For decades, a commonly held belief among international investment lawyers has been that while bilateral investment treaties (BITs) may not necessarily be crucially important for foreign investment decisions, they have an important indirect effect: BITs lower the price and increase the availability of political risk insurance (PRI), thereby reducing the transaction costs of conducting foreign investments in the developing world and assisting in the stimulation of global investment flows. This view has also been repeated time and again in publications by international organizations such as the United Nations Conference on Trade and Development (UNCTAD), when advising developing countries on the economic rationale behind the treaties.
There is a logical basis for this view. Backed by a powerful enforcement mechanism, BITs provide foreign investors considerable legal protection against political risks, many of which are also covered by PRI. The overlap between the two instruments suggests it would only be natural if PRI providers took BITs into account when assessing the risk of investment projects. But this has never been subject to empirical testing, and a recent survey of the PRI industry indicates that the link between BITs and PRI is rarely considerable in practice.
To uphold the assumption that BITs are crucial for PRI, the standard reference used by academics, practitioners, and international organizations alike has often been the German investment insurance program, where coverage availability is contingent on the existence of an applicable BIT.Although the German program is not alone in this respect, most other programs do not incorporate BITs as a precondition for coverage. In the United States, the Overseas Private Investment Corporation (OPIC) does not “pay much attention to BITs” a senior official noted, and another stated that the existence of BITs is “entirely inconsequential when underwriting risks.” Of course, OPIC is somewhat special among the family of public investment guarantee agencies due to its inter-governmental agreements, which provide for international arbitration of disputes arising under those agreements and allow OPIC to be subrogated to covered investors’ claims. But even programs without such agreements are not too concerned with the existence of BITs. Apart from the German and American programs, I interviewed officials from eight public (or mixed private/public) PRI programs in developed countries, including ECGD (UK), EDC (Canada), EKF (Denmark), NEXI (Japan), SACE (Italy), Austria, Finland (Finnvera), Sweden (EKN), and the Netherlands (Atradius Dutch State Business). All were clear: while some are obliged in their formal guidelines to look to BITs, the treaties rarely had an impact on either premiums or availability. “We do not take BITs into account,” a senior NEXI official noted, “even if there is a BIT, it will not impact the premium compared to a similar country without a BIT.” Similarly, a Dutch official noted that, “BITs can perhaps simplify our analysis in some cases if taken as an indicator that the legal regime is favorable towards the protection of investment. But in practice they are hardly ever decisive.” So although differences among providers do exist, and most find that the treaties can play a role in exceptionally risky jurisdictions, overall BITs are rarely part of the underwriting process in any decisive way.
The Multilateral Investment Guarantee Agency (MIGA) deems a foreign investment to have adequate legal protection if it is covered by a BIT, and the treaties are relevant for other parts of MIGA’s operational regulations as well. Yet, whereas a BIT is a desirable condition for coverage, it is not at all necessary. And, with respect to the pricing of expropriation risk, the existence of an “investment protection agreement” is only one of the 57 rating factors MIGA underwriters have to consider when determining premium rates. Senior MIGA officials noted in interviews that while BITs are undoubtedly a part of the underwriting process, they are far from essential when determining eligibility for MIGA insurance or its pricing. “While we have to look to BITs, they are not important determinants to our perception of the risk of an investment project,” one official noted, and “it is very rare that BITs become crucially important for us in practice.” If countries engage in conduct that signals a scale-back of investor protections—such as withdrawing their consent to submit investment disputes to international arbitration—that would naturally be factored into MIGA’s underwriting decisions. But for developing countries that remain committed to foreign investment and the rule of law, past and current high-ranking MIGA officials confirm that the absence of a BIT rarely impacts pricing or coverage, and is never in itself a sufficient reason for MIGA to withhold a guarantee. As one senior official put it, “cancelling all its BITs would not have a substantial impact on whether, and to what extent, MIGA would be willing to underwrite investments to that country.”
The feedback from private insurers was largely similar. While a few incorporate BITs into their products, for instance by insuring against treaty-based arbitration award defaults, and some occasionally use them as a guiding tool when assessing investment risks, most find BITs largely irrelevant for the underwriting process. “I would be very surprised,” one underwriter noted, “if out of a sample of 10 underwriters any of them would mention BITs as being directly relevant for their risk-evaluations…While the treaties are part of the backdrop to the investment regime, and will be relevant if claims arise, they don’t play any direct role for the ranking or pricing of investment risks.”
Again, cancelling or failing to honor existing BITs is naturally important if it can be taken as a signal that a host country is likely to weaken its investor protections, but for developing countries that treat foreign investors fairly and in a non-discriminatory way, BITs very rarely have a positive effect on private insurers’ underwriting decisions. The typical view appears to be illustrated by this representative: “While they should perhaps have a role to play, I would say they are likely to be considered completely irrelevant by underwriters today and thus irrelevant for the pricing of risk insurance…Rather than having a role in the investment decision, they are just an extra arrow in the lawyer’s quiver on the occasions where disputes arise.”
So while BITs are basically aimed at reducing the risk of investing abroad, insurers that price that risk rarely take them into account. Why might that be? One reason, unfortunately, appears to be ignorance. Just as many investors are still partly or entirely unaware of the existence of BITs, a number of insurance representatives complain that although BITs should be relevant for ranking and pricing political risks, many underwriters have yet to realize their potency. So perhaps the treaties will have a transformative impact on the PRI industry once their risk-reducing potential is more fully realized.
There are, however, reasons to be skeptical whether the treaties will ever be particularly crucial for PRI. If governed by international law and allowing recourse to international arbitration, contracts between investors and governments often provide investors with greater and more tailored protections than BITs can. Also, even among insurers well informed about BITs, there is skepticism about their relevance to risk mitigation because of the protracted nature of BIT arbitration.
Of course, BITs are likely to impact the insurance industry through other channels than coverage availability and pricing. This is particularly so in case of claims. BIT-based arbitration awards provide the foundation for arbitral award default coverage, although that form of coverage demands that the investor endure the considerable time and expense of an arbitral proceeding. But for now, at least, it appears that while BITs may be decisive for some firms and underwriting decisions, they have not had a transformative impact on the global market for PRI. If they ever will remains to be seen. ■
Lauge Skovgaard Poulsen is a Fellow in International Political Economy at the London School of Economics. This article is adapted from Yearbook on International Investment Law & Policy 2009/2010 (Karl P. Sauvant, ed., New York: Oxford University Press, 2010).