Maria Chiara Malaguti: The Future of Investor-State Dispute Settlement in the New World Order

Investment arbitration has become a cornerstone of international trade and finance, offering a mechanism for resolving disputes between investors and states. This legal framework emerged prominently in the late 20th century. Historically, arbitration was designed to provide Western investors protection when they invested in developing countries with less stable political climates and insufficient legal frameworks. At its core, arbitration sought to prevent unfair expropriation and discrimination against investors who ventured into politically or economically volatile regions.

Fast forward to the 21st century, and the landscape of investment arbitration has evolved. The 2020s, in particular, have seen a surge in arbitration cases as both developed and developing nations now find themselves navigating a complex web of investor-state relationships. Globalisation has resulted in an intricate balance, where states are simultaneously host nations for foreign investments and home countries for investors venturing abroad. This duality creates new challenges in protecting investor rights while safeguarding national sovereignty. As Maria Chiara Malaguti, President of UNIDROIT and a seasoned arbitrator, states, “The world has changed, and the rules that we have should be questioned.”

One of the most pressing issues today is the perceived imbalance between investor rights and the state’s ability to regulate its own affairs. The original intent of investment arbitration was to protect investors from unstable legal systems in host countries. However, in today’s globalised world, many host nations now possess robust regulatory frameworks. This raises the fundamental question: Do they still need special forms of protection for foreign investors, or, Do they need a different approach to handling foreign investors in host countries?

Maria Chiara highlights the changing dynamics: “We are now in a more balanced world where countries are both home and host states simultaneously. The logic behind investment arbitration needs to adapt to this reality.”

Moreover, critics of investment arbitration argue that the system suffers from a lack of legitimacy and consistency. The system is fragmented, as there are multiple panels consisting of different arbitrators and a multiplicity of different treaties, leading to accusations of inconsistency in rulings, with different panels sometimes delivering vastly different judgments on similar issues.

Additionally, arbitrators are typically appointed on a case-by-case basis, often by the very parties involved in the dispute. This raises concerns about conflicts of interest, as arbitrators might be perceived to rule in favour of repeat clients to secure future appointments. Maria Chiara acknowledges these challenges, noting that, “While arbitrators are independent, the legitimacy of the process can be questioned when there is a perceived lack of transparency and consistency in rulings.”

Another critical issue is the disproportionate impact of arbitration on developing countries. Historically, investment arbitration was framed as a tool to protect Western investors from venturing into less stable markets. However, as developing nations grow economically and legally, they often find themselves on the receiving end of arbitration disputes.

For many developing countries, the costs of arbitration can be exorbitant, with legal fees running into the millions of dollars. Furthermore, unfavourable rulings can strain national budgets and divert resources away from essential services like healthcare and education.

The growing emphasis on human rights, sustainability, and climate goals has added complexity to the investment arbitration landscape. Investment treaties historically focused on protecting economic interests, often ignoring environmental and social concerns. Today, however, there is increasing pressure for corporations to uphold human rights standards and contribute to sustainable development, particularly when operating in foreign countries.

Maria Chiara underscores the shift in priorities, stating, “We must ensure that the rules protecting investors also consider the environment and human rights.” One real-world example involves companies operating in countries with lower environmental standards. While these companies may legally comply with the host nation’s laws, they often exploit weaker regulations, leading to environmental degradation and the exploitation of human rights.

This raises another fundamental question: Should foreign investors be held to the same high standards abroad that they adhere to in their home countries? The answer is becoming increasingly clear as international pressure mounts to align investment practices with sustainable, global climate, and human rights objectives.

In light of these issues, there has been growing interest in replacing the traditional arbitration model with a more structured and transparent system: the Investment Court System (ICS). The European Union has been at the forefront of this movement, advocating for the establishment of a permanent court to handle investment disputes.

According to those who propose this model the multilateral investment court would address many of the criticisms leveled at arbitration, including the lack of consistency and conflicts of interest. Unlike ad hoc arbitration panels, the ICS would feature a roster of permanent judges selected through a transparent process. This would enhance the legitimacy and predictability of rulings, providing both investors and states with greater legal certainty.

On the other hand, some still believe that the current mechanism has merits with age. A possible way forward could be to keep the traditional model but then introduce an appeal mechanism, that could offer several advantages over the current arbitration system. First and foremost, it would ensure greater consistency in rulings, as cases would be handled by a permanent judiciary rather than ad hoc arbitrators. This would help to build a body of legal precedents, providing clearer guidance for future disputes.

Both the court and the appellate body would operate under established rules of procedure, reducing the scope for conflicts of interest and ensuring greater transparency in proceedings. This would benefit both investors and states, as it would promote fairness and accountability.

Whenever institutional institutions would finally be selected, there would need to be a system in place that would better align investment protection with broader societal goals, such as human rights and environmental sustainability. This could ensure that foreign investments contribute to sustainable development rather than undermining it.

As Maria Chiara Malaguti aptly observes, “Balancing investor rights with state sovereignty, promoting sustainability, and ensuring transparency are key challenges that lie ahead.”