In the autumn of 2013, the Chinese leadership raised the initiative of the Silk Road Economic Belt and 21st Century Maritime Silk Road (One Belt and One Road) ("OBOR"). In 2014, both the G20 Summit and the APEC Economic Leaders' Meeting put infrastructure financing on top of their agenda. On November 8, 2014, Chinese President Xi Jinping announced that China would commit 40 billion U.S. dollars to establish the Silk Road Fund.
OBOR Initiative is not an aid package, nor a foreign direct investment policy, but a development leading plan with the aim of increasing regional connectivity and stimulating trade. China is offering substantial loans on competitive terms to the governments of the countries along the OBOR routes, to finance the development of infrastructure designed to stimulate economic growth and connectivity. Obviously, there are geopolitical considerations, which are not the subject of this article, but the new "Great Game" for influence in the region continues, and another great power retreats into protectionism.
Two new financial institutions were launched in 2014 in China: The Asian Infrastructure Investment Bank ("AIIB"), and the Silk Road Fund. The AIIB will boost investment in Asian infrastructure with an initial capital of almost $100 billion available. The 57 founding member countries signing the Articles of Agreement in June 2015 will be looking to take advantage of their involvement, and the first four projects slated to receive AIIB funds have already been announced, all of which are co-financings with established multilateral lenders.
Most OBOR projects are currently being led by large Chinese state-owned entities ("SOEs") in partnership with Chinese banks. The opportunities for non-Chinese businesses to get involved in OBOR projects vary from region to region. For non-Chinese businesses, there are likely to be many opportunities for legal, financial and technical consultancies, and the potential for joint ventures with Chinese partners with complementary skill sets.
Observers liken the OBOR to the Marshall Plan, the large aid package given by the US government to Western European countries for reconstruction after the Second World War. Although similar in their shared goals for boosting economic growth and trade through infrastructure development, OBOR and the Marshall Plan differ in critical ways. The principal difference is OBOR is not based on aid or even foreign direct investment, but on loan financing. This underscores the importance, for creditors and debtors alike, carefully to factor in risks with OBOR projects
OBOR envisages a silk road from Xian China to Europe and Russia. The maritime route links Fuzhou and Hong Kong with South East Asia, East Africa and Europe. There are 64 countries covered with 900 planned projects. Along the New Silk Road 63% of the world population will be covered, and 30% of the World's GDP.
Many of the countries potentially involved in the OBOR initiative have undeveloped infrastructures, and many have unstable political environments.
Nevertheless, there are huge opportunities for investment in infrastructure and construction and in particular public transportation, mining resources and energy.
When advising a party in relation to a particular project there are a number of risk areas that need to be considered in relation to the host countries. Some of the key considerations will be:
Political risks and stability
- Legal regulatory environment
- Foreign trade issues
- Payment issues
- Labour regulations and markets
- Financial risks/taxes
- Policy changes by government such as currency controls and exchange control
- International sanctions on the host country
- Regime change which will be detrimental to the project
- Terrorism, revolution or civil unrest
Legal regulatory risks
- What licences are needed to operate in the host country?
- What are the local building laws and regulations?
- What permits and approvals are needed for the project?
- What are the host country's environmental laws?
- Is the contract subject to the law of the host country? If so, what are the relevant laws?
Foreign trade risks
- Are there restrictions on the import of materials?
- Are there any trade emOBORgoes relevant to the host country?
- Are there tariffs on certain goods and materials?
- Can you freely remit currency to and from host country?
- Are there exchange controls?
- Currency risk – In what currency will payments be made?
- Are there to be fluctuation payments to take into account inflation?
- Is there relief for non-payment under the contract?
- Contract termination
- Suspension of work
- Are there restriction or quotas for import of labour?
- Is there a sufficiently skilled local labour force?
- Is there an available local labour force?
- What is the cost of labour / the cost of sub-contracting?
What is the tax regime for the host country?
- Income Tax
- Profit Tax
- Import duties on materials
Are there guarantees of payment by the host country?
Project performance risks
- Adverse Ground Conditions
- Impossibility of performance
- Delay to performance
- Difficulties in resourcing labour and materials
- Increased costs of performance
- Ground conditions
Allocation of risks
The project documentation will need to clearly and unambiguously allocate risks to individual parties to the project.
Political risk and changes to the regime or the law – Risk best allocated to host country.
Impossibility risk – Risk best allocated to host country.
Regulatory risk (e.g. permits and approval process) – Risk best allocated to contractor.
Materials and labour risks – Risk best allocated to contractor.
Force Majeure risk – Shared allocation of risk between host country and contractor.
Site access and site conditions risk – Risk best allocated to host country.
Environmental risks – Shared allocation risk between host country and contractor.
Negotiation of risks
All the above-mentioned risks need to be carefully considered and negotiated at the outset.
Contractors need to price for any risks which are placed on them
Insurance should be considered to cover the contractor's risks as far as possible.
Careful due diligence needs to be undertaken on a project by project basis and proper legal advice obtained before entering into binding agreements.
The law of contract is likely to be the law of the host country.
Arbitration in a neutral venue should be specified for all disputes
It is worthwhile for OBOR tenderers to pause and consider the dispute resolution clause very carefully, and decide whether they need to go back to the Employer and /or the Lenders to explain why more thought about the dispute resolution clause might be beneficial to all parties concerned. Some Employers and Lenders will say: "no, we are not changing this clause". But others can be persuaded, perhaps as a trade-off for other concessions.
There is no doubt that dispute resolution clauses on OBOR projects should utilise arbitration as the principal mode for resolving disputes. The court systems in many OBOR countries are too risky. Commercial parties will raise issues of concern what is the applicable law, will the judge be impartial, and will the decision be recognised abroad. International parties prefer arbitration because it is private and confidential, less formal than court proceedings; and easier to enforce in different jurisdictions under the New York Convention. But arbitrate where? And according to the laws of which jurisdiction?
On an OBOR project, it may be thought that CIETAC arbitration in China ("PRC") or arbitration in host country, will be specified. If so it may be advisable to specify a neutral jurisdiction, as the seat of the arbitration, if possible, where the legal environment is pro-arbitration, and supervisory role of the court is trusted.
For governing law, if possible a neutral law should be chosen, e.g. England, Singapore or Hong Kong.
It is advisable to specify an administering arbitration institution and rules. e.g. ICC, HKIAC, SIAC and KLRCA (AIAC). If China law applies, ad hoc arbitrations are not permitted.
The arbitration clause should specify the number of arbitrations, language and seat. It is expected that English will be the default language of the arbitration.
On enforcement, the PRC Supreme People's Court promulgated an opinion in July 2015 stating that Foreign arbitral awards relating to OBOR, should be promptly recognised in accordance with the law.
Investor protection – BITs and MITs
As at July 2017, 55 Bilateral Investments Treaties (BITs) exist between PRC and OBOR nations as well as several Multilateral Investment Treaties (MITs). While these treaties provide a robust source of potential investor protections, they must be understood and carefully planned for by OBOR investors.
BITS are international law instruments – treaties – agreed between two states. MITs are treaties agreed between more than two states. The purpose of BITs and MITs is to create a stable legal environment that fosters direct foreign investment. This is achieved by one contracting party (i.e. the state in which the investment is made) agreeing to provide certain guarantees and standards of protection to the investments of private foreign investors of the other contracting party. With the inclusion of investor State Dispute Settlement (ISDS) mechanisms in these investment treaties, corporate and individual investors may be able to bring claims against OBOR governments for breaches of the substantive rights set out in those treaties. Importantly, investor rights and remedies through ISDS are often in excess of those that a OBOR investor will enjoy under their contract. The independence of this process from domestic legal systems means that BIT and MIT protections are a crucial bulwark against the political and legal risks that OBOR investors are likely to face.
Arbitration mechanisms, whether under contract or treaty, are powerful rights for OBOR investors because they permit investors to enforce their rights without reliance on local procedures or diplomatic means. Notably, the usual dispute resolution method under PRC investment treaties, and ICSID arbitration, allows investors to rely on simplified enforcement mechanisms under the Convention on the Settlement of investment Disputes between States and Nationals of Other States (the "Washington Convention").
Contracting parties to the Washington Convention are required to enforce arbitral awards made under the Convention as though they were final judgments of those states, making enforcement of awards an international law obligation. Fifty-five countries along the OBOR route are party to the Washington Convention and voluntary compliance is the norm, although not always the rule. Nevertheless, concerns surrounding reputation and creditworthiness are likely to continue to encourage OBOR governments' compliance with enforcement.
The number of ICSID cases has dramatically increased over the past three decades, as more investors have become aware of the ICSID dispute resolution system.
Typically, the protections offered in BITs are similar to the protections offered in MITs, but the scope of guaranteed protection offered by each treaty will be set by its wording. Common forms of guaranteed protection include.
- Compensation for expropriation or nationalization of investor's assets by state. Typically, the guarantee covers both direct and indirect expropriation, and additionally prohibits expropriation unless it is for a public purpose.
- Fair and equitable treatment, which creates an obligation to provide a stable and predictable investment environment to act transparently, and to act consistently. Clauses setting out these protections are designed to create a standard of treatment independent of that afforded to domestic investments, which can vary dramatically from state to state.
- This protection extends to how investors are treated in the host state's legal system. In White Industries Australia Limited v Republic of India, for example, our international arbitration team successfully advised White Industries against the Republic of India under the Australia-India BIT, as a result of the failure of India's courts promptly to enforce White Industries' ICC Award. The tribunal ruled that India had violated the Most Favoured Nation ("MFN") provision of the Australia India BIT, because the Indian courts had been unable to resolve White Industries' jurisdictional claim in over nine years ("denial of justice"). MPN clauses allow investments covered by a particular treaty to be afforded the same treatment that the host state would give to any other third state's investments. This allows a OBOR investor to rely on guaranteed protections set out not only in treaties to which PRC and the OBOR countries are parties, but potentially also any other, better substantive protections that any third party country enjoys under the treaty with the OBOR investment hosts state in which the investor is investing.
- Full protection and security, which provides a positive obligation to protect investment by the exercise of reasonable care.
- Non-discrimination. Protection against discriminatory measures e.g. taxes, fines penalties, licences, permits, visa restrictions; and
- "Umbrella clauses". These clauses incorporate into the BIT, by reference, obligations entered into between a host state and investors in other contracts. An example of an umbrella clause can be found in Article 10 of the China-Iran BIT. "Either Contracting Party shall guarantee the observance of the commitments it has entered into with respect to investments of investors of the other Contracting Party." For PRC investors on the OBOR, such provisions provide additional protection and assurance, in that host states undertake to honour investment contracts as their international obligations.
Falling under the scope of "Investment": in order to fall within the scope of a particular treaty, the investment needs to fall within the definition of "investment" under that treaty. Typically, the definition of 'investment' under treaties is broad and non-exhaustive, in the hope of capturing evolving types of investments. The broad definition is often followed by a list of non-exhaustive examples such as tangible and intangible property, capital investments in local ventures (regardless of form through which they are invested) financing obligations, infrastructure contracts. Often, the definition of 'investment' encapsulates not only the primary investment, but also its collateral elements such as loans which may themselves be considered distinct investments. While treaty definitions of investment are often broad, each treaty may also set out requirements that an investment must comply with in order to be afforded protection under the treaty, for example compliance with national law.
The definition of investment has been subject to significant arbitral scrutiny. In Salini v Morocco (ICSID Case No. Arb/00/04 (Decision on Jurisdiction, 23 July 2001), the tribunal identified five criteria indicative of the existence of an investment under the Washington Convention, namely:
- A substantial commitment or contribution to the state;
- Duration (i.e. a certain degree of longevity);
- Assumption of risk;
- Contribution to economic development; and
- Regularity of profit and return.
Subsequent tribunals have applied these criteria flexibly, giving rise to an ongoing debate as to their status. Nevertheless, it is safer for OBOR investors to structure their deals with these criteria in mind so that, if a dispute does arise, they will have a better chance of falling under the scope of "Investment". This will allow them to take advantage of the protections afforded by the investment treaty. If investors take these precautions, they have a good chance of success with the ICSID. Statistics show that 72% of those arbitrations which were heard were decided in favour of investors.
Depending on the scope of application of the treaty, it is possible that guaranteed protections in treaties which did not exist at the time of investment may nonetheless apply to those investments. Typically, guaranteed protections survive for a certain period of time after termination of a treaty.
Being a qualified "investor": It is also necessary that investors are viewed as such for the purposes of the treaty. Typically, natural and legal persons must be nationals of a contracting state in order to rely on benefits set out in a treaty, but such persons cannot be nationals of the host state. Often, the question of nationality of the investor is difficult to answer when complex holding structures are used to invest. Under some treaties, place of incorporation is relevant whereas under other treaties, the place from which substantial control of the investments is directed determines who the investor is, and accordingly what is the investor's nationality.
As of 2015, 32% of all ICSID arbitrations failed at the jurisdiction stage, as claimants did not qualify as an "inventor" for the purposes of the treaty in question. Given that most PRC investment treaties choose ICSID arbitration. OBOR investors need to be aware not only of the existence of BIT/MIT rights but the definitions included under the ICSID convention.
For instance, under Article 25(2) of the ICSID Convention, a "National of another Contracting State" means:
(a) any natural person who had the nationality of a Contracting State other than the State party to the dispute on the date on which the parties consented to submit such dispute to conciliation or arbitration as well as on the date on which the request was registered pursuant to paragraph (3) of Article 28 or paragraph (3) of Article 36, but does not include any person who on either date also had the nationality of the Contracting State party to the dispute; and
(b) any juridical person which had the nationality of a Contracting State other than the State party to the dispute on the date on which the parties consented to submit such dispute to conciliation or arbitration and any juridical person which had the nationality of the Contracting State party to the dispute on that date and which, because of foreign control, the parties have agreed should be treated as a national or another Contracting State for the purposes of this Convention.
OBOR is a huge and ambitious project, and will present tremendous opportunities for investors/contractors. Due diligence about the risks of doing business is critical, as many of the countries involved have challenging political, regulatory and legal environments. Great care is required in drafting the dispute resolution procedures, and the BITs and MITs need careful reviewed for investor protection.