PETER LEON: Achilles heel of investment in SA
Draft regulations on dispute resolution with trading partners lack much-needed certainty, writes Peter Leon
During his recent visit to Davos for the World Economic Forum’s annual meeting, Deputy President Cyril Ramaphosa assured investors that SA would "do all in its power to ensure economic policy certainty".
This is an important message as the world grapples with the upending of the post-Second World War liberal economic order and the rise of economic nationalism in major economies such as the UK and the US. A critical element of policy certainty for foreign investors is the predictability and reliability of the dispute-settlement systems to which they have access.
A few weeks before Davos, while most South Africans were on holiday, the trade and industry minister published draft regulations to govern the mediation of investment disputes between foreign investors and the South African government for public comment by January 30. These draft regulations were published under the controversial Protection of Investment Act, passed in 2015 to "replace" various bilateral investment treaties SA has entered into since 1994.
As they stand, the regulations, in effect, give the government a veto over any referral to mediation
Such treaties afford foreign investors strong guarantees against government interference in their business interests and the right to enforce these protections through international arbitration.
Since 2012, the Zuma administration has terminated at least 13 of these treaties (including those with major investor countries such as France, Germany and the UK), arguing that they were weighted unfairly in favour of foreign capital at the expense of domestic industries and the country’s socioeconomic aspirations. The act aims to assure foreign investors that their interests will remain protected under the South African constitution, in the same way as domestic investors.
This regime of equal treatment admits of only one exception (inserted into the act after objections by foreign business chambers). A foreign investor may ask the Department of Trade and Industry to appoint a mediator to facilitate resolution of an investment dispute with the government (in addition to the ordinary right of recourse to domestic courts).
The regulations published in December aim to establish how these special mediation facilities will work. Depending on their final form, they hold the potential to strengthen or further weaken the international community’s confidence in SA as an investment destination.
As a relatively open economy (with exports representing more than 30% of GDP), SA needs to resist this trend if it is to take advantage of 2017’s projected acceleration in global economic activity, which the IMF has forecast after a subdued 2016. As the IMF warns, protectionism and insularity are impediments to foreign investment and will thus prevent SA from achieving its economic potential.
Perceptions of growing economic nationalism in SA’s investment regime may, however, be hard to counter. By terminating most of its bilateral investment treaties, denouncing investor-state arbitration and campaigning for its removal from a recent Southern African Development Community investment treaty, SA has demonstrated a desire to fragment and domesticate international investment law rather than to contribute to multilateral harmonisation or integration.
At the same time, SA has suffered a precipitous decline in foreign direct investment (FDI). In 2015, the UN Conference on Trade and Development reported that SA’s investment inflows fell to their lowest level in 10 years: $1.77bn, which was 69% lower than 2014 ($5.77bn) and 79% lower than 2013 ($8.3bn).
While the World Bank in January noted a welcome upswing in FDI inflows for the first two quarters of 2016, SA remained a net exporter of capital (as its investment outflows exceeded its inflows). For this reason the World Bank stressed that it "remains important for policy makers to stimulate FDI inflows", which in turn "stimulate economic growth".
In redesigning SA’s foreign investment regime, of which the regulations form a key part, it is crucial that foreign investors are assured of access to a familiar, fair and effective system of dispute settlement. In so doing, SA should follow international best practice, such as the investor-state mediation rules approved by the International Bar Association (IBA) in 2012.
As currently drafted, the Department of Trade and Industry’s regulations are missing many vital elements of a credible mediation system. The IBA rules, for example, contain elementary safeguards and guidelines to ensure the competence and independence of mediators, which are absent from the regulations. As a principal player in the process, the mediator’s qualifications are integral to the credibility of the system.
Another shortcoming in the regulations is that they do not prescribe any concrete outcome for mediation, unlike the IBA rules, which envisage a written, signed settlement agreement.
Of greater concern is that (again, unlike the IBA rules) the regulations view mediation in a vacuum, divorced from any potential recourse to investor-state arbitration if it fails. This insular approach strips investor-state mediation of much of its effectiveness. A key driver of good faith participation in mediation, as well as compliance with its outcome, is the risk of a costly and lengthy arbitration, potentially resulting in an adverse award, binding and enforceable anywhere in the world.
Of greater concern is that the regulations view mediation in a vacuum, divorced from any potential recourse to investor-state arbitration if it fails
The most patent error in the regulations, however, is that they are inconsistent with the act itself. The regulations provide that mediation will be available only if the foreign investor and the government "have agreed" to submit their dispute to mediation. No such requirement is imposed by the act, section 13 of which clearly articulates recourse to mediation as a right afforded to foreign investors. As they stand, the regulations, in effect, give the government a veto over any referral to mediation and deprive foreign investors of the only special protection provided by the act.
Under the rule of law doctrine, which is foundational to the constitution, the executive cannot prescribe regulations that are inconsistent with an act of Parliament; in this case the Protection of Investment Act. To the extent that the regulations are unlawful, they must be brought into harmony with the act lest they be susceptible to judicial review.
SA faces a fork in the investment road: the path of protectionism and economic nationalism can lead to economic stagnation, while that of openness and multilateralism drives investment and economic growth. As former US vice-president Joe Biden warned delegates at Davos last week: "Whether we reinforce the ties that bind us, or whether we unravel under the pressure, these choices have to be made about every single nation." As a relatively small but open economy, SA is no exception to this.
• Leon is a partner and Africa co-chairman of Herbert Smith Freehills