Commercial Awareness Update – W/C 11th July 2022

Rethinking Investor-State Dispute Settlement Through The Investment Agreements Lens

What is the Investor-State Dispute Settlement (ISDS)?

The ISDS clause affects investment and trade agreements and refers to how foreign investors can hold states accountable for corporate loss if any regulations impact it. In other words, the ISDS prevents governments from safeguarding human rights and the environment. Such prevention poses a threat to business, human rights, and environmental agendas.

In demonstrating this, for example, if new legislations are enacted to strengthen corporate accountability, the European Union human rights due diligence law could be disputed by the corporation on its effectiveness and negativity, thereby weakening states’ duty to protect fundamental rights as enshrined in the United Nations Guiding Principles.

Cases To Demonstrate Usage Of ISDS

In the past, tobacco giant Philip Morris engaged the ISDS to sue Australia concerning the introduction of plain packaging on cigarettes. Secretive arbitration panels have dealt with these cases involving international investors, as domestic businesses and citizens are not eligible for such processes.

Recently in the Asia-Pacific region, the treaty gained importance after the rise of Bilateral Investment Agreements (BITs) enforced in the region by different states. However, the BITs containing ISDS clauses caused repercussions; notably affecting most multilateral agreements on the ISDS relating to investment chapters, such as the Regional Comprehensive Economic Partnership (RCEP) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), were negotiated.

The RCEP And The CPTPP

The CPTPP and the RCEP came into force in 2018 and 2020 respectively, helping to shape economics and politics worldwide currently, very likely in the future, and more specifically, in the Asia-Pacific region.

While the RCEP covers the global trade bloc, which deals with 30% of global gross domestic product and is subsequently representative of 2 billion people, the CPTPP represents around 14% of the worldwide economy and half a billion individuals. Both these treaties are essential as they fall within the scope of Free Trade Agreements (FTAs).

Interestingly, the past half-century has seen an exponential increase of BITs in the Asia Pacific. However, the number of BITs acceded to dropped significantly after 2010; a response to the investment treaty issues presented against the Asia-Pacific region. In other words, it resulted in a setback against ISDS.

Responses To ISDS In The Asia-Pacific Region

Australia condemned the ISDS and decided to exclude it from any investment provisions in the future as a response to investor claims in the case of Philip Morris. However, their approach has become increasingly lenient.

Direct foreign investment is a pivotal contributor to economic progress in the Asia-Pacific region and states have developed innovative ways of reforming the system, such as binding interpretative statements rather than completely getting rid of ISDS. These joint interpretation clauses require tribunals to ensure both parties perform joint interpretation of ISDS provisions agreements and the parties’ interpretations are binding on tribunals. An example of such a trade deal is the 2009 Comprehensive Investment Agreement of the Association of Southeast Asian Nations (ASEAN).

However, it is up to the tribunals to decide if they fail to provide it.

Could The Negativity Around ISDS Improve?

The ISDS can be improved through the development of appellate mechanisms in the Asia-Pacific region. Many investment treaty arbitrations have yet to undergo change or review, but some Asia-Pacific investment agreements have tried to adopt the appellate mechanism.

Furthermore, the United States-Singapore Free Trade Agreement (USSFTA) stated in support of reducing the negativity surrounding the ISDS that ‘parties shall strive to reach an agreement that would have an appellate body that a separate multilateral agreement may establish in force as between the parties, review awards’ rendered under the USSFTA.

Thus to conclude, the hostility around ISDS will likely improve with the introduction of investment agreements with economic advantages and excellent dispute resolution.

Article written by Lima Sala

The Importance Of Corporate Governance In Mitigating The Risk Of Misconduct And Enhancing Organisational Performance

The 23rd session of The International Federation of the Red Cross and Red Crescent Societies (IFRC) General Assembly was held in Geneva from June 19 to June 21, 2022. This year’s theme was ‘Local Action, Global Reach’—with members discussing themes such as trust, integrity, and accountability, all being the core tenets of corporate governance. The session focused on exploring how humanitarian organisations and corporations can scale up their efforts to tackle pressing integrity issues to promote sound corporate governance and reduce the risk of internal misconduct.

What Is Corporate Governance And Why Is It Important?

Corporate governance is a system of rules, processes and practices which inform how a company’s board of directors manages and oversees the operations of a company. These include principles of transparency, accountability, fairness, and responsibility.

Corporate governance is crucial in mitigating the risk of fraud, corruption, bribery and enhancing organisational performance. The UK’s 2020 CFA Society study examines how ten governance factors materially affected the financial performance of more than 8,500 companies in 72 countries and overall, such factors can be positively linked to financial performance. Furthermore, corporate governance plays a critical role in building an environment of trust, transparency and accountability necessary to foster long-term investment, financial stability and business integrity. This, in turn, supports more robust growth and attracts further investments.

Sound corporate governance also plays a crucial role in building a company’s reputation. A company’s public image accurately reflects its internal culture. It follows, then, that good corporate governance has to be in the bones and bloodstream of the company since this will be reflected in its culture and, by extension, its reputation.

Poor corporate governance, at best, leads to a company failing to achieve its stated goals and, at worst, to the company’s collapse and significant financial losses for shareholders. Its true impact is illustrated by a 2018 UN press release, which valued the amount lost to corporate misconduct, particularly corruption, at an eye-watering 2.1 trillion pounds annually.

Overall, the failure to effectively implement a zero-tolerance culture on fraud, bribery and other forms of corporate misconduct taints the integrity and reliability of the organisation and creates both internal and external mistrust.

How Does Corporate Misconduct Arise?

The absence of adequate internal controls that ensure authorised transactions are recorded, assessed and analysed, inevitably leads to corporate governance failure and misconduct, providing opportunities for fraudsters to misappropriate company assets. Such failure leads to poor accountability and loss of trust in business partners, donors, and internal staff members.

Lax due diligence in the hiring process is another way corporate misconduct arises. Background checks are a critical risk mitigation strategy in protecting businesses from misconduct, particularly for board members with substantial responsibilities within a company. The absence of background checks and suitable qualification criteria for board members leads to weak board oversight and underqualified board members are often unwilling or unable to set the tone from the top.

Also, unethical leadership typically has a trickledown effect on employees, and thus, the resulting negative corporate culture increases opportunities for misconduct and decreases trust and accountability.

The absence of a ’speak-up’ culture is another risk area. While notable improvements have been observed in the UK (53% of employees say they are aware of their organisation having a ’speak up’ mechanism to report misconduct confidentially, in comparison with 46% in 2018), in its 2021 survey on ethics at work, the Institute of Business and Ethics found that 43% of employees who spoke up against misconduct say that they experienced retaliation as a result. This illustrates the need to instil adequate systems which empower employees to speak up.

What Are The Effects Of Corporate Governance Failure?

Lack of adherence to a company’s governance strategies can result in difficulty raising capital, as the implementation of corporate governance plays an increasingly important role in investors’ decisions. Deviation from such strategies nurtures mistrust amongst the company’s shareholders. Such mistrust erodes any confidence the shareholders had in the business.

The company’s exposure to lawsuits from stakeholders due to varying impropriety is also increased. This could damage the company’s reputation and lead to high legal costs. Corporate governance failure also means a company’s ability to honour its debt obligations may be hindered, thus increasing bankruptcy risks and especially if its creditors embark on a litigious route as means of remedy. A company with a reputation for lack of adherence to such strategies may incur increased government oversight. In summary, corporate governance failure heightens a company’s exposure to legal, regulatory, and reputational risks.

What Are Some Best Corporate Governance Practices?

Good corporate governance practices include conducting due diligence and other precautionary checks before engaging employees to obtain assurance on the individuals and entities companies intend to partner with. Companies can also do more to inform employees about available reporting procedures and mechanisms.

Implementing reliable structures/having a robust, regularly updated framework that the company circulates to all employees is of utmost importance. Frameworks should be broken down into implementable plans and actions to manage bribery and corruption risks. They should offer clear guidance on breach reporting, investigation, and disciplinary procedures. Finally, companies must have a distinct body coordinating compliance and ethics initiatives, including anti-bribery and corruption programmes. Internal and external trust is a by-product of functional procedures implemented and seen to work.

Further, promoting a culture of accountability, integrity, trust and providing adequate training for the company’s staff and business partners ensures all staff members are aligned with the company’s values. Such practices must be carried out from the bottom up, and management must lead from the front and promote open communication. Culture and positive behaviour drive internal compliance and align individual interests with the company’s vision.

Adequate reward plays an essential role in disincentivising employees from resorting to misconduct, therefore ensuring employees are adequately rewarded is critical as it leads to greater employee engagement, thereby increasing retention and creating a positive culture.

Corporations must also take the lead in investigating allegations of misconduct and promptly fixing identified process gaps and system faults that cause a rift between companies and their client base and between companies and their shareholders and partners.

Finally, discontinuing the employment of staff members not fitting in with the company’s culture early should not be downplayed.

Article written by Wanjiru Chigiti

Buy Now, Pay Later Regulation

Last month the government announced it will begin the task of regulating ‘Buy Now, Pay Later’ (BNPL) credit.

The value of BNPL transactions quadrupled through 2020 to £2.7 billion, reflecting its explosive growth during the first year of the pandemic. It is now believed that more than 17 million people are using this largely unregulated service.

BNPL firms such as Klarna and Clearpay offer interest-free short-term loans that enable consumers to spread payments over a number of months and with no rigorous credit checks performed, thereby facilitating a more accessible and cheaper service when compared to, for example, taking out a credit card.

In 2021 the Financial Conduct Authority said there was an urgent need to regulate products. Offering countless BNPL transactions can quickly go wrong, providing the potential for a debt spiral. Many campaigners argue that the main issue is that consumers do not have enough information to make well-informed decisions. Many consumers are unaware that they could accrue hundreds of pounds of debt that mainstream lenders and credit reference agencies have limited access to.

However, last month, Klarna announced it would begin to share data with two major UK credit reference agencies, Experian and TransUnion. Many campaigners have welcomed this recent change as it can help to ensure lenders are aware of any BNPL debts which would have seemingly gone unnoticed.

Arguably the cost of living crisis will only push consumers further toward borrowing. According to research undertaken by the Guardian in June 2022, consumers are now paying off an average of 4.8 purchases. The latter figure had almost doubled since February 2022 when it was reported that consumers were paying off 2.6 purchases. The average outstanding balance is now £254.

Last month, the Treasury announced reforms and regulations of the services which would ensure adverts are clear for consumers. Martin Lewis, the founder of the campaign group MoneySavingExpert.com, has argued that the progress on regulating the service has been ‘painfully slow’. Additionally, Citizens Advice have said that consumers were ‘piling borrowing on top of borrowing and sinking into ever more desperate situations’.

However, stricter rules are unlikely to take effect until 2024. According to the Treasury, this is due to the complexity of the regulations that will require updates to its largely outdated consumer credit laws to simplify rules and cut costs. The reforms will also enable borrowers with complaints to approach the Financial Ombudsman Service.

The need to regulate these services is becoming ever more desperate as the cost of living crisis deepens.

Article written by Maddy Preedy