ZHAO Hong

Professor of Peking University Law School

Former Chair of the Appellate Body of the World Trade Organization

Dispute Settlement Mechanism

In recent years, the number of investment disputes involving supply chains has continued to increase. The Investor-State dispute settlement mechanism (ISDS) can play a positive role in mitigating these risks. Chinese enterprises may make active use of investment arbitration to safeguard their legitimate rights and interests and enhance supply chain resilience. 

I will begin with the increasingly stringent foreign investment screening (FIS). FIS has brought profound implications for the stability of global supply chains and industrial chains. As the international economic order shifts from the neoliberal one toward a geoeconomic one, the scope of national security has continuously expanded into the field of economic security. In recent years, some countries have not only strengthened FIS at the pre-establishment phase but also introduced retrospective FIS of established investments. Given the political sensitivity of FIS, judicial remedies in host States are often of rather limited value to injured investors, and the international investment arbitration, by contrast, can provide an additional means of limiting losses and it may exercise a certain restraint on measures designated at reshaping supply chains. Even where IIAs contain non-conforming measures or other exclusion clauses intended to exempt FIS review measures from jurisdiction, investors may still invoke IIAs to argue that the host State’s FIS violate treaty obligations concerning non-discriminatory treatment, due process, and other standards, investors may also seek compensation for losses caused by those measures. Investment arbitration may therefore delay unilateral measures to reshape supply chains. In the longer term, however, this effect may gradually weaken as states regain regulatory space in IIAs. First, arbitral tribunals have so far failed to establish a uniform standard of review for security exceptions, leaving their scope of application uncertain. Second, tribunals have become increasingly restrained in reviewing FIS measures. Investment arbitration is increasingly involving self-judging clauses, and the review is gradually being confined to whether the measure was adopted in good faith. Third, the allocation of the burden of proof is unfavorable to investors. Investors bear the burden of proving a lack of good faith, while host States enjoy evidentiary privilege with respect to confidential information involving national security. Investors seeking to rebut a security-exception defense may therefore easily find themselves in an evidentiary dilemma. 

Second, in addition to investment security review measures, policies driven by resource nationalism also affect supply chain stability. Since the beginning of this century, resource-rich States have rapidly increased the number of measures designed to strengthen domestic control over supply chains, including extraction quotas, bans on exports of unprocessed ores, foreign exchange restrictions, localization of industrial chains, nationalization, and revocation of franchise. Such measures may raise the costs of overseas mining supply chains, weaken supply chain resilience, and may violate investors’ legitimate expectations, constitute discrimination or indirect expropriation, or breach prohibitions on performance requirements, thereby giving rise to numerous disputes. Overall, investment arbitration plays a positive role in remedying the adverse effects of such measures. Although investors and host States have each prevailed in different cases, a considerable number of disputes have been settled in order to maintain amicable cooperative relations. Arbitration may imply supply disruption at a critical node, exposure to substantial compensation liabilities, reduced trade volumes along the supply chain, and even harm to upstream and downstream industries. In light of these consequences, host States may delay the implementation of supply chain adjustment measures. In addition, investors often rely on favorable awards to renegotiate with host States and seek the withdrawal of legislation, retention of licenses, preferential commitments, and other concessions, thereby objectively enhancing supply chain resilience. Many Chinese mining enterprises operating overseas are deeply involved in the integration of local industrial chains and possess considerable bargaining power. They may actively consider using existing IIAs to protect their legitimate interests and the security of critical supply chain nodes. 

Apart from this, the negative impact of social risks on supply chain security has become apparent. In recent years, as environmental and human rights concerns have intensified, protests by anti-mining groups and even violent conflicts have frequently occurred, leading governments to revoke mining franchise and, in turn, affecting the supply of critical minerals. Where enterprises suffer losses as a result of social risks, they may invoke IIAs to hold host States liable for breaching FET and FPS obligations and unlawful expropriation, and seek compensation for preliminary construction costs and even expected profits. However, with the advancement of ISDS reform and the deepening influence of sustainable development goals, host States and arbitral tribunals are paying increasing attention to investor conduct. Although controversy remains, the absence of a social license to operate has already had a substantive negative impact on both the merits and quantum. This not only makes claims more difficult, but also indirectly raises the compliance costs of maintaining supply chain stability within the industry. Supply disruptions at critical nodes caused by opposition from local communities are often irreversible. Overseas enterprises should therefore actively consider participating in local governance relating to the protection of human rights and the environment, to obtain a social license to operate, safeguard the stability of investment operations and supply chains, and prevent supply chain risks at their source.