This is the second half of a feature delving into how advisors and clients should regard political risk when making decisions.
This is the second part of a feature by Withers, the international law firm, examining how private clients and advisors should consider political risks. The first part of the article can be viewed here.
Investment protection agreements
Into this challenging context comes a very significant international legal instrument which is all too often overlooked by family offices: the investment treaty. Investment treaties are international agreements between sovereign states that aim to promote and encourage investments between them. Investment treaties can be multilateral (such as the Energy Charter Treaty), but bilateral investment treaties between two states (often referred to as BITs) are the most common form. There are over 3,000 investment treaties worldwide.
Although these investment treaties are entered into by sovereign states and operate on the public international law plane (rather than being contracts governed by a designated national law, such as English law), they provide direct rights for international investors which qualify for protection under their terms.
For example, the bilateral investment treaty between the UK and Nigeria gives UK investors in Nigeria the following rights:
These substantive rights are wide-ranging and protect UK investors vis-à-vis the State of Nigeria, which includes the Nigerian government, legislature, courts and regulatory authorities. However, perhaps the most important aspect of investment treaties is one of procedure: the right for investors (in the example given, UK investors) to bring direct international arbitration claims against the host country government (in this case, the Nigerian government) for breaching the substantive investment treaty obligations set out above.
The majority (but not all) investment treaties provide for the resolution of disputes directly between foreign investors and host states through international arbitration. If an investment treaty contains arbitration rights for investor-state disputes, an investor does not need to have a contract with the state providing for arbitration to be able to refer its dispute to international arbitration. The investor needs to follow the procedures set out under the dispute resolution clause of the relevant investment treaty.
Arbitration under investment treaties is often conducted under the auspices of the International Centre for Settlement of Investment Disputes (ICSID), a branch of the World Bank. This framework and the World Bank’s involvement is generally perceived to enhance state compliance with ICSID arbitration proceedings and Arbitral Awards. ICSID has specific rules and procedures for international investment dispute settlement, including by way of investor-state arbitration and a powerful enforcement mechanism.
Given the value of investment treaties to manage political risk, they are routinely considered and utilised by the world’s largest multinationals and private equity companies in making and protecting international investments. Sophisticated international investors also increasingly structure their investments through holding companies and special purpose vehicles established in specific jurisdictions to take advantage of particular investment treaties, alongside other considerations.
To determine whether an investor has the protection of one or more investment treaties, the first stage is to identify whether there is an applicable treaty between the investor’s home state and the host state of the investment. However, the question of whether an investor can rely on a specific treaty, and the arbitration provisions contained in it, depends on the scope and application of the treaty in question. In order to benefit from the standards of protection under a treaty, both the investor and the investment need to qualify under the terms of the investment treaty (which will be defined in the treaty itself). This is where specialist investment treaty protection advice must be sought since every treaty is unique (notwithstanding certain seeming similarities).
The importance of dovetailing investment protection with other considerations in investment structures, including taxation, corporate efficacy and disclosure, can be considerable. An investment structure that takes a holistic approach to all factors that are relevant to the specific circumstances is likely to be optimal.
Diversification of ownership structures is also an important element of political risk minimization planning. In the investment world, diversification is almost always recommended to reduce investment risk. But family offices sometimes fail to consider diversification at the ownership level. Having everything held in a single trust or holding company means that a political risk event can affect the totality of the family’s assets. Safer might be to use multiple structures, and in different locations and of different kinds. Some assets could be held in trusts, and perhaps some in trusts that are designed to limit distributions that can give rise to information exchange. Other assets could be held in insurance arrangements or in other structures. And diversification can also include having different family members owning assets rather than concentrating ownership in one family member.
Location of residence of family members (and their citizenship) also comes into the picture. A family that is diversified in terms of where they live can take advantage of considerable political risk reduction and, in a world of mobility, this is more and more realistic. The UK has, among others, attracted families seeking a safer place to live, albeit that they continue to own and manage businesses in their home countries.
While this requires careful consideration and calibration of different legal specialisms, the net effect can be meaningful: the difference between losing the entire value of an investment or securing market compensation if political risks manifest that would otherwise damage or destroy the value of investments.