91174 Investment Law Reform 2010 A Handbook for Development Practitioners Investment Climate Advisory Services I World Bank Group With funding from FIAS, the multi-donor investment climate advisory service in partnership with INVESTMENT LAW REFORM A HANDBOOK FOR DEVELOPMENT PRACTITIONERS Investment Climate Advisory Services of the World Bank Group June 2010 in partnership with Copyright © 2010 The World Bank Group 1818 H Street, NW Washington, DC 20433 All rights reserved June 2010 The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank Group encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. 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The Organizations (IFC, MIGA, and IBRD), through IC, endeavor, using their best efforts in the time available, to provide high quality services hereunder and have relied on information provided to them by a wide range of other sources. However, they do not make any representations or warranties regarding the completeness or accuracy of the information included in this publication. The findings, interpretations, and conclusions included in this report are those of the authors and do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. Cover photo credits: globe–Patricia Hord Design (also appears on chapter opening pages); photo inserts (left to right)–Robert Achinger; Neil Gould; David Lat; Bazil Raubach. Table of Contents List of Acronyms............................................................................................ vi Preface........................................................................................................ viii Acknowledgments.......................................................................................... x ................................................................................................... 1 Introduction. Focus...................................................................................................................... 1 Goal and Target Users............................................................................................. 2 Methodology........................................................................................................... 2 Content................................................................................................................... 2 .................................... 4 Chapter 1: Key Notions and Typology of Investment. ................................................................. 4 Investment Climate and Investment Policy. Investment Climate............................................................................................ 4 Investment Policy............................................................................................... 4 ............................................................................. 10 International and Domestic Law. Investment Typology .............................................................................................. 10 Public Investment v. Private Investment.............................................................. 10 Direct Investment v. Portfolio Investment............................................................ 12 .......................................................... 13 Foreign Investment v. Domestic Investment. Chapter 2: Pervasiveness, Usefulness, and Limitations .................................................................................... 16 of Investment Codes. Pervasiveness (“To Have and Have Not”)................................................................. 16 Usefulness ............................................................................................................ 18 ............................................................................................................ 20 Limitations. Chapter 3: Preparing an Investment Code: Objective, Scope, Structure, and Characteristics...................................................................... 21 Objective and Scope.............................................................................................. 21 Structure and Characteristics.................................................................................. 22 Preparing an Investment Code in Subnational and Conflict-affected Areas................ 24 Investment Codes in a Subnational Context ..................................................... 24 Investment Codes in Conflict-affected Areas . ................................................... 25 Chapter 4: Considerations for Entry of Foreign Investment........................ 26 Sectors closed to FDI.............................................................................................. 27 Sectors Subject to Limits on Foreign Ownership....................................................... 29 Authorization Requirement for “Strategic Sectors”.................................................... 29 iii ................................................. 31 Screening Requirement for Non-“Strategic Sectors”. Minimum Investment Requirement.......................................................................... 33 Performance Requirements..................................................................................... 35 Chapter 5: Investor Rights, Guarantees, and Obligations.......................... 38 Fair and Equitable Treatment.................................................................................. 38 National Treatment................................................................................................ 41 ............................................................................. 42 Most-Favored-Nation Treatment. .......................................................................... 43 Guarantees Against Expropriation. ........................................................................................ 43 Direct Expropriation. Indirect Expropriation ..................................................................................... 44 ............................................................................... 47 Convertibility and Repatriation. Settlement of Disputes............................................................................................ 49 Other Provisions.................................................................................................... 53 ...................... 53 Boards of Directors, Senior Management, and Entry of Personnel. Armed Conflicts and Civil Disturbances............................................................ 54 Chapter 6: Investment Incentives................................................................ 55 Definition.............................................................................................................. 56 ................................................................................ 56 Types of Investment Incentives. Summary Analysis of Fiscal Incentives..................................................................... 57 Tax Holiday..................................................................................................... 57 Performance-Based Icentives............................................................................ 58 ................................................................................... 59 Export Based Incentives. Regional/Subnational Incentives....................................................................... 59 Conclusions on the Effectiveness of Fiscal Incentives.......................................... 60 Good Practice Principles......................................................................................... 62 Chapter 7: Investment Promotion Intermediaries ......................................................................... 66 and Investment Legislation. Which IPI Provisions Should the Investment Code Include?....................................... 66 Role of the IPI........................................................................................................ 67 .................................................................................................... 69 One-stop Shops. Status and Structure of IPIs..................................................................................... 69 Checklist – Financial Provisions . ............................................................................ 70 Chapter 8: Project Cycle for Investment Law Reform .................................. 73 Evaluating a Government’s Request........................................................................ 73 Looking at the Client....................................................................................... 74 ..................................................................................... 75 Screening the Request. ................................................................... 76 Screening of Existing Policies and Laws. ................................................. 76 Determining Degrees of Engagement and Funding. iv ............................................................... 76 Elements of Small-scale Engagement. Elements of Medium- and Large-scale Engagements ........................................ 77 ........................................................ 77 Pre-field and Field Research (Scoping Mission). Delivery of Report and Project Plan......................................................................... 77 Project Initiation ............................................................................................. 77 Project Planning ............................................................................................. 79 Chapter 9: Supporting the Drafting and Promulgation of the Law............. 80 Challenges in Preparing an Investment Code.......................................................... 81 .................................................................................. 81 Making the Case for Reform. Building Support for and Sustaining Reform through Communications...................... 81 Policy Development and Legislative Drafting............................................................ 84 “Post-enactment” Assistance................................................................................... 84 Chapter 10: Monitoring and Evaluation...................................................... 85 .................................................................................................. 93 Appendices. Appendix 1: Guidance Note: Preparing an Investment Policy Statement ................... 94 Appendix 2: Case Study: Positive Outcomes and Preliminary Impact of Investment Law Reform in Turkey.......................................................................... 103 Appendix 3: Lessons of Experience: Review of Liberia’s FDI Entry Exclusions............ 105 Appendix 4: Assessment and Mission.................................................................... 109 Appendix 5: Template for Assisting in the Evaluation of the Client’s Request........... 110 Appendix 6: Law Assessment Tool......................................................................... 115 Appendix 7: Drafting Guidelines for a New Foreign Investment Law....................... 119 ....................... 127 Appendix 8: Checklist of Issues that a new FDI Law Should Address. Appendix 9: Pre-field and Field Assessment........................................................... 129 Appendix 10: Bibliography................................................................................... 132 v List of Acronyms BIT Bilateral Investment Treaty BP British Petroleum CAFTA Central American Free Trade Agreement CAFTA-DR Central American Free Trade Agreement – Dominican Republic CATIC China National Aero-Technology CEMAC Communauté Economique et Monétaire de l’Afrique Centrale CIT Corporate Income Tax CFIUS Committee on Foreign Investment in the United States DPW Dubai Port World ECT Energy Charter Treaty EPZ Export Processing Zone EU European Union FDI Foreign Direct Investment FET Fair and Equitable Treatment FTA Free Trade Agreement FTC Free Trade Commission (NAFTA) GATS General Agreement on Trade in Services GDP Gross Domestic Product IC Investment Climate Advisory Services ICC International Chamber of Commerce ICJ International Court of Justice vi ICSID International Centre for Settlement of Investment Disputes IFC International Finance Corporation IIA International Investment Agreement IMF International Monetary Fund IPI Investment Promotion Intermediary ISPAT Investment Support and Promotion Agency for Turkey LCIA London Court of International Arbitration M&E Monitoring and Evaluation MFN Most Favored Nation NAFTA North American Free Trade Agreement OECD Organisation for Economic Co-operation and Development OEPC Occidental Exploration and Production Company OSS One-Stop Shop PEP Private Enterprise Partnership P&O British Peninsula and Oriental Steam Navigation Company R&D Research and Development REIO Regional Economic Integration Organizations SCC Stockholm Chamber of Commerce SME Small and Medium-size Enterprises TNCs Transnational Corporations TRIMs Trade-Related Investment Measures UNCTAD United Nations Conference on Trade and Development UNCITRAL United Nations Commission on International Trade Law URA Uganda Revenue Authority VAT Value-added Tax WBG World Bank Group, comprising the World Bank (International Bank for Reconstruction and Development (IBRD) and International Development Association (IDA)), the International Centre for the Settlement of Investment Disputes (ICSID), the International Finance Corporation (IFC), and the Multi lateral Investment Guarantee Agency (MIGA) WTO World Trade Organization vii Preface Laws evolve as societies do. To be relevant and separate and distinct in most countries over effective, laws have to keep pace with global changes decades, have been converging in recent years. The and with changes within the particular societies nature, scope, and level of sophistication of to which they apply. Investment laws are no guarantees to investors have also evolved in recent exception. This “Handbook on Investment Law,” years. Finally, until the recent financial and a welcome contribution prepared by the World economic crises, the overall majority of economies Bank Group, shows the evolution of the field, some expanded the openness of their economy to FDI, 20 years after the publication of the “Legal to the point where, to be more practical and Treatment of Foreign Investment: World Bank investor friendly, “negative lists” − short lists of Guidelines,” developed by the late Ibrahim Shihata, sectors in which foreign investment is regulated or and published in 1993. Since the early 1990s, prohibited − have been replacing “positive lists” − norms and standards of, and investors’ expectations lists of sectors open to FDI. from, investment climates have evolved around the world. The present handbook, written for These three illustrations of the evolution of policymakers, advisors, and practitioners, captures investment laws are a small, partial reflection of the many of those changes and weaves them within evolution of investment policies and investment guidelines based on well-tested good practices seen climate. Indeed, investment laws and their across economies at different levels of development implementing regulations are but the tip of the over the last few decades. investment climate iceberg. There are many definitions to investment climate. Irrespective of One of the major structural changes is the coverage how inclusive or minimalist a definition is, it of both domestic and foreign direct investment encompasses the factor endowment of an economy; (FDI) policies in one investment law. This is not its physical and institutional infrastructure of surprising when one considers that the investment relevance to investment, including its legal system; regimes for domestic and foreign investment, and various socioeconomic policies, particularly its viii investment policy, whether explicit or not. Past attempts at developing a universal model Investment policies reflect what governments seek investment law have failed miserably. This is not from investment for the purpose of meeting surprising. While they need to be in line with global national objectives, as well as the rights and trends and expectations of foreign investors whose responsibilities they assigned to investors and investment domain is theoretically the world, investment. An investment law and its regulations investment laws have also to reflect fundamental are respectively the codification and administrative characteristics of the country, including its implementation of the national investment policy. economic priorities, culture, legal system, and stage It is therefore important that the investment policy of its social and economic development. On the and its corresponding investment law stay in basis of good experiences of many countries over harmony. When the policy experiences a the last few decades, guiding principles for good substantive change, it is good practice for a investment laws have been drawn. This handbook government to amend or rewrite the investment emphasizes those guiding principles, recognizes the law accordingly, lest that harmony is broken to the possibility of using them under different conditions detriment of the national welfare and of investors. and, as illustration, offers various options for good practice. Investment laws are not necessarily the most important laws in a country nor are they high in Whether policymakers or advisors are looking the hierarchy of laws within a national legal for guidelines about what should go into an framework. In addition, the overall majority of investment law or what policy options they may OECD countries do not have investment laws, yet wish to adopt to follow good practice, or law they attract the lion’s share of FDI. So why give drafters are seeking support for a way to craft a importance to investment laws? From an economic clause effectively, they will all find the handbook development point of view, investment laws carry very useful. Their challenge is to produce an their importance on two levels. First, they investment law that is faithful to their national contribute to the quality and characteristics of the priorities and reflects the characteristics of their investment climate because they are part of the country, and at the same time that meets development and expression of a national international standards to be attractive to investors, investment policy package. They are also a focal whether domestic or foreign. They will find the point for the expression of the authorities’ handbook highly useful in meeting that challenge. expectations from, and treatment of, investors. Second, unlike in OECD countries, developing countries’ economic and legal frameworks are still in various stages of development, and public and Joseph Battat private institutions are still maturing. So Former Manager of the investment laws are crucial in that they provide in Investment Climate Advisory Services of the one place a succinct coverage of much of the World Bank Group investment policy of a country and its legal underpinning, as well as a signal that the government is welcoming investment. They help frame the conditions under which a country wishes to attract FDI, FDI being an important source of technology, finance, and know-how, and an avenue to access foreign markets. ix Acknowledgments The publication of this handbook was made Ofori-Atta drafted the communication sections, possible due to the generous support of the Federal Sebastian James and Nathalie Larionov contributed Ministry of Finance of the Government of Austria. to the incentives chapter, and Eduardo Hernandez and Daniela Maria Perovic worked on the M&E This handbook was prepared by the World Bank chapter. The handbook also benefited from the Group’s Investment Climate Advisory Services. review and comments of the following peer Xavier Forneris was the project director as well as reviewers: Joseph Battat, Geoffrey Walton, co-author of the handbook, with Kobina Daniel. Ekaterini Yannaca, Shamali De Silva, Ivan Nimac, The authors worked under the guidance of Marc Reichel, Greg Elms, Peter Kusek, Nina Pierre Guislain (Director IC), Cecilia Sager Mocheva, and Antonia Menezes. (Manager, CICIG) and Robert Whyte (Product Leader). Prof. Jean-Pierre Laviec acted as scientific advisor to the team. Celia Ortega advised the team About the Authors on the production of user-friendly knowledge management tools and contributed to the Mr. Kobina Egyir Daniel is a lawyer and a private investment promotion intermediary chapter. sector development specialist who advises Joelle Maalouf made valuable contributions governments of developing countries on policy throughout the handbook and assisted in the foundations and legal and regulatory frameworks drafting, research and production. Fuad Bateh for private enterprise. Mr. Daniel joined Private made substantial contributions on the country and Enterprise Partnership (PEP) Africa’s rapid response case study examples and complementary research investment climate advisory team (SWAT) in July was done by Deborah Eskinazi. Nana Yaa 2006 and has led World Bank Group legal and x regulatory reform projects in a number of Group. He manages programs and projects African countries. Mr. Daniel is currently the assisting developing-country governments on a International Finance Corporation’s Advisory range of economic, legal, and regulatory reforms. Services Coordinator for Liberia. Xavier Forneris has also been the group’s lead expert on investment law since 2000 and has led or Mr. Xavier Forneris is a lawyer and Senior contributed to investment law reforms in over 40 Investment Policy Officer for the Investment developing and transitioning countries. Climate Advisory Services of the World Bank xi Introduction Focus More specifically, it deals with creating new and reforming existing investment legislation in Investor survey after investor survey, study after developing and transition economies in study, identifies a country’s legal framework as a key furtherance of the WBG’s mandate to promote component of its investment climate and thus of its private investment − domestic and foreign − in attractiveness for private investors, domestic and those economies. foreign. Handbook appendices contain drafting guidelines The legal framework is not the only or most and checklist of issues that FDI laws should important component; the political environment, include and that countries can use when macroeconomic conditions, physical and institu- drafting investment legislation. While including an tional infrastructure, and quality of economic and model investment law might seem useful, we opted tax policies, regulatory processes, and labor market, not to do so for the following reasons: to name but a few other components, all play a role in making a country more or less attractive. n A country’s investment law should reflect its investment policy, its current laws, and so While the Investment Climate Advisory Services forth. Presenting a model law would create the (IC) of the World Bank Group (WBG) provides risk that the country (or the drafters of its expert advice and technical assistance to legislation) would use the model without governments around the world on many of these adapting it to the country context, which components, this handbook focuses on one might result in failure. element of the legal framework for investment: investment legislation. 1 n Previous attempts to present a model invest- Methodology ment law were not successful. Some countries have an investment law that covers both Consistent with its goal and target users, the foreign and domestic investment, whereas handbook is designed to be a practical tool, not an other countries choose to cover only foreign academic treatise. By simplifying underlying direct investment (FDI). This would concepts and terminology of investment law, most necessitate the development of two model sections of the handbook are accessible to laws. nonlawyers. That said, law is a complex, technical topic, and some sections discuss intricate legal issues that are more appropriately left to the lawyers in our audience. Most of the data and information used in the Goal and Target Users handbook come from the 20 years of experience that IC has gained in advising governments in The chief purpose of this handbook is to provide developing countries on how to reform their invest- government lawyers with a framework to evaluate ment policy and legislation and from extensive data the quality of a country’s investment legislation (if it has collected on the various aspects of the legal it exists) and how the legislation relates to its invest- framework for investment. This experience is ment policy and investment incentives. It also pro- complemented by research conducted by the WBG vides practical guidance on how to write new or team and discussion held with outside lawyers. reform existing investment legislation based on emerging “good practices.” Although the starting point for each process is different, the same principles and objectives apply to both. Depending on their respective responsibilities and Content needs, different readers will find what they need in the handbook. While a government official may Chapter 1 defines key terms about investment law only want to better understand the link between reform in an effort to clarify terminology and investment policy, law, and incentives, a legal concepts and show how they are related. drafter or ministry team tasked with drafting legis- lation will need the more detailed information, for n First, the chapter looks at investment climate, instance, the drafting guidelines. Staff in the WBG investment policy, and investment legislation so or other donor agencies who work on private sector that readers understand why governments development might not need to know much about should enact better investment legislation. an individual investor’s rights or guarantees, but Legislation is the key tool for implementing they do need to know how to design an investment investment policy, and investment policy is a legislation reform project in a client country. The core element of the country’s investment cli- project cycle and monitoring and evaluation mate – at some point, a country that wants to chapters might be more useful to WBG staff than adopt a more liberal investment policy to make they are to government legal drafting team. This its investment climate more attractive will have handbook provides such information and to review its investment legislation. One has to guidance. understand the relationship between these three notions and what is considered a 2 “conducive investment policy” if one is to convertibility and repatriation of profits, and prepare good practice investment legislation. settlement of disputes. n Second it discusses international law vs. Chapter 6 looks at the issue of investment incen- domestic law. tives, (fiscal incentives in particular) and their effectiveness. It does not attempt to cover this n Third, it discusses the typology of investments: complex and sensitive issue in detail but it does public v. private, direct v. portfolio, domestic v. touch upon this component of many current foreign investment. This is important because investment laws – even though incentives more investment codes usually cover only private rightly belong in tax and customs legislation. direct investment (not public or portfolio) and some codes cover only foreign, not domestic Chapter 7 summarizes key aspects of investment investment. promotion to guide legal drafters, should policy- makers want the investment code to set out the Chapter 2 examines how widespread investment basic framework of investment promotion. The codes are and explains their utility and limitations. chapter also addresses the alternative approach of writing separate legislation to establish an invest- Chapter 3 provides recommendations on the ment promotion intermediary (IPI). structure of investment legislation and the key pro- visions to be included such as definitions, investors Chapter 8 presents the various phases of invest- guarantees, incentives, framework for investment ment law reform projects, from the government’s promotion, and transitional provisions. This request for assistance with legislation to the delivery chapter also discusses the particularities of the of a project plan. The steps include evaluating the preparation of an investment code in a subnational government’s request to determine the degree of context and in conflict-affected areas. engagement (from a simple desk review, to medium- and large-scale projects) as well as the Chapter 4 discusses the fundamental issue of pre-field and field research. investor entry, in particular the conditions under which foreign investors can invest including Chapter 9 identifies some of the challenges in pre- sectoral restrictions, limitations on foreign paring an investment code and the support ownership, authorization and screening, minimum that governments may need until the law is investment and performance requirements. In promulgated. Issues discussed in this chapter in- many countries, burdensome investor entry clude how to make the case for reform for stake- procedures can constitute a significant barrier to holders and how to support the reform effort investment. through smart use of communication. Chapter 5 discusses key investor guarantees Chapter 10 discusses the monitoring and including fair and equitable treatment, national evaluation (M&E) of investment law reforms, treatment, most-favored-nation (MFN) treatment, including the key indicators involved in a desk protection against expropriation, guaranteed review and medium- and large-scale projects. 3 Chapter 1: Key Notions and Typology of Investment Investment Climate and Investment investment, domestic and foreign, while preserving Policy legitimate national interests. Investment Climate This handbook focuses on one component of the investment climate, the legal framework for private A host of interacting factors determine the quality sector development and, within that framework, of a country’s investment climate. They include the investment legislation. It does not cover the many macroeconomic policy framework, trade policy, other types of legislation that a country needs, their taxation, foreign exchange, land and labor; political quality, or the judicial enforcement of laws. risk and governance; government administration and management of the regulatory process related to commercial activities; legal and judicial Investment Policy frameworks and their ability to protect property, settle disputes, and enforce contracts; and the A country’s investment code cannot be drafted out quality of both the physical infrastructure – power, of context – it must reflect its investment policy. In transportation, and water – and institutional fact, the code is the legislative instrument for infrastructure – educational and banking systems implementing the policy. and civil society institutions. Too many countries put “the cart before the horse”: Different investors will have different views on the Often a government minister asks a lawyer within relative importance of these components of the or outside the government, to draft a “good” invest- investment climate, but, generally speaking, they ment code, without underlying policy guidance. are all important. A country needs to make sure This usually leads to disappointing results. Drafters that each component works well and that together of legislation cannot make policy and should not be they form a coherent system that will attract asked to do so. 4 Instead, before asking lawyers to draft a new invest- ment code or revise the existing one, a government Box 1. Fundamental Investment needs to formulate its investment policy: How Policy Questions for Policymakers open does the country want to be to private invest- ment, particularly foreign investment? Will foreign How open does the government want to be to n investment be allowed in all economic sectors or private investment and particularly to foreign only in some of them? These critical questions are investment? not “legal” issues; they are, however, prerequisites Where can an investor invest – in all economic n to any effort to draft or revise an investment code. sectors or just in certain sectors in which the government wants more competition? Appendix 1, Guidance Note on Preparing an Investment Policy Statement, discusses this issue at Which sectors are to be reserved for national n greater length. (private or public) investment? Why? Will a foreign investor be allowed to own 100 n Once a government has determined how open or, percent of a project or only a certain percentage? Why? in contrast, how restrictive it wants to be, lawyers can draft the legislation, putting the policy into How will foreign investors invest? Will the n legal language. investment have to be screened or be automatic? What important policy questions should a What will be foreign investors’ rights? Will they n be treated like domestic investors? In all government address? respects? The policy questions can be formulated in relatively Will foreign investors be able to transfer their n profits and capital overseas? simple terms, at least on the surface. Essentially, they have to do with who can invest in the coun- Would investors’ projects be susceptible to n expropriation? If so, under what conditions? try, where, and under what conditions. (See Box 1 for illustrative questions that policymakers should What incentives instruments, if any, will the n answer.) The answers, of course, can be more government use to promote domestic and foreign investment into the economy? How is complicated, especially those pertaining to foreign this consistent with the tax policy? investment. This is consistently the most sensitive Will the government put in place a special issue that policymakers and, hence, legal drafters n agency to deal with investors? All investors or face. only foreign investors? Once a government has formulated its overall investment policy or strategy based on issues such as the degree of openness and control or facilitation From a restrictive investment policy (and n it wants to put in place, it has to implement the legislation), with a government ideologically policy. Investment legislation “translates” the policy averse to foreign or all private investment that into legal terms that are actionable including in a erects myriad and fragmented controls, court of law. If the policy is not clear, however, prohibitions, and restrictions, these issues will resurface and hamper the To a “liberal,” or more “open” investment n law-making process. policy (and legislation), the result of a change It also should be noted that policy (and therefore in government, in economic conditions, or legislation) is not a static principle, “carved in when the government considers such policy stone,” but a dynamic element that evolves with the suitable for its economic strategy and country’s political and economic circumstances. development and wants to encourage Over time, a country may shift: economic growth. 5 The policy change can be gradual or more rapid, depending on the country circumstances. Box 2. Benefits of Private and Foreign Investment for a Many developing and transitioning countries have Country’s Economy already made this shift toward facilitation and openness. With policies that provide investors Private capital deployed in a country provides many greater legal security predictability and potential benefits to the recipient economy. In transparency and fewer restrictions, the countries particular it can: actually compete against each other to promote n Allow the reallocation of public resources to and facilitate investment. other needs n Create employment through new or expanded Rationale for Investment Policy Openness projects n Generate tax revenues (in the absence of tax We have noted that investment policy drives holidays) investment legislation (and not the other way n Provide the domestic labor force with new skills around). We need to answer another question: and training Why should developing countries reform their n Improve local management skills (because the investment policy, particularly with respect to economics of expatriate labor creates an foreign investment? incentive for the utilization of local managers) n Provide new technology and know-how transfer In today’s globalized economy, a growing number Accelerate the rate of infrastructure of developing and transition countries have come n development to realize the benefits that can be derived from private investment, including foreign investment, for economic growth and poverty alleviation. take a range of measures. One of the first things Governments wishing to attract FDI can do (and In a country with insufficient domestic investment, should do) is to establish an enabling policy framework foreign investment can provide much needed for FDI. Of course, they need to recognize that the resources through injection of new capital, transfer FDI policy framework is but one of the factors that of technology and know-how, job creation, attract FDI inflows. It is a necessary but not a increased market access, strengthening of the local sufficient condition to influence locational decision. private sector through backward linkages, and so Business facilitation measures –the efficiency and forth. Box 2 summarizes the main benefits of efficacy of the administrative system that impinges on private and foreign investment for an economy. the entry and operations of TNCs (transnational corporations), as well as investment promotion Good Policies, a Necessary but not Sufficient (including incentives available to foreign investors) Ingredient can also influence FDI inflows.” (UNCTAD 1999) It is important to note here that good policies are In other words, investment-friendly policies necessary but not sufficient to automatically promote economic growth by providing a more guarantee increased flows of private investment. In secure and predictable environment in which one the area of FDI for instance, the United Nations can invest in productive business activities. Conference on Trade and Development (UNCTAD) states: Growth patterns of developing countries support the conclusion that facilitative policies serve to “To attract FDI and benefit from it, Governments attract more and better investments. Based on this 6 recognition, developing and developed countries attract and facilitate private investment in general have increasingly moved toward introducing more and FDI in particular; it encourages domestic and open and “market or investor-friendly” policies foreign investors to invest in the country by raising and associated legislation, regulations, and the level of comfort and minimizing uncertainty, administrative practices (UNCTAD 2003) discretion, and ambiguities. A nonconducive policy environment, by definition, discourages “Conducive” Investment Policies investors by not providing the level of comfort they need to invest. This is true in any economy, Now that we have established that (i) investment developed or developing, but it is particularly policy formulation is a prerequisite to investment relevant in a developing country, where investors legislation drafting and that (ii) putting in place have the perception that they are taking greater open investment policies can have a positive impact risks. on economic development, we need to identify the key attributes of such “conducive” policies. Box 3 lists the main determinants of investment including conducive policies. A conducive investment policy is designed to Box 3. Determinants of Investment Economic Market access Size, income levels, urbanization, stability and growth conditions prospects, access to regional markets, distribution and demand patterns Resources Natural resources, location Competitiveness Labor availability, costs, skills, trainability, managerial and technical skills, access to inputs, physical infrastructure, supplier base, technology support Host-country Macro policies Management of crucial macro variables, ease of remittance, policies access to foreign exchange Private sector Promotion of private ownership, clear and stable policies, easy entry/exit policies, efficient financial markets, other support Trade and industry Trade strategy, regional integration and access to markets, ownership controls, competition policies, support for SMEs* FDI policies Ease of entry, access to inputs, transparent and stable policies Multinational Risk perception Perceptions of country risk based on political factors, macro enterprise management, labor markets, policy stability strategies Location, sourcing, Company strategies on location, sourcing of products /inputs, integration transfer integration of affiliates, strategic alliances, training, technology Source: Lall (1997). Note: The fundamentals of attracting FDI can also be extended to attracting sustained domestic investment. * SME=small and medium enterprises 7 Substantive Qualities of Conducive Policies economies, several countries have eliminated various restrictions to FDI entry. Box 4 lists two As stated above, conducive investment policies are examples of such reform in the East Africa region. those that support and enable private investment, including foreign investment. They ensure ease of Although none of the world’s largest FDI market entry and exit and access to inputs investors recipients, which include Brazil, China, India, and need. They impose few restrictions on sectors in Russia, has a completely open entry regime the which investors can invest, how they can invest, ideal framework is a liberal entry regime that and how much they can invest. Conducive policies recognizes that there is little connection between also provide legal security to the investment the amount of capital invested and viable project, the investors, and their assets. businesses that encourage innovation and that investment provides employment and government None of these policies are inconsistent with the revenue through taxes paid. legitimate desire to regulate investment and economic activities to protect the environment, public health, consumers, or national security interests. Investors are subject to host-country laws; Box 4. Relaxing Investment Entry for example, the government can reject a project Policy: Examples from East Africa that would violate environmental law or negatively affect health. Nothing in this handbook suggests The government of Tanzania has eliminated that there should be no governmental regulation or n minimum capital requirements for FDI entry in control over economic activities including general.* investment. The suggestion is not “no regulation” n The government of Uganda has stopped but “better regulation.” requiring foreign investors to invest minimum amounts although it only offers the facilitation The following are features of a policy that is support of its Investment Authority when “conducive” to private/foreign investment: investment exceeds $100,000 (soon to be revised to $25,000 for both national and Flexibility in Investor Entry foreign investors).** *However, Tanzania makes special incentives conditional Several countries impose some restrictions on upon holding an investment licence and investing a minimum of US$300,000. investment entry such as mandatory minimum **UNCTAD and Japan Bank for International Cooperation capital requirement for investors and the require- (2005). ment that a governmental institution screen any potential foreign investment. While sometimes serving the legitimate objective of ensuring high-quality investments, such qualifications Investors’ Rights and Guarantees tend to discourage private investment and unwittingly go against governments’ own stated Most investors expect a recipient country to policy of promoting domestic and foreign guarantee them, at minimum, the rights and pro- investment. Minimum capital requirements for tections listed below. The government needs to first investments are likely to dissuade valuable small establish these guarantees as a matter of policy and investments, particularly those in noncapital- then to seek implementation through legislation. intensive businesses in the services sector. n Nondiscrimination: National or equal In recognition however of the role of FDI in their treatment of foreign and domestic investors, 8 without discrimination, is a good practice While such rules respond to the legitimate standard that encourages foreign investment interest of ensuring employment priority for and is a key characteristic of an open invest- citizens, a country should ensure that the rules ment policy. It is usually articulated in do not discourage investors, particularly when constitutionally mandated equal treatment critical human resources capacity is unavailable clauses that do not derogate from a domestically. country’s need to provide special support for its citizens. Nonsubstantive Qualities of the Policies n Right to ownership and security of “Nonsubstantive” does not mean unimportant. investment: All investors look for a guarantee Rather, it refers to qualities that do not pertain to against arbitrary nationalization, unlawful the “substance” of the policy. That is, they are not expropriation, or confiscation of their “content-specific.” (See Box 5.) The same qualities property, or any other governmental measure can in fact apply to other areas of economic policy with similar effect. A guarantee of due process (trade and taxation, for instance). with prompt, adequate, and effective compensation in the event of expropriation Therefore, in addition to the above-mentioned of is widely viewed as best practice. substantive aspects, good investment policies should have the following features: clarity, stability, n Convertibility and repatriation of capital and transparency. Ambiguous investment policies and earnings: Foreign investors will not consider a location without a clear guarantee that they will be able to freely convert and Box 5. Features of Good transfer profits, capital, and other proceeds of Investment Policy their enterprise (after they have fulfilled their host-country tax obligations). Investment policy should be: n Alternative dispute resolution mechanisms: n Transparent and publicly documented, so that any investor can readily ascertain where they Many private investors want to have the option can and cannot invest and under what of utilizing alternative dispute settlement conditions mechanisms to resolve their disputes with Simply stated, so that they can be easily both private companies and the government. n understood by everyone This is particularly true for foreign investors in Unambiguous, so that their meaning is developing or transitioning countries. n indisputable n Expatriate Labor: The issue of host-country n Nondiscretionary, so that decisions are taken on objective criteria facilitation of investment-related employment for foreigners while domestic unemployment is n Comprehensive and complete, so that potential investors know the full situation and will not high is a difficult one that sometimes results in encounter “surprises” host-country regulations prohibiting or Stable and predictable, so that investors’ limiting employment of noncitizens. These n legitimate expectations will not be jeopardized regulations include requiring employers to by unforeseen policy changes provide justifications and meet preconditions n Consistently applied, so that there is no such as proof of unavailability of local uncertainty in the outcome from following them expertise. Source: IC research 9 will produce ambiguous investment legislation, n International conventions established to which will likely lead to disputes between the state ensure competition, even when a country is and investors. Policy that is well written but that not a party to the agreements. changes frequently generally makes investors unsure about investing. Policy that is not available, Box 6 lists examples of international conventions easily accessible, and transparent also discourages and agreements on investment and trade that a investment. Consistency and transparency must government should consider when revising its permeate all levels of government policy, from the investment policy and legislation. Conventions on highest-level cabinet policy to the lowest-level investment and trade provide a great degree of decree or individual decision made for an investor. protection to foreign investors. If the country is The same qualitative features should be applied to already a signatory to these conventions, it is investment legislation and administrative important that the government does not introduce procedures. into the investment code any provisions that may contradict the content or undermine the effect of As discussed below, some countries choose to adopt these conventions. In certain countries and legal a single instrument, called an investment act or systems, international treaties validly signed and investment code. Other countries prefer to regulate ratified prevail over domestic legislation. investment through a number of distinct laws and Governments should carefully check for the consis- regulations. Chapter 2 will discuss the advantages tency of their domestic investment legislation with of having a special investment law. the international obligations they have undertaken by adhering to these international instruments. International and Domestic Law Investment Typology Should this handbook about domestic legislation to regulate investment be concerned with Public Investment v. Private Investment international law? There are many types of investment. To simplify, While an investment code is domestic legislation, one can start by drawing a line between public and foreign investment, with its cross-border flows of private investments, depending on whether the capital, residency issues, investor guarantees, and so source of the investment is the government or the forth, necessarily adds an international dimension private sector. to the topic. A distinction should be made between public Many international agreements on foreign entities that operate as state entities and those that investment are in force today. When investment act on a commercial basis, operating like any legislation reform is considered, it is essential to business and competing with private sector entities. take into account: To simplify a complex status, which differs across jurisdictions, we will note here that the activities of n A country’s obligations at the international the commercial “public” entities are often regarded level, to avoid conflict and ensure consistency and treated as private investment. between the proposed national legislation and international instruments that supersede Although public investment is important for domestic legislation. economic development, this handbook focuses on 10 Box 6. Examples of International Conventions and Agreements on Investment and Trade Convention on the This convention has been adopted within the framework of the WBG. It Settlement of Investment establishes the International Centre for Settlement of Investment Disputes Disputes between States (ICSID), which facilitates the settlement of investment disputes through and Nationals of Other arbitration and conciliation. States, known as the Washington Convention (1965) World Trade Organization The TRIMs agreement aims keep at eliminating performance requirements that (WTO) Agreement on have trade restrictive and distorting effects. It prohibits any trade-related Trade-Related Investment investment measure that is inconsistent with either the principle of national Measures (TRIMs) treatment or the principle of abolition of quantitative restrictions. It applies to all WTO members. General Agreement on GATS relates directly to the regulation of foreign investments in services. It Trade in Services (GATS) aims in particular at the liberalization of market access for services. Regional agreements Provisions on foreign investment also appear in several other regional agreements, involving the Association of Southeast Asian Nations (ASEAN), Southern Common Market (MERCOSUR), and African, Caribbean and Pacific Group of States (ACP)-European Union (EU) countries. North American Free Trade Adopted in 1992 by Canada, Mexico, and the United States, NAFTA contains Agreement (NAFTA) detailed provisions on the protection of foreign investment (Chapter 11, NAFTA). Other significant provisions ensure freedom of admission or establishment to investors of one party on the territory of another party, through the extension of the national treatment principle to the so-called “pre-establishment” phase. Central American Free CAFTA’s provisions are similar to those of NAFTA. Trade Agreement (CAFTA), extended to the Dominican Republic (CAFTA-DR) Energy Charter Treaty (ECT) The ECT covers more than 50 European and Central Asian countries and contains a specific chapter on foreign investment. Bilateral investment Over 2,700 BITs have been concluded by countries all over the world.* The treaties (BITs) most extensive networks of BITs have been negotiated by Germany and China, with more than 100 BITs each. Over 600 BITs have been signed between developing countries. Standard BITs contain provisions on the admission and establishment of foreign investments, standards of treatment, expropriation or nationalization measures, transfer of income and capital, protection of investment agreements or contracts, guarantees granted to foreign investments by home state agencies, and dispute settlement mechanisms. Recent BITs are often more detailed, with provisions on senior management and entry of personnel, performance requirements (very few), monopolies and state enterprises, health, safety and environmental measures, taxation, and prudential measures and procedural details under the dispute settlement provisions. Such a global and dense network of bilateral treaties has inevitably had an impact on national investment laws. Free trade agreements FTAs have been negotiated, first by the United States, and more recently by (FTAs) Japan, the EU, and others, and include provisions on foreign investment similar to those in BITs. * For a list of BITs with relevant information by country, see http://www.unctadxi.org/templates/docsearch____779.aspx 11 are not easily liquidated (Box 8). Box 7. Types of Private Investors When an investor is an individual who owns n Corporations and other business legal entities physical assets in an enterprise, it is not difficult to n Individuals and unincorporated entities such as identify this as a direct investment. But most partnerships (business entities without indepen- investments today are made in corporations or dent legal personality) limited liability companies that have an n Not-for-profit organizations and foundations independent legal personality. In such cases, the test of a direct investment derives from the degree of control exercised by a shareholder and its influence private investment. Most investment codes only over the management of the corporation. seek to regulate private investment, that is, investment realized by a person in the private Control is assumed when an investor owns the sector, be it a juridical or natural person (Box 7). majority of the equity capital of a corporation, or has the majority of the voting rights on the board of directors. Direct Investment v. Portfolio Investment Sometimes relatively lower thresholds are enough to confer “control” over the management of a An important distinction that should be made is corporation. It is often assumed that 10 percent of between direct and portfolio investment. This has the equity capital or voting power of an enterprise practical implications on the content of investment gives the investor a significant degree of influence legislation. over the management of an enterprise. Direct investment is a long-term investment in a However, sometimes an investor with a smaller share plays an active role, while a larger investor may remain passive. Hedge funds, private invest- Box 8. Types of Direct Investment ment funds, and distressed funds are considered direct investors when they have equity ownership n Enterprise creation, such as establishment of a of 10 percent or more in an entity (Joisce and new business and construction of a facility. This Patterson 2006). Depending on the circumstances, is often referred to as “greenfield” investment. a licensing agreement alone could provide a n Investment in an existing enterprise generally to measure of control over an enterprise. Thus, the expand or reorganize a business. This includes existence of control depends on the circumstances, acquisitions or mergers. which need to be assessed on a case-by-case basis. In addition to financial resources, direct investment new business or a preexisting one that is may result in a number of spillover benefits, such as accompanied by a measure of effective product innovation, transfer of technology and management control by the investor. The investor know-how, management skills, increased market exercises a dominant influence on business access, and employment generation. operations, and remains responsible for the development of the enterprise. Direct investment is Portfolio investment (also referred to as “indirect a lasting interest in an enterprise and is typically investment”) usually implies a shorter-term illustrated by ownership of physical assets such as objective, the use of financial flows that have a buildings, machines, and other lasting interests that higher degree of liquidity, and an investment that 12 regulatory issues and many of the “lessons of Box 9. Types of Portfolio, or experience” we share in this handbook will be of Indirect Investment limited value and applicability to governments interested in promoting portfolio investment. n Equity participation, including shares and stocks that do not provide any control or Foreign Investment v. Domestic Investment management of the company. n Purchase of equity securities such as shares, An investor can be an individual, a public or private stocks, participation, preferred shares, or the sector enterprise, a group of related individuals or acquisition of debt instruments or securities of related incorporated or unincorporated such as loans, credits bonds, debentures, notes, enterprises, governments or government agencies, or options. or estates, trusts, or other organizations n Contractual arrangements, such as licensing (IMF 1993, OECD 1996). agreements or turnkey contracts that do not involve management control. A domestic investment is an investment made in a country by a resident or a national of that country. does not involve management control by the investor (Box 9). In contrast, a foreign investment is an investment made by a person in a project or enterprise in a Portfolio investments are generally more specula- country other than their country of residence or tive than direct investments. Such investors can nationality. Thus investments made by foreign easily be persuaded to shift their investment from nationals in the territory of a host state are one security to another that is more profitable. considered as foreign investments. Because of their portability and short-term orienta- The two key criteria for determining the foreign tion, portfolio investments are usually not the focus nature of an investment are nationality and of investment laws. Portfolio investments are regu- residence. Depending on the criteria chosen by the lated in a very different manner from direct invest- country, an investment can be deemed domestic or ments, usually under the supervision of monetary foreign as follows: and financial authorities such as central banks, ministries of finance or treasury departments and Some differences can also be drawn depending on security and exchange commissions. Portfolio whether an investor is an individual or a investment thus raises very different policy and corporation: Box 10. FDI vs. Domestic Investment Investor Criterion Resident/ Resident/ Nonresident/ Nonresident/ National Non-national National Non-national Nationality Domestic Foreigner Domestic Foreigner Residency Domestic Domestic Foreigner Foreigner 13 n In the case of individuals: important as, if not more important than foreign investment and that concerns about Dual nationality, where an investor holds the security of investment, dispute resolution nationality of both the host state and of mechanisms, and human capacity constraints another state, can lead to difficulties with are not limited to foreign investors. classification. Some legal instruments, such as articles 25 of the ICSID Convention seem to Other countries have adopted laws on FDI retain the sole criterion of nationality for only, while domestic investment is covered by natural persons. all other national legislation. n In the case of corporations: There is no best practice in this area. There are valid arguments for each of these two options. The most widely used criterion is the place of incorporation or the registered office (siège Arguments in favor of a law covering FDI n social); however, some host countries’ legal only systems apply the “control test” to determine whether the corporation is a foreign investor Domestic investors are more familiar with the (ICSID Convention article 25). domestic legal framework than foreign investors. If an important policy objective of In the systems where the control test applies, a the government is to attract more FDI, having corporation’s nationality is impacted by the a specialized law for that form of investment nationality of investors having the control; makes sense. Of course, the law should not because of foreign control, the host state lead to discrimination against domestic considers a corporation as a foreign national investment/ors. for purposes of certain specific legislations such as investment law even if such corporation is Arguments in favor of a law covering both n incorporated in the host state.1 It does not domestic and foreign investment matter in this respect whether the foreign investor has the majority or minority equity in Countries used to have two separate the corporation; what matters is whether the investment regimes, one for foreign and one said investor has the control. for domestic investment. The past two decades have seen a major convergence of such regimes. Why is the distinction between foreign and Having a law that covers both domestic and domestic investment important? foreign investment is becoming increasingly common. From a technical point of view, such The distinction between FDI and domestic a law may be somewhat more complicated to investment is important for the scope of the write, as rules that apply only to foreign legislation. investors (such as profit repatriation) will be intertwined with provisions for domestic In recent years, a number of countries have investors only and provisions applying to both adopted comprehensive or omnibus foreign and domestic investors, but it is investment laws that cover both FDI and technically feasible. domestic investment. This phenomenon recognizes that domestic investment is do In the modern world of commerce, what used to be categorized as foreign investor concerns, such as the existence of rules for fair 1  See ICSID Convention, Article 25(2)(a) and (b). compensation in the event of expropriation, 14 the opportunity to hire expatriate staff in the the decision of a country to proceed with one absence of local capacity, the need to settle law covering both foreign and domestic commercial disputes fairly and expeditiously, investment or not should be based on the and the ability to convert local currency into history and particularities of the said country foreign exchange to service foreign debts, now and determined on a case by case basis. are recognized to also concern domestic investors. This recognition, together with the Conclusion: Whether a country chooses a law reality that FDI laws have – unwittingly or covering both foreign and domestic investment or intentionally – created a two-tier system that is one covering only foreign investment, what really perceived to prejudice domestic investors, matters is that the investment law should not create provides little support or justification for different standards of treatment between domestic legislation that exclusively addresses the and foreign investors. Seeking to reassure foreign specific needs of foreign investors. The needs of investors and assuage their specific concerns by both domestic investors and foreign investors providing clear legislative guarantees does not mean – to the extent that they are not the same – can that the government is discriminating in their favor certainly be reconciled in one law. against domestic investors. A major benefit of having a law covering both IC supports and advises reform programs that domestic and foreign investment is that it remove constraints and streamline procedures for removes an important risk for government, all private sector firms, whether domestic or which is being perceived as favoring foreign foreign. We strongly recommend against any investors over domestic investors. In countries provision that introduces any sort of discrimination where this risk is elevated, the government between domestic and foreign investors. Removing should consider omnibus legislation covering key constraints in the investment climate that affect both domestic and foreign investors. private enterprise productivity is a very large part of our advisory and technical assistance programs.2 In contrast, if this risk is low, and the government had a previous policy hostile to FDI, then the government might consider adopting a single, transparent piece of legislation covering all important FDI issues such as conditions of admission, guarantees offered, the institutional framework, and 2  This assistance is provided by the various units of the WBG incentives enabling foreign investors to easily and International Finance Corporation (IFC), including access the information and evaluate investment the IFC’s regional facilities (such as the IFC Investment Climate Advisory Services in Africa) and IC among others. conditions in the country. Based on the above, 15 Chapter 2: Pervasiveness, Usefulness, and Limitations of Investment Codes This chapter looks at the “universe” of investment codes.3 How widespread such codes are and why do Box 11. International Distribution some countries choose to have an investment code, of Investment Codes and others not? What is the usefulness, actual or perceived of investment codes and what are their Investment codes exist in all types of economies n limitations? − large and small, industrialized and developing, socialist and market-oriented, and transitional. Contrary to common belief, investment codes n Pervasiveness (“To Have or Have Not”) are not a “developing country” phenomenon: Canada, New Zealand, and several EU Since 1992 the number of countries around the countries have or until recently had investment world having national investment codes has codes. considerably increased and Box 11 shows the Investment codes are not reserved to a diversity of countries that had or have investment n particular legal tradition: Common law codes. The list dispels the often-heard myth that countries with an investment code include this instrument is used mainly by developing Bangladesh, Ghana, Kenya, Malawi, Pakistan, countries and countries with romano-germanic Tanzania, and Uganda. legal tradition. Civil law (Napoleonic or “romano-germanic” n tradition) countries with an investment code 3  The term “investment code” is a general term for a wide include countries as diverse as Brazil, the range of legislative instruments: foreign company act, Democratic Republic of Congo, Kazakhstan, foreign investment promotion act, foreign investment Senegal, and Turkey. statute, legislation on foreign capital, and others. Because using all these terms here might be confusing, the handbook limits itself to “investment code” or “investment law/legislation.” 16 Countries without investment codes: Is investment unregulated? Box 12. Advantages of Consolidating Investment France, Singapore, and the United States are Regulations into a Code interesting examples of countries that do not have an investment code and yet attract large n For government, drafting and adopting one levels of FDI. From the 1950s through the 1970s, piece of legislation can: Brazil was the leading FDI recipient among n Save time developing countries, without having an n Save scarce resources* investment code. n Be easier to amend than several laws and regulations (when circumstances Does it mean that these countries do not regulate necessitate revisions) foreign investment, that investment is totally Be easier to implement free, or that investors have no guarantees? n The answer, of course, is no. In such countries, n For a prospective investor, finding most of the the guarantees, restrictions, and rules governing guarantees and rules applicable to its invest- investment simply are found elsewhere in the ment in a single text is much more convenient than having to review a number of disparate legal framework: in the Constitution; in separate laws and regulations to understand how open laws and regulations dealing with commercial the country is and to be immediately reassured activity, expropriation, taxation, and foreign about the security of investment and property. exchange; or in laws governing specific sectors (such as banking, finance, insurance, *Although it is doubtful that a serious flaw or gap in the overall legal framework can be redressed simply by inserting telecommunications, mining, or tourism). It is a provision or two in the investment code. An expropriation therefore important to move away from the clause in the code is no substitute for a good expropriation notion that “no investment code equates no rule act. governing investment, no guarantee, or total freedom.” fundamental rights under which investors expect to operate. The legislative vehicle that As stated above, some countries choose to governments use to effectively introduce and centralize investment-related regulations in a enforce such principles and guarantees in the special piece of legislation called an investment country is less important. code, while others regulate these regulations through various national laws. The fact that the However, there is an obvious advantage in having same guarantees or conditions can be as one central piece of legislation that specifies effectively introduced through other laws and which sectors are open to foreign investors, regulations actually supports the notion that a what the entry requirements are, what guarantees key function of investment codes is investment investors have, and which public institutions promotion. (such as IPIs or one-stop shops [OSS]) they can access for assistance. Box 12 lists additional Is there any strong advantage of one approach advantages. over the other? One host-country legislative instrument that In choosing between the two approaches, the foreign investors usually want to review government’s principal consideration should be themselves, rather than through a local lawyer, is to ensure that the legal framework clearly the investment code (another one is a summary recognizes and effectively protects the 17 of the tax system for businesses). So, if a country Europe. Although investment codes appeared in does not have an investment code, it could, at that region prior to 1989 (in Hungary and least in theory, miss the opportunity of receiving Poland), they became pervasive throughout the the interest from this potential foreign investor. region after the collapse of the communist system. In effect, the new governments used In addition, from a practical point of view, investment codes to send a clear signal to governments with low capacity and capabilities investors that there had been a major change in would do better to have a single investment code policy toward private/foreign investment, and in which government officials can find most of that they were now “fully open for business” and what they need to know about investment offering necessary guarantees starting with the regulation in their country. recognition of private property rights (which most socialist economies did not recognize). The signaling function of investment codes is not to be underestimated and has been extensively used Usefulness by many developing countries including in Africa, Asia, and Latin America, following Developing an investment code has been popular important changes in economic policies.4 for some time and shows no sign of abating. One successful example is Turkey (see the case study in Investment codes are obviously also a legal tool Appendix 2). that may augment legal security and trans- parency, by providing the fundamental guaran- Clearly, the policymakers and nations that have tees that investors expect, by correcting gaps or adopted an investment code must see the benefit inconsistencies in the legal framework, and by of such a tool. clearly stating the entry requirements and sectoral restrictions that exist in the country. Why do countries choose to have an investment code? By informing potential investors of the conditions to invest in the country, as well as of Investment codes serve two key purposes: the guarantees that they will receive, investment codes, if enforceable, can provide investors with 1. They help to implement government policy the comfort they seek when investing in a foreign on private investment (domestic or foreign). jurisdiction, particularly a developing economy. They translate policy into legislative This is why we often take the view that the language, and embed it in a normative investment code is not “just” a legal tool but also instrument that has the force of law. a potentially important promotional tool that Administrative agencies can then apply the can support the government’s effort to attract instrument, and parties can use it in a court more private investment, particularly FDI. of law or arbitration proceedings. Box 13 summarizes the various purposes that 2. They also are an important tool for investment codes serve. supporting investment generation. As we have shown, investment codes can serve As a policy implementation instrument, invest- several purposes. However, they are not a ment codes have been particularly useful in countries that have undergone a radical change in economic orientation, notably the former 4  On the “signaling” function of investment codes in command economies of Central and Eastern transition economies see Gray and Jarosz (1995). 18 Box 13. Purposes of Investment Codes 1. An investment law: It is an instrument of policy implementation n is an instrument of policy implementation in terms of: a. the role of the private sector in the economic development. b. industrial policy (that is, which sectors to favor or not and for whom). c. the role of FDI in economic development. n contributes to setting up or clarifying rights and obligations of inves- tors, of the host government and its administrative agencies, and of other investment stakeholders. n is a vehicle to strengthen the rule of law in this field of paramount economic importance. n deals with institutions related to investments, and their operations and impact. n establishes a governmental framework for the protection and promotion of investment, which is an essential ingredient of economic development. 2. Promotion starts with informing potential and existing investors, and the It is a tool for investment code certainly contributes to this. But an investment code can also help to promotion and investment improve the country’s investment climate through a reduction of legal and climate reform institutional barriers to private investments. The establishment of a stable and consistent framework is in itself an incentive and a signal to investors, and a mean to expand domestic enterprise and access international investment markets. 3. A peculiar feature of most investment operations, compared with trade It provides security to transactions, is their duration. Because their timeframe is much longer, private investments investors look for a stable and predictable legal framework and for institutions with authority over their investments. Investors value the legal security provided by investment legislation, and this influences their investment decisions. 4. Faced with the complexities and uncertainties of many national legal It enhances transparency systems, investors look for a single piece of legislation that brings in investment operations consistency and homogeneity to the legal framework covering their contributing to good investments, instead of myriad legal provisions and administrative governance rulings. Transparency implies that all relevant legislative and regulatory provisions have been published and that they are made easily available in a comprehensive form to interested investors. Source: IC research 19 panacea. In fact, it is very important to discuss market or highly advantageous production their limitations. costs. To foster the development of a good investment climate, those factors need to be addressed in conjunction with the invest- ment code to form a coherent system attrac- Limitations tive to potential investors, domestic and foreign. Obviously, each investor will have a There are limits to what even the best investment different view on the relative importance for code can achieve. their business of these different dimensions of the investment climate, but, generally n First limitation: An investment code does speaking, they are all important factors and not constitute the entire legal and regulatory need to be addressed to establish an attractive framework applicable to economic activities. business environment. Investors, foreign or domestic, are subject to all the laws and regulations of the country of investment. If such laws are overly restrictive of private business, even a well-written investment code will not produce an Box 14. Usefulness and Limits of environment conducive to investment. Investment Codes n Second limitation: Investment legislation Investment codes are useful in the following ways: must be well implemented and enforced. n As the chief instrument to implement While well-crafted legislation is essential to government policy on investment n As a binding legal tool for security and implementation and enforcement, the predictability that investors can invoke in court legislation is worthless if administrative or arbitration proceedings practices undermine it or courts or n As a signal to investors after a country has arbitration do not enforce it. Technical undergone major political or economic policy assistance for investment code reform should changes that open up investment extend to these additional steps. n As a promotional tool providing critical information to prospective investors n Third limitation: The overall legal Investment codes have limits. An investment code framework (of which the investment code is by itself will never create a first-rate investment a small part) is only one of many components climate that attracts investment. The country also that constitute a country’s investment needs: n Complementary legislation on business and climate or attractiveness. These include the investment-related issues (company economic policy framework (trade, fiscal, establishment and operation, protection of foreign exchange, land and labor); the bu- property, expropriation, dispute resolution, reaucracy, with its ability to regulate and pro- taxation, access to land, employment, trade, mote the business environment; the judiciary, and so forth) with its ability to protect property, settle dis- n Efficient and effective code implementation putes, and enforce contracts; and the quality A country’s investment climate includes many of both the physical infrastructure – power, factors and dimensions beyond the legal transportation, and water –and institutional framework. Advisors in both the development community and private sector should infrastructure – educational and banking communicate this to the government client and systems and civil society institutions and manage expectations. business opportunities such as the size of the Source: IC research 20 Chapter 3: Preparing an Investment Code: Objective, Scope, Structure, and Characteristics Although a country must tailor its investment As such, it is normally granted different code to its own objectives, circumstances, and rights and is subject to different restrictions legal framework, being aware of what other and regulatory authorities. If the scope of countries, particularly those whose investment legislation is limited to direct investment, the policy and code were instrumental in attracting law will deal with the creation or acquisition significant private investment and FDI, have of enterprises and the foreign investor exer- included in their code can be extremely valuable. cising control or having a predominant influence over the management of the business. If the concept of “investment” is broader, the law will cover minority Objective and Scope shareholdings, transfers of technology, and concession contracts. Our experience The key objective of the investment code is to suggests the investment law should apply promote private investment and protect the only to direct investment, and that concept rights and property of investors. needs to be defined at the outset of the law. Policymakers must define the scope of the invest- Private or public sector: Interest in n ment code, that is, the types of investment the developing an investment code assumes that code should cover. (See Chapter 1 for a country seeks private investment. But it explanations of each type.) Following is a must decide from whom or what it will summary of the key options. accept investment: Individuals? Corpora- tions? Noncorporate entities such as n Direct or portfolio investment: As foundations, associations, or nongovernmen- discussed in Chapter 1, portfolio investment tal organizations? What about public entities differs substantially from direct investment. such as sovereign wealth funds? 21 Foreign or domestic investment: Policy- n Structure and Characteristics makers must decide whether the investment code should focus on foreign investment or There is no international consensus on the cover both domestic and foreign investment. recommended content for an investment code. However, some provisions in the World Bank New or existing investment: It must be n guidelines are increasingly considered standard, decided whether the legislation will apply to almost universal.5 A review of recently adopted all investment − existing as well as new investment codes confirms this. investment − or only to one category. To fulfill its objectives of promoting investment Form of investment to be governed: This n and protecting investors, an investment code refers to the types of assets that can be should have the structure and characteristics as invested (equipment, know-how, funds, and discussed in Box 15. so forth). This will also affect the scope of the law and should be examined early in the process. 5  See Shihata, (1993) and one of the papers that led to the guidelines: Parra (1991). Box 15. Structure and Characteristics Structure 1. A preamble or a “purpose and scope” section should appear at the beginning of the investment code, followed by a definitions section. The definitions set forth the key terms and concepts used Definitions: in the law by reference to international standards. Here are the terms typically useful to investors: n The law should specify the investments covered. It is preferable to retain a broad definition of the investment concept. Ordinary trade transactions and (short-term) monetary operations should be excluded. It should also be made clear that the legislation covers the investments made in conformity with the laws and regulations of the host country. n One of the most important definitions is that of a “foreign investor.” The government will have to decide whether to base the definition on the investor’s nationality or residence. One factor to consider is whether the government wishes to seek investment from its own nationals residing abroad. Some countries have large numbers of nationals living as expatriates in other countries. Treating them as ”foreign investors” under the investment law can be an incentive for them to invest some of their earnings in a productive way in their homeland. n It is common for an investment law to distinguish between a “resident” and a “nonresident,” mainly to address the issue of whether the investor is entitled to repatriate profits and capital. Investment codes frequently use the definitions of these terms that are found in the country’s foreign exchange law. Good practice: It is international good practice to define “nonresident” in a broad, all-encompassing way, not subject to any significant limitations. n Another important definition is the distinction between direct investment and portfolio investment. n The investment law should define investment-related institutions and authorities mentioned in the law, as well as the entities that will implement the law. This will help the investor understand the steps of the investment process. 22 Box 15. Structure and Characteristics (continued) Structure 2. An important issue for the preparation of the investment policy and then the investment code is how the country will regulate investors’ entry and in particular foreign investors’ entry. The trend Entry: today is toward an open-admission approach. Examples of entry barriers used in investment codes that do not have an open admission are the following: n sectors restrictions through positive or negative lists. If the government insists on restricting investment in certain sectors, it is advisable to have such sectors listed in the investment code in a short, clear, and concise negative list. n Limitations on foreign ownership n Screening v. registration/notification n Minimum investment requirements n Performance requirements 3. The “heart” of an investment law lies in a small number of guarantees and principles that are increasingly considered good practice and almost prerequisites for attracting serious investors. Guarantees: These fundamental guarantees (discussed in Chapter 5) include the following: n Fair and equitable treatment n National treatment n MFN treatment n Guarantees against expropriation n Convertibility and repatriation of capital and “fruits of enterprise“ n Settlement of disputes n Other provisions 4. An investment law may address investment promotion and incentives. Often, a government uses Promotional the investment code to: n Establish the institutional framework in charge of promoting investment (either as a devices: separate entity or as a unit within the ministry in charge of investment or private sector development). n Define investment incentives offered to investors and how they are granted. Although investment codes of many countries include provisions on these two issues, it is advisable to organize both incentives and promotion through other pieces of legislation. We will review those two issues in Chapters 6 and 7, respectively. 5. An explicit transitional section at the end is useful for understanding how the law complements, amends, or repeals previous laws and regulations, thus reducing uncertainty and risks of Transition: “conflict” with other laws. Grandfathering clauses are usually included in transitional sections and create a framework by which existing investments are permanently or temporarily excluded from the ambit of new investment laws. Sometimes, albeit rarely, an option may be given to investors to choose to keep their investment package or to switch to the new one as provided under the new law. 23 Box 15. Structure and Characteristics (continued) Characteristics 1. If a government’s principal objective in preparing an investment code is to create a tool that will help in its investment promotion effort, a principle for the drafting team to follow is “less is Length: more.” There is some tendency to include in the investment law various provisions including tax, environmental protection, and establishment of corporations, which should be covered by the relevant pieces of legislation and not by investment codes. It is important, however, for an investment code to refer to such other legislation when necessary. The law should be as short and clear as possible. There is no ideal length for an investment code, but common sense should prevail. For instance, investors with significant presence in Eastern Europe who may have looked at the Belarus investment code of 2001 were probably not reassured by the fact that it contained 105 clauses. Prospective investors are likely to assume that a lengthy code is indicative of a cumbersome, restrictive, and probably unpredictable policy and regulatory environment. In contrast, the foreign investment statute of Chile (decree law # 600) had 18 articles. A short code, if it includes basic guarantees and entry rights, is more likely to be an effective promotion tool than a lengthy one. 2. Investment legislation should be easily accessible to foreign investors and published in an easely comprehensive format. It should be published without undue delay. To the extent Accessibility: possible, the host government should publish in advance any measure that it proposes to adopt, and provide investors an opportunity to be kept informed on such proposed measures. 3. The investment code should be transparent, allowing investors to know not only the basic rules but also the procedures investors should follow. Transparency requires ready access to reliable, Transparency: comprehensive, timely, and understandable information.* * http://www.transparency.org/news_room/faq/corruption_faq#faqcorr2 and http://www.estandardsforum.org/about_standards/ code-of-good-practices-on-transparency-in-fiscal-policy Preparing an Investment Code in autonomy. This is important to determine Subnational and Conflict-affected whether the new or reformed subnational investment law will be implementable. Even Areas where the subnational government is semi-autonomous (has direct authority within its Investment Codes in a Subnational Context borders subject to existing national laws, regula- tions, and procedures), it may encounter When considering subnational investment law problems if it tries to make significant changes reform, it is important to start by reviewing the such as streamlining and simplifying the devolution of powers to the subnational regulatory regime: government, to (i) check whether the devolution is clear and (ii) determine to what extent the n It might be deemed contravening national subnational government has authority and law. 24 n Other parts of the country may refuse to legislative act) and such ratified investment recognize the investment licenses and agreement may in certain jurisdictions supersede permits it issues, meaning its investors risk national provisions such as labor, environmental increased difficulties in doing business in the etc. rest of country. Consultations on the design and enactment of new or revised investment laws can take longer and be more complicated in post-conflict Investment Codes in Conflict-affected Areas settings. The law must anticipate post-war political sensitivities without restricting the In post-conflict areas, investment law reforms principles of commercial practice. For example, have a good chance of being adopted because the law might have to restrict investments in often the government will be willing to adopt certain subnational locations. It might also have liberal investment policies and donors are more to (i) contain different provisions, some that likely to assist with reform. However, a post- would apply before the peace process is com- conflict government might have to make pleted and some afterwards, or (ii) be amended tradeoffs when developing its investment law after the peace process. Where multiple political reform: parties have conflicting interests, the law might have to provide for an investment committee that n The government’s need to attract investment would comprise members of each party and in the short term may conflict with a law require investment decisions to be made by written for the longer term, once the consensus instead of by majority. economy is healthy. The following chapters discuss the various issues n The country’s need for immediate, expensive that may discourage or encourage investors to infrastructure (re)construction might limit invest in a country. Although the recommenda- the government’s bargaining power with tions below will most immediately benefit indi- investors. vidual investors, more importantly, the resulting investments are likely to benefit countries over Investors entering into investment agreements in the long term through increased a post-conflict country might try to take employment, transfer of technology, revenue advantage of the situation. Such agreements generation, among others. Eliminating likely will need to be revised and renegotiated, unnecessary approvals is not only good for with better terms for the government, or even investors but also for the government − cancelled. For example, Liberia’s 2005 iron ore streamlining the approval process can lower costs, concession to Mitta Steel had to be renegotiated avoid opportunity costs, diminish the risk of in 2007 with better terms for Liberia. In losing projects, reduce opportunities for addition, when the investment agreement is corruption, and improve the image of the confirmed by a legislative act, a similar act may country both domestically and externally. be required to amend the agreement (i.e. a 25 Chapter 4: Considerations for Entry of Foreign Investment An important issue for the formulation of the Since the early 1990s however, the trend in investment policy and investment code is how admission of foreign investments is toward a the country will regulate “investor entry” (or more open or liberal policy. Today, the “admission”) and in particular “foreign investor open-admission approach prevails in countries of entry.” Entry is a special requirement imposed on the Organization for Economic Co-operation investment projects. It is usually not an issue for and Development (OECD) and in an increasing domestic investors, who, by definition, are resi- number of developing and transition countries as dent in the country and can invest under the well. normal procedure generally defined in the law. We have elected therefore, to dedicate this In an open-admission system, the host country chapter to entry of foreign investors. However, it admits foreign investment without a formal is important to note that in many countries, screening and approval process. In some cases, a entry can also apply to domestic investors such filing or notification requirement is required as when certain strategic sectors (such as from the foreign investor purely for statistical or infrastructure) are restricted or subject to special investor after-care purposes. conditions. Even with an open-admission system, a country Some countries, especially developing countries, may impose restrictions on foreign investment, have a screening process that subjects foreign usually for host-country national security investment projects to host-country review concerns or economic development objectives. and formal authorization before project imple- The World Bank guidelines on foreign mentation can begin. investment (WBG 1992) recognized this possibility (Guideline II, Section 4): 26 “Without prejudice to the general approach of Sectors Closed to FDI free admission recommended in Section 3 above, a State may, as an exception, refuse admission to Few countries are completely open, allowing a proposed investment: foreign investment in all sectors and subsectors, and under identical conditions and procedural n which is, in the considered opinion of the requirements as domestic investment. Chile, State, inconsistent with clearly defined Guatemala, Georgia, and Montenegro allow requirements of national security; or foreign ownership of all major sectors in their economy.6 n which belongs to sectors reserved by the law of the State to its nationals on account of the One country that is nearly open is Mauritius, State’s economic development objectives or which limits FDI (and all private investment) in the strict exigencies of its national interest.” nationalized sectors such as electricity transmi- ssion and distribution, waste management and The restrictions to foreign investment can be recycling, and port and airport operation are general or sector based, and they usually take the characterized by monopolistic market structures, following forms that will be detailed below: with one dominating publicly owned enterprise, making it difficult for foreign companies to n Certain sectors are closed to foreign invest.7 In the past 15 years, the trend in many investment developing countries has been to allow foreign investment in even previously government- n Foreign ownership is allowed but can be owned and -operated sectors. In spite of the trend limited to a certain percentage of overall toward openness, many countries still restrict or ownership, either in general or in certain prohibit foreign investment in various sectors sectors. including the media, defense, and nuclear industries. n Foreign investment is allowed but is subject to prior authorization based on “strategic The OECD FDI Regulatory Restrictiveness sector” rationale Index of 2008 (OECD 2008) found that: n Foreign investment is subject to general n Among OECD countries, the EU countries screening and approval (for other reasons are generally more open than others than on “strategic sector” rationale) n Among non-OECD countries, those of n Foreign investment is subject to a minimum Eastern Europe, Chile, and Argentina are investment requirement among the most open whereas India, China, and Russia are the most restrictive n Foreign investment is subject to certain performance requirements. n The most restricted sectors are electricity, transport, telecommunications, and finance There can be overlap between these forms of restrictions. n The least restricted sectors are manu- facturing, tourism, construction, and distribution. 6 World Bank Group Investing Across Borders database 7  World Bank Group Investing Across Borders database 27 Box 16 gives examples of sectors closed to foreign A much more common approach is the n investment, by country. negative list, under which authorities list the sectors or subsectors that are closed Governments generally use either a “positive list” (prohibited) or restricted (allowing only mi- or “negative list” approach to implement sectoral nority foreign ownership, requiring special restrictions. authorization from foreign investors, and so forth). This system is preferable to the posi- n In a positive list approach, the government tive list for a simple reason: if a sector or attempts to enumerate all the sectors or sub- subsector is not on the list, investment in sectors in which foreign investors may invest. that sector is automatically deemed allowable Only a minority of countries use this without restriction. Of course, a long approach. The list cannot possibly cover the negative list means that the country is not whole economy, and keep up with the really open to FDI and defeats the benefit of development of new industries. Also, the the negative list. The negative list should be treatment of the sectors or subsectors that are as short as possible and should be revised not on the list is ambiguous. As such, the over time as restrictions are lifted. It should positive list approach is not recommended. be a dynamic process, not a static one. The negative list should be precise (not open to Box 16. Examples of Sectors Closed to Foreign Investment The following list shows a range of examples of sectoral restrictions on foreign investment in selected countries. n Brazil: The health care sector is completely closed to FDI. n Canada: The health care sector is de facto closed to FDI because private hospitals and clinics may not receive payments from provincial health insurance funds, which are critical for the financial viability of operators in the sector. n China: Sectors such as publishing, television broadcasting, and newspaper publishing are closed to foreign investment. n Egypt, Arab Rep. of: Publishing a daily newspaper is limited to domestic companies. n Greece: The Hellenic Transmission System Operator S.A. is granted exclusive rights to the transmission and distribution of electricity in Greece. Private capital participation, domestic or foreign, in those sectors is, therefore, not possible. The electricity generation sector is also completely closed to FDI from countries outside of the EU. Presidential Decree 41/2005 imposes the same restriction on the railway freight transportation sector. n India: Sectors such as railway freight transportation and forestry are dominated by public monopolies and are completely closed to foreign investment. With the exception of certain activities specified by law, foreign investment in the agriculture sector is also not allowed. n Mexico: In the service industries, foreign investors are not allowed to engage in electricity transmission and distribution. Foreign ownership in electricity generation companies is possible under certain circumstances. The oil and gas industry is also completely closed to FDI as well as the ownership of nationwide television channels. n South Africa: Monopolistic market structures with dominating publicly owned enterprises that inhibit FDI include the electricity sector as well as in the port operation and railway freight transportation sectors. Source: World Bank Group Investing Across Borders database 28 interpretation and should be in any event strictly interpreted), and limited in scope and Box 17. Negative Lists: Some sectors. An example of an unclear and broad Examples restriction that some negative lists include and that is sure to create interpretation Many countries close or restrict certain activities or problems is this: Any sector that has a sectors to foreign investment, usually for national negative impact on environment. defense. Typical examples are the military sector and the media. Other limitations are based on the country’s economic interests. The range of Box 17 provides illustrative examples of negative restrictions is wide, as seen in the following lists. It should be noted that IC does not examples. recommend that a country adopt such lists but Kosovo’s Investment Regulation (UNMIK) # provides them simply as examples of negative 2001/3 stated: lists in existing legislation. Appendix 3, on Section 5: “With the exception of the specific indus- Liberia’s FDI Entry Exclusions, discusses this tries listed in section 6, foreign investors issue further. may wholly-own and wholly-control business organizations in all sectors of the economy of Kosovo. Foreign invest- ments in strategic or other specific sec- tors shall be subject to the same licensing requirements by the authorities as domestic business organizations.” Sectors Subject to Limits on Foreign Section 6: “Foreign investors may have not more Ownership than a forty-nine per cent (49 percent) ownership or control interest in business Investment codes may also limit the percentage organizations that are manufacturers or of equity that a foreign investor can own. (See distributors of military products.” Box 18 for examples.) This restriction in effect Republic of Angola’s Foreign Investment Law # forces foreign investors into joint ventures with 15/94 stated: local investors, and in some cases, with the host Article 3. (Permissibility of Foreign Investment) government. 2. Foreign investment is prohibited in the following areas: The limitation on foreign ownership can be a) defence, internal public order and State general or limited to certain sectors. Among its security: disadvantages is that it increases the cost of pri- b) banking activities involving central bank and vate capital. For instance, where there are owner- issuing bank function; ship limitations, foreign investors may transfer a c) other areas which are considered by law to less-advanced technology to protect a more be absolutely reserved for the State. advanced one. A local partner’s lack of Source: IC research financial or managerial resources may also limit growth of the project (Salacuse 2000). Authorization Requirement for “Strategic Sectors” Many countries subject foreign investments in certain “strategic” activities to authorization for reasons of national security or economic interest. 29 Box 18. Examples of Limits Imposed on Foreign Ownership Argentina: According to the Aeronautic Code n Egypt, Arab Rep. of: Foreign ownership is n (Law No. 17,285) foreign capital participation in limited to a minority stake in sectors such as companies providing commercial air transporta- construction and air transportation. tion of passengers, on both domestic and inter- national routes, is limited to 49 percent. In Greece: Greece imposes restrictions on the air n addition, the company must be incorporated transportation sector, in which foreign investment according to Argentine laws and must be domi- is limited to 49 percent. This equity restriction, ciled in Buenos Aires. For the media sectors, Law however, only applies to investors from countries No. 25,750 establishes a limit on foreign outside of the European Economic Areas. ownership of newspapers, journals, magazines, Furthermore, foreign capital participation in the and publishing companies, as well as on televi- airport operation sector is limited to a sion and radio companies. According to article 2 less-than-50 percent share. of the law, foreign companies are allowed to hold up to a 30 percent stake in the capital and voting rights of such companies. India: Foreign ownership of publishing compa- n nies and newspapers is limited to 26 percent. In the financial services sector, foreign investment in Brazil: Restricts foreign equity ownership in the local banks is limited to 87 percent and in insur- n air transportation sector to a maximum of 20 per- ance companies to 26 percent. Furthermore, FDI cent and in media industries (both TV broad- in the telecommunications sector (including fixed- casting and newspaper publishing) to 30 percent. line and wireless/mobile infrastructure and ser- vices) is limited to a less-than-75 percent stake. Canada: Foreign capital participation in the n domestic and international air transportation sec- Mexico: Foreign capital participation in the n tors is limited to a maximum share of 49 percent. agriculture and forestry sectors is limited to a Furthermore, under the Canadian telecommuni- maximum share of 49 percent and in fixed-line cations and broadcasting regime, foreign inves- telecommunications, railway freight transporta- tors may own only up to 20 percent of the shares tion, port and airport operation, and newspaper of a Canadian operating company directly, plus publishing to a less-than-50 percent stake. an additional 33⅓ percent of the shares of a holding company. On aggregate, total direct and indirect foreign ownership in the telecommunica- Poland: The media sector is subject to foreign n tions sector (fixed-line and mobile/wireless infra- ownership restrictions in Poland, too. Pursuant to structure and services) and in the television the Broadcasting Law, the required license to broadcasting sectors is limited to 46⅔ percent. operate a TV broadcasting company may only be granted if the voting share of foreign owners does not exceed 49 percent and the majority of the China: In several sectors, including telecommu- members of the management and supervisory n nications (fixed-line and mobile/wireless), elec- boards are of Polish nationality with permanent tricity transmission and distribution, railway freight residence in Poland. Polish laws impose a transportation, air transportation (domestic and maximum share of 49 percent for foreign capital international), and airport and port operation, in air transportation companies. In addition, foreign ownership is limited to a less-than-50 foreign capital participation is limited to 49 per- percent stake. Further restrictions are imposed on cent in the airport and port operation sectors. The foreign capital participation in the oil and gas in- perceived difficulty of obtaining required dustry, the financial services sectors (banking and operating licenses further inhibits FDI in the port insurance), health care, and the tourism industry. operations sector, which is currently dominated by publicly owned operators. 30 Box 18. Examples of Limits Imposed on Foreign Ownership (continued) n United States: According to the Federal Avia- 100 percent) if consistent with the public interest. tion Act of 1958, foreign investors can hold a Cable television providers are exempted from this maximum of 25 percent of the shares of a com- restriction. pany providing domestic air transportation ser- vices in the United States. Furthermore, the South Africa: Foreign investment in the mining n president and at least two-thirds of the board of as well as in the oil and gas industry is limited to directors and other managing officers of such a a maximum of 74 percent by the Mineral and Pe- company must be U.S. citizens. The aforemen- troleum Resources Development Act 28 of 2002. tioned restrictions do not apply to the provision of Furthermore, the share of foreign capital in com- international air transportation services, which panies owning or operating telecommunications are fully open to FDI. The Communications Act of infrastructure or providing telecommunications 1934 specifies that foreign investment in the TV services cannot exceed 30 percent in order to broadcasting sector is limited to 25 percent. obtain the required operating licenses. In the However, the Federal Communications media industry, foreign ownership of nationwide Commission (FCC) has the discretion to allow TV channels is limited to 20 percent. higher levels of indirect foreign ownership (up to Source: World Bank Group Investing Across Borders database For instance, Article L 151-3 of France’s Mone- U.S. persons by foreign interests when such tary and Financial Code as modified by law acquisitions threaten national security. The n°2004-1343 of December 9, 2004, submits for Committee on Foreign Investment in the United the Minister of Finance’s prior approval certain States (CFIUS) has 30 days to decide whether to foreign investments in activities pertaining to investigate a case and an additional 45 days to public authorities: make its recommendation and the President has 15 days to make a decision after receiving CFIUS’ n Activities that could damage public security recommendation. Congress may also decide to or national defense interests block any FDI if national security is threatened. Box 19 provides illustrations of the Exon-Florio n Activities concerning research, production, legislation in practice. or marketing of weapons and explosive substances8 In other countries, the government can prevent a specific foreign investment in sectors that are generally open. For instance, no U.S. law forbids Screening Requirement for a foreign takeover of the major defense- Non-“Strategic Sectors” contracting firms. However, the 1988 Exon- Florio Amendment9 authorizes the President, “The most problematic barrier to foreign invest- after investigations, to restrict, suspend, or ment is the presence of a screening mechanism” prohibit mergers, acquisitions, or takeovers of (OECD 1998, 37) to nonstrategic sectors.10 http://www.legifrance.gouv.fr 8  Section 721 of the Defense Production Act of 1950, 50 9  U.S.C. App. 2170 (as amended by the Foreign Investment For an analysis of this mechanism, see Shihata, (1994, 10  and National Security Act of 2007) 47−70). 31 Box 19. FDI in the United States: The Exon-Florio Amendment The following are three illustrations of restrictions to FDI levied by the U.S. Congress based on the Exon-Florio amendment: n China National Aero-Technology: In 1990, the state-owned China National Aero-Technology (CATIC), wanted to purchase the American Mamco Manufacturing Company, an aerospace parts manufacturer. After the Exon-Florio complete investigation, President Reagan forbade this acquisition. The rationale for this position was that CATIC might have gained access to technology through Mamco, while it would otherwise have needed an export license to obtain this technology. n Thomson-CSF: In 1992, the French firm Thomson-CSF offered to acquire the missiles division of LTV Aerospace and Defense Company, which was in bankruptcy. Congress expressed concerns over a major defense contractor coming under foreign control. Indeed, this contractor produced important weapons and held large amounts of classified information. In addition, the French company was state owned and a major military contractor in France. An Exon-Florio investigation started, but Thomson-CSF withdrew the bid before a recommendation to block the transaction was made. n Dubai Port World: In 2006, the state-owned company Dubai Port World (DPW), based in the United Arab Emirates, took over the British Peninsula and Oriental Steam Navigation Company (P&O), which operated six major U.S. ports. CFIUS approved the transaction without launching the Exon-Florio 45-day investiga- tion after the 30-day review. Many congressmen expressed concern over the threat of this takeover on port security. However, President Bush argued for the approval of the deal and threatened to veto any legislation preventing the deal. DPW offered to defer the takeover of significant operations at the seaports to give President Bush more time to convince Congress that no threat existed. Yet, after a report showed that the deal covered not six but 22 U.S. ports, Congress blocked the deal with a veto-proof majority. In the end, DPW sold P&O’s American operations to an American company. Twenty percent of the countries around the world investment to be made and grow successfully. still require for example approvals for manufacturing for foreign investments.11 Notwithstanding its objectives, screening is not an effective way to assess the benefits and costs of A number of countries screen foreign investment prospective investments because it is difficult to projects. The rationale for screening is that establish objective economic criteria for deciding governments need to decide whether a specific whether a particular investment is desirable. foreign investment is desirable. In general, the screening process involves an assessment of the In addition, screening provisions tend to be so investment’s potential economic benefits for the vague that they are often useless. Because of their host country. (See also Box 20.) lack of objectivity, screening provisions restrict FDI and reduce FDI inflows. Screening The argument against screening should be made also costs agencies staff time and can lead to at the economic policy and strategy level. The corruption, where the process permits discretion. government’s role should not be to decide which (Rosenn 1998, 5) project is profitable or not. That is the role of the private sector. The government’s role is to provide From the investor’s perspective, screening adds to a “conducive” environment to allow beneficial their investment costs in the form of time delays, onerous compliance requirements, and what are 11 World Bank Group Investing Across Borders database. generally described as “hassle costs.” When an 32 screening, many countries have reduced or Box 20. Various Modalities eliminated screening requirements. of Entry The screening process has been criticized for n Simple registration of an investment project establishing cumbersome or complicated with the investment agency as part of an infor- procedural regulations and for leading, in mation and intelligence system to monitor the most cases, to inefficient results. An interesting type and number of investors/investments example is provided by Canada, where the made. (no screening) legislation in force remains based on a n Minimal examination to ensure that the pro- screening system, but the screening is no longer posed project is not outside relevant legislation applied, except in exceptional circumstances and/or policy requirements. (See Box 21). n Simple due diligence checks to verify a foreign investor’s commercial standing and establish that the proposed investment is “serious,” in- For a more comprehensive treatment of the tended to reduce the risk of fraudulent activity important question of registration procedures, by the investor. The additional issue would be in see other IFC handbooks, in particular: this regard the exact interpretation and defini- tion of “serious.” n Reforming Business Registration, February n Detailed financial evaluations of the proposed 2006 investments’ viability (based on feasibility studies or business plans) and assessment of n Reforming Regulatory Procedures for their likelihood of success to avoid potential Import and Export, June 2006 investment “failure.” n Complex cost-benefit evaluations that seek to n Good Practices for Business Inspection: examine the net impact of the proposed invest- Guidelines for Reformers, October 2006 ment on the country. This may include an evaluation of economic and social impacts. n Business Licensing Reform, November 2006 n Screening by host-country authorities to receive an approval. Those authorities often have to assess the economic impact of the proposed investment to decide whether they will approve or not. Minimum Investment Requirement investment agency is also a screener/decision- maker, the hassle cost can include the costs of Some investment codes require a minimum rent-seeking behavior by corrupt agency officials. amount of investment from foreign investors. This is exemplified by a famous case in a Middle This is to protect small domestic enterprises, East country where approval of a joint venture traditionally the backbone of employment between General Motors and Isuzu took seven opportunities and economic growth. years. This requirement should not to be confused with Foreign investors obviously prefer open, the minimum capital requirement stipulated by a transparent, and unrestricted entry policies and country’s company act for incorporation in the practices, and tend to invest in countries that country. In certain countries, investment codes have minimal or no screening barriers to entry. require a higher minimum capital than the Aware of this and of the issues entailed in company act, which can constitute an additional barrier to entry. 33 Box 21. Investment Canada Act of 1985 Under the Investment Canada Act, the following acquisitions of Canadian businesses by “non-Canadians” are subject to review by the Director of Investments: (a) all direct acquisitions of Canadian businesses with assets of C$5 million or more; (b) all indirect acquisitions of Canadian businesses with assets of C$50 million or more; (c) indirect acquisitions of Canadian businesses with assets between C$5 million and C$50 million that represent more than 50 percent of the value of the assets of all the entities the control of which is being acquired, directly or indirectly, in the transaction in question. 2. A “non-Canadian” is an individual, Government or agency thereof or an entity that is not “Canadian.” “Canadian” means a Canadian citizen or permanent resident, Government in Canada or agency thereof or Canadian-controlled entity as provided for in the Investment Canada Act. (…) 4. An investment subject to review under the Investment Canada Act may not be implemented unless the Minister responsible for the Investment Canada Act advises the applicant that the investment is likely to be of net benefit to Canada. Such a determination is made in accordance with six factors described in the Act, summarized as follows: (a) the effect of the investment on the level and nature of economic activity in Canada, including the effect on employment, on the utilization of parts, components and services produced in Canada, and on exports from Canada; (b) the degree and significance of participation by Canadians in the investment; (c) the effect of the investment on productivity, industrial efficiency, technological development and product innovation in Canada; (d) the effect of the investment on competition within any industry or industries in Canada; (e) the compatibility of the investment with national industrial, economic and cultural policies, taking into consideration industrial, economic and cultural policy objectives enunciated by the Government or legislature of any province likely to be significantly affected by the investment; and (f) the contribution of the investment to Canada’s ability to compete in world markets. 5. In making a net benefit determination, the Minister, through the Director of Investments, may review plans under which the applicant demonstrates the net benefit to Canada of the proposed acquisition. An applicant may also submit undertakings to the Minister in connection with any proposed acquisition which is the subject of review. In the event of noncompliance with an undertaking by the applicant, the Minister may seek a court order directing compliance or any other remedy authorized under the Act. However, the Director of Investments will not review a foreign investment project if the value of the gross assets of the Canadian business is less than an applicable threshold, which has been set over C$265 million. In practice, it means that the legislation’s requirements will not be applicable to many foreign investment projects. Source: An Act Respecting Investment in Canada, R.S., 1985, c.28 (1st Supp.) s.2 34 The minimum investment requirement either Performance Requirements precludes smaller investments outright or precludes them from falling under the scope of Performance requirements are stipulations the regime for “foreign investment” − and from imposed on investors, requiring them to meet benefiting from the legal guarantees and/or certain specified goals with respect to their financial incentives provided by the regime. operations in the host country (UNCTAD 2004 a,2). They can be imposed as conditions for FDI Increasingly, countries do not set a minimum admission but also as conditions for the provision investment threshold. Arguments against a mini- of some kind of advantages. However, the WTO mum are that any investment can become does not welcome them, because they tend to successful and grow into a larger business. This restrict trade-related investment. type of requirement may deprive the country’s economy of a number of smaller investments, There are three categories of performance which together could have a more important im- requirements. The first includes all the pact than a single large investment. Finally, in requirements prohibited by the WTO TRIMs most thriving economies, SMEs are the Agreement because of their incompatibility with backbone of employment opportunities and the General Agreement on Treaties and Tariffs economic growth. (GATT). The second contains requirements prohibited, conditioned, or discouraged by Recommendation on minimum investment interregional, regional, or bilateral agreements. requirement The third category of performance requirements consists of those that are not subject to control by Investment codes should not include any mini- any international investment agreement (IIA). mum investment requirement. Instead, they (See Box 22 on Categories of Performance should encourage investments of any size, given Requirements.) that such investments have economic and social value. The potential impact of a business on the Conclusion on performance requirements: economy is not necessarily determined by its initial level of capitalization. For example, soft- n The inclusion of specific obligations or re- ware development project might not require a quirements in investment legislation (beyond large investment but can help a country in many the normal obligation of complying with the ways. It is not clear that an investment of, say, laws of the land) has to be weighed carefully. US$5 million (an amount we have seen in some Each requirement will be seen by potential investment codes) is superior or more beneficial investors as a constraint, limiting their to the host country than five projects of freedom of choice, and, taken together, can US$1million each. At most, the only capital dissuade investors from even considering the requirement should be the one already mandated country as a possible investment location. under the country’s company act, based on the So, from an “investment promotion” form of corporate entity to be created. Such a perspective, the inclusion of performance requirement should apply indiscriminately to requirements, especially stringent ones that both domestic and foreign investors. are not required in competing locations, and the ones that are unreasonable or poorly designed, can undermine the government’s strategy to attract investors. 35 Box 22. Categories of Performance Requirements Category Performance Requirement Prohibited by the Local content requirements (supposedly to promote local enterprise) n TRIMs Agreement Trade-balancing requirements n Foreign exchange restrictions related to the foreign-exchange inflows attributable to an n enterprise Export controls (requirement to export a minimum percentage of the production) n Prohibited, Requirements to establish a joint venture with domestic participation n conditioned or Requirements for a minimum level of domestic equity participation n discouraged by IIAs at bilateral or Requirements to locate headquarters for a specific region n regional levels Employment requirements n Export requirements n Restrictions on sales of goods or services in the territory where they are produced or n provided Requirements to supply goods produced or services provided to a specific region n exclusively from a given territory Requirements to act as the sole supplier of goods produced or services provided n Requirements to transfer technology, production processes, or other proprietary n knowledge Research and development (R&D) requirements n Not restricted All other performance requirements Source: UNCTAD (2004 a,3) There is no evidence that the results sought n n Some performance requirements are not only can be achieved. For example, until 1999 counterproductive but can also be illegal Chile had performance requirements in the under the international commitments of the automotive industry. There is no evidence host country. For instance, the WTO TRIMs that those requirements helped raise local Agreement has made illegal requirements for value addition in this industry. Neither has minimum local content, trade-balancing, production been negatively affected by the export controls, or foreign exchange elimination of the requirements. They can restrictions related to the foreign-exchange even have some unintended, negative conse- inflows attributable to an enterprise. quences. For instance, it could be expensive (See Box 22 above.) for an investor to meet the requirements. Then, the cost of production might increase, Summary of the Recommendations on raising the price of the products sold in the Admission Policy and Procedures: host country. n The worldwide trend is toward more open admission systems allowing private 36 investment including FDI, in most sectors of investment. That said, we also realize that the economy. However, if there is a desire to some form of screening is used in many limit sectors where foreign or even domestic countries, particularly but not only in investors may invest the investment code developing countries. When the government should be transparent by defining clearly insists on having a screening, our recommen- closed or restricted areas in a “negative.” A dations are the following: negative list should ideally be as short, clear, and nondiscretionary as possible. n When there is a special entry procedure for FDI, the law should clearly define the Admission policies should have as few n agency responsible for approval. sector-specific restrictions as possible (consis- tent with the government’s strategy to attract n The criteria for decisions and procedures more investments) and a country should try should also be clearly defined and to lift these restrictions as its economy transparent. modernizes and liberalizes. Some restrictions may be inevitable, for example, for national n The responsible agency should decide the security, but they should be the exception, matter within a reasonable time period. not the rule. The best laws utilize the “silence is consent” rule, which defines a time limit The body of the investment legislation should n for decision; if a decision is not rendered only refer to the existence of a negative list within that time, the decision is deemed and attach the actual list in a separate docu- positive. ment such as a governmental decree. An executive-level norm is easier to amend than n If the foreign investor’s application is a legislative act. Experience shows that rejected, the authority should explain its sector-specific restrictions will be lifted over decision. time as the country continues to liberalize, and open its economy. n The investment code or its regulations should permit and organize an appeal We discourage screening of foreign n mechanism to a higher government body investment just because it is a foreign or ombudsman. 37 Chapter 5: Investor Rights, Guarantees, and Obligations If a country wants to attract significant levels of Fair and Equitable Treatment private investment and promote itself as a good place to do business, it must protect investments Under national investment legislation, fair and and investors in terms of the acquisition, equitable treatment (FET) should be accorded to management, conduct, operation, and sale or all investors, although in practice, it is perhaps other disposition of the investments in the host most important for foreign investors. The FET country. standard protects investors against discrimina- tion and, where discrimination is claimed, This chapter reviews the fundamental guarantees provides due process of law. Countries in which that investors seek and that, over time, have be- national law provides insufficient or no protec- come synonymous with a good, open, modern tion to foreign investments should include the investment policy, and thus investment legisla- principle of FET in their investment code. tion. “The obligation to provide “fair and equitable It should be noted from the outset that all the treatment” is often stated, together with other obligations below are usually also included in a standards, as part of the protection due to foreign BIT or other international agreement and any direct investment by host countries. It is an “ab- violation could lead to the activation of the dis- solute”, “noncontingent” standard of treatment, pute settlement mechanism in such agreements. i.e. a standard that states the treatment to be accorded in terms whose exact meaning has to be determined, by reference to specific 38 circumstances of application, as opposed to the faith, and protection of the investors’ legitimate “relative” standards embodied in “national expectations. The most recent US and Canadian treatment” and MFN principles which define the BITs and a number of US, Canadian, and required treatment by reference to the treatment Mexican FTAs limit the fair and equitable accorded to other investment.”12 The obligation treatment standard to the minimum standard of of the parties to investment agreements to pro- customary international law. NAFTA does not vide to each other’s investments FET13 has been include such language but the NAFTA Free given various interpretations by governmental Trade Commission issued an interpretation officials, arbitrators, and scholars. Discussion of along such lines (Box 23): this standard has focused mainly on whether the standard of treatment required is measured Some tribunals operating outside of NAFTA against the customary international law mini- have followed a similar approach such as the mum standard, a broader international law stan- dard including other sources such as investment protection obligations generally found in treaties Box 23. Fair and Equitable and general principles, or whether the standard is an autonomous self-contained concept in treaties Treatment: NAFTA which do not explicitly link it to international law. The implications of this discussion could be NAFTA Article 1105 reads as follows: very broad, in particular given the growing num- 1. Each Party shall accord to investments of inves- tors of another Party treatment in accordance ber of arbitral awards whitch examine claims of with international law, including fair and equi- denial of fair and equitable treatment.14 It is still table treatment and full protection and security. debated in international law whether FET stan- An official interpretation of Article 1105(1) dard incorporates the minimum standard of has been provided by the NAFTA Free Trade treatment under customary international law,15 Commission (FTC), a body composed of the three in particular as demonstrated in acts such as de- state parties with the power to adopt binding nial of justice (judicial and administrative). Some interpretations. The FTC Note of Interpretation of 31 July 2001 states: consider it an autonomous standard that incor- Minimum Standard of Treatment in Accordance porates principles such as transparency, good with International Law: 1. Article 1105(1) prescribes the customary inter- national law minimum standard of treatment of aliens as the minimum standard of treatment to be afforded to investments of investors of another Party. 12  See UNCTAD (1998) and Fatouros (1962, 135-141, 214- 215) and OECD (2004) 2. The concepts of “fair and equitable treatment” 13 Investment treaties vary in their precise drafting. Some ex- and “full protection and security” do not pressly define the standard by reference to international require treatment in addition to or beyond that law: examples are treaties concluded by France, the U.S. which is required by the customary international and Canada; others do not make reference to international law minimum standard of treatment of aliens. law, for instance, treaties concluded by the Netherlands, Sweden, Switzerland, and Germany. For example, The Ger- 3. A determination that there has been a breach of man model BIT states: “Each Contracting Party….shall in another provision of the NAFTA, or of a any case accord such investments fair and equitable treat- separate international agreement, does not ment”; and the Swiss model BIT states: “Investments and establish that there has been a breach of Article returns of investors of each Contracting Party shall at all times be accorded fair and equitable treatment…” 1105(1). UNCTAD (1998 n.1) 14 OECD (2004). Source:http://www.sice.oas.org/trade/nafta/chap-111.asp 15 Some authors believe that the FET standard does not inc and http://www.international.gc.ca/trade-agreements- porate the minimum standard, but rather is stand-alone. accords-commerciaux/agr-acc/nafta-alena/texte/index.aspx See for example, Dolzer (2005). 39 Tribunal in CMS Gas Transmission Company v. arbitrary, grossly unfair, unjust or idiosyncratic, is Argentina, although most of them interpreted discriminatory and exposes the claimant to sec- the FET as an autonomous standard. tional or racial prejudice, or involves a lack of due process leading to an outcome which offends judicial propriety – as might be the case with a manifest failure of natural justice in judicial Box 24. CMS Gas Transmission proceedings or a complete lack of transparency Company v. Argentina and candour in an administrative process.”17 In this case the tribunal stated that: The FET standard requires host states to comply There is one additional aspect the Tribunal must with the due process of law and includes the examine (…). That is whether the standard of fair obligation not to deny justice in criminal, civil, and equitable treatment is separate and more or administrative proceedings. The standard expansive than that of customary international law covers proceedings before the courts of the host (…), or whether it is identical with the customary international law minimum standard (…). In fact, state. The principles of access to justice, fair the standard of fair and equitable treatment and its procedure, and the prohibition of connection with the required stability and denial of justice relate to three stages of the predictability of the business environment, founded on solemn legal and contractual commitments, is not different from the international law minimum standard and its evolution under customary law. Box 25. Concept of Due Process and Its Application to Foreign Source: CMS Gas Transmission Company v. Argentina, Award of May 12 2005, 44 ILM (2005) 1205. Individuals The concept of due process has been expressed by the International Court of Justice (ICJ) in the following terms: We acknowledge that this discussion on FET can “The foreigner shall enjoy full freedom to appear be complicated, especially for nonlawyers. To before the courts for the protection or defense of make it easier to understand, let us note that the his rights, whether as plaintiff or defendant; to bring FET standard is intended to protect investors any action provided or authorized by law; to deliver against discriminatory measures. A measure any pleading by way of defense, set off or counter- would breach the FET standard when it lacks a claim; to engage counsel; to adduce evidence, whether documentary or oral or of any other kind; legitimate purpose, or is otherwise unjustified, to apply for bail; to lodge appeals and, in short, to and when it has a negative effect on a foreign in- use the Courts fully and to avail himself of any vestor. Discriminatory measures are also often procedural remedies or guarantees provided by the considered as arbitrary, and the two concepts law of the land in order that justice may be have been closely associated. 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