How European companies can benefit from a US-China Bilateral Investment Treaty, by Timothy P. Stratford, Covington and Burling LLP.

The announcement last summer by Chinese officials that China will negotiate a bilateral investment treaty (BIT) with the United States based on core elements of the US Model BIT is good news―not only for American companies but for European companies as well. Though such a treaty would most directly benefit US investors (including US subsidiaries of European companies), Chinese officials have acknowledged that a US-China BIT will require “fundamental reform of China’s foreign investment regime”, suggesting that systemic changes mandated by the treaty will benefit all foreign investors in China. Moreover, given parallel efforts underway to conclude an EU-China BIT, we can expect that many of the benefits and safeguards included in the US-China BIT will also be reflected in the EU treaty. These developments presage the largest potential new opening of the China market for foreign investors since China entered the WTO in 2001.

However, to take full advantage of this opportunity, foreign investors should assess the current operating environment in China and provide a list of key negotiation priorities to US and EU trade officials, who indeed would welcome such input.  To help facilitate participation of EU Chamber members in this process, we provide below a brief description of the types of issues addressed in the US Model BIT and the current status of US-China negotiations, and then suggest ways that companies can push for reforms of particular relevance to their specific circumstances and industries.

The US Model BIT[1]

The US Model BIT, most recently revised in 2012, is a relatively technical 42-page document that sets forth the obligations each party has towards investors and covered investments of the other party. Investment is defined very broadly to include every asset that has the “characteristics of an investment”, including such characteristics as a commitment of capital or other resources, the expectation of profit or gain and the assumption of risk. Examples include equity interests; construction, management, production and similar contracts; licenses and permits; and intellectual property rights.

The national treatment article provides that parties must accord to investors and covered investments of the other party “treatment no less favourable than it accords, in like circumstances, to its own investors [and investments]” across a broad range of circumstances, including “the establishment, acquisition, expansion, management, conduct, operation, and other sale or disposition of investments in its territory.” Of particular note is the inclusion of “establishment” in this list, which means that the benefit of national treatment applies not only to investments after they are established but also to potential investors during the “pre-establishment” phase. In other words, foreign investors should be able to invest in any industry in China on the same terms and conditions as domestic investors. Any exceptions to a party’s national treatment obligation must be specifically listed in a schedule of non-conforming measures—the so-called Negative List—to be included as an annex to the treaty.

Other Model BIT articles mandate additional protections and safeguards, including, for example, that the parties must permit “all transfers related to a covered investment to be made freely and without delay into and out of its territory”, and that parties cannot impose or enforce performance requirements related to export volumes, domestic content, technology transfers or use of domestic technology. In addition, the Model BIT imposes specific transparency requirements on the parties, and permits “investor-state dispute settlement”, which means that an aggrieved foreign investor may initiate international arbitration proceedings directly against the host country.

The July 2013 Breakthrough

The US and China launched BIT negotiations in 2008 and completed several rounds of constructive technical discussions over the next five years, but little progress was made in resolving major differences regarding certain core elements—including, most notably, the US insistence on “pre-establishment” coverage and adopting the negative list approach. Many observers were therefore caught off guard when China agreed, during the July 2013 US-China Strategic and Economic Dialogue, to accept these two elements as a basis for continued BIT negotiations with the US.

Since July, US-China BIT negotiations have proceeded apace, including two rounds completed thus far during 2014. Bilateral discussions are currently focused on the text of the treaty, while the Chinese side continues the internal process of developing a draft negative list, which they will likely present to the US side by late 2014 or early 2015.

As the negotiations continue, we will likely see a number of measures implemented nationwide—or at least locally on a trial basis—in support of commitments destined for inclusion in the US-China BIT.  Already, the establishment of the China (Shanghai) Pilot Free Trade Zone (CSPFTZ or Zone) has permitted foreign investors to invest under a negative list approvals scheme, and the Zone has featured several sectoral openings likely to be included in the US-China BIT.  However, the US side has made clear that it expects an “extremely different” level of ambition to be reflected in a much shorter negative list for the BIT than the one issued for the CSPFTZ.

How companies can contribute to and benefit from successful BIT negotiations

As American and European trade negotiators prepare for meetings with their Chinese counterparts, they seek and appreciate input from businesses and industry groups regarding issues that should be priorities during the BIT negotiations. To assist with this effort, companies should consider and provide input on the following questions:

What are the priority concerns of my company?

Companies should identify and rank in order of importance the current laws, regulations and regulatory practices that restrict or otherwise hamper their operations in China, including not only specific legal provisions but also unofficial (or unwritten) administrative practices or oral instructions.  For instance, although many industry sectors are open to wholly-foreign owned enterprises, Chinese administrative officials sometimes condition issuance of required operating licenses or other approvals on the establishment of a joint venture with a domestic company, or use other means to favour domestic investors over foreign investors.

Are my company’s concerns included within the intended coverage of the US Model BIT, and should they be covered by the EU-China BIT?

Companies should review the US Model BIT to determine if the priority concerns, identified per question 1 above, fall under the intended coverage of the treaty. If such concerns are not currently addressed in the US Model BIT, and arguably should be, then discussions with US and European negotiators should be initiated, directly or via industry groups, to assess the importance and viability of addressing them.

Are relevant US Model BIT provisions as currently drafted workable and effective within the Chinese context?

China’s economic, political, legal and regulatory systems include a number of unique features that often are not adequately captured by traditional treaty language—as demonstrated by the fact that Chinese WTO commitments have not always been interpreted and implemented in accordance with international expectations. For example, China’s commitment to make judicial review of administrative decisions available to foreign investors has not been helpful in practice, because companies have often lacked confidence in the independence of the judiciary and have feared retaliation by administrators if their decisions were challenged. Taking these sorts of considerations into account, should any modifications be made to Model Treaty language to help ensure that the promised benefits of treaty protections will actually be realised by foreign investors?

Opportunities to help drive fundamental economic reform in China are rare. Companies should position themselves now to capitalise on this opportunity and benefit directly in a new era of Chinese reform and opening.

Timothy Stratford is managing partner of the Beijing office of Covington & Burling LLP, a leading international law firm headquartered in Washington, D.C. with offices in Brussels and London as well as in the US and Asia. He has lived and worked in China continuously since 1982, except for 2005-2010 when he was based in Washington, D.C. and served as the Assistant U.S. Trade Representative responsible for US-China trade relations. Mr Stratford has previously served as Minister-Counsellor for Commercial Affairs at the US Embassy in Beijing, general counsel for General Motors China operations, and chairman of AmCham China. He wishes to thank his associate, Scott Livingston, for assistance in preparation of this article.