. Undoubtedly, this case raised legal questions about the limits of foreign corporations’ rights.

Nevertheless, ICSID ruled in favor of Uruguay, affirming the sovereign right of states to enact laws to protect their citizens, which strengthened the role of international arbitration in defending national policies related to public health.

Moreover, this case resonated internationally in all investment hubs across Europe and the Americas, sparking calls for reform, particularly in enhancing the concept of public health as a priority that surpasses commercial interests. The case also drew global attention to the need for balancing the protection of foreign investments with ensuring states’ sovereign rights.

Furthermore, regulatory approaches in European cities such as Brussels and Amsterdam have significantly evolved to address such cases within bilateral investment treaties. These approaches allow for the adoption of local political measures that meet compliance standards while granting arbitration courts the authority to recognize the legitimacy of public policy goals on a case-by-case basis. This enables investors to assess the risks of investment before proceeding and clarifies the primary boundaries of the relationship between investment rights and public policy objectives.

Reference: Salacuse, J. W. (2020). The Law of Investment Treaties. Oxford University Press.
Reference: UNCTAD. (2021). World Investment Report 2021. United Nations Conference on Trade and Development. Retrieved from UNCTAD website.

4. Reform Proposals and Inspirations from Global Hubs

After reviewing the aforementioned examples, various proposals for reform emerge due to differences in judicial practices and institutional frameworks worldwide. Below are some of the most prominent international trends:

• Enhancing Transparency and Accountability: This proposal is partially inspired by the stringent measures of certain international institutions, such as the European Court of Human Rights (Strasbourg), and the innovative digital transparency initiatives increasingly adopted in legal circles in New York. It aims to implement arbitration procedures that include public hearings and the publication of detailed rulings, as some disputes may directly impact society, whether through public policies or the state’s financial resources as a whole.
• Multi-Tiered Dispute Resolution Mechanisms : The goal of this proposal is to preserve diplomatic channels and reduce the risk of escalation. This view has been echoed in international forums in Geneva and London, promoting mediation as a step prior to full arbitration.

Reference: International Centre for Settlement of Investment Disputes (ICSID). (2022). Recent Trends in ISDS Reforms. ICSID Reports.

6. Concluding Thoughts

In conclusion, I would like to emphasize that dealing with arbitration mechanisms is a specialized process based on principles of consent and contractual agreement. Therefore, it must be approached with care and precision, ensuring that everything is clear and explicitly stipulated in bilateral agreements and arbitration clauses. The examples discussed in this article reflect the broader development of international law adapting to the modern era, where compliance, sustainability, and public accountability are of utmost importance.

The key reform proposals, which have been tested in various contexts from New York to Tokyo, offer the opportunity to restructure the dispute resolution system between investors and states in a manner that respects state sovereignty while maintaining strict protection for investors. Notably, the experience of Saudi Arabia’s new investment law has embraced the most prominent international trends and added a unique national touch that reflects the distinctiveness of the Saudi economy. This aims to bridge the gaps between previous practices and future aspirations in the realm of international arbitration. If you have any questions, do not hesitate to seek your legal consultation with Khalaf Bandar Khalaf.

References:

1. Dolzer, R., & Schreuer, C. (2012). Principles of International Investment Law. Oxford University Press.
2. UNCTAD. (2021). World Investment Report 2021. United Nations Conference on Trade and Development. Retrieved from https://unctad.org
3. Salacuse, J. W. (2020). The Law of Investment Treaties. Oxford University Press.
4. International Centre for Settlement of Investment Disputes (ICSID). (2022). Recent Trends in ISDS Reforms. ICSID Reports.
5. International Institute for Sustainable Development (IISD). (2019). Integrating ESG into International Investment Law. IISD Publications.