[T]he Tribunal must balance the legitimate and reasonable expectations of the Claimants with […] [the] right to regulate the provision of a vital public service.
This quote from an investment arbitration tribunal highlights the relationship between international investment law and the regulation of public services. This essay illustrates areas of contention between the requirements of international investment law and the regulation of public services.
Regulation of public services and international commercial interests
Public services are provided and regulated based on non-commercial public interests and on the need for the provision of such services in a way the market cannot achieve. Public service obligations aim at securing a certain quality of the service, general (universal) access and affordable prices. This involves value judgments that may vary by country and over time. Regulation of public service should be developed in democratic processes and articulated by democratically accountable public bodies. Public services are a key element of the modern social and welfare state that is subject to continued processes of adaption and reform. This implies reviewing and re-assessing existing models of providing public services. In this context, it is noteworthy that models exclusively relying on market-based solutions are increasingly challenged. It is, therefore, necessary to maintain regulatory autonomy and to create space for discourse and reflection on reforming public services regulation.
At first sight, regulating public services does not seem to collide with international investment law. However, an activity perceived in one country as a public service provided by a public monopoly on a non-commercial basis may be a commercial activity pursued by private companies in another. For example, traditional postal services, such as the delivery of letters, are subject to a state monopoly in Canada, whereas these services are provided on liberalised markets in Europe. This renders the inclusion of postal services a contentious issue in the Canada-European Union Economic and Trade Agreement (CETA) currently under negotiation.
Furthermore, in the process of transforming public services through liberalisation and privatisation, countries often experiment with various instruments and may also withdraw or change liberalisation or commercialisation policies. This may conflict with the interest of private companies active in the relevant field. For example, after several Latin American countries pursued privatisation policies in water and sewage services in the late 1980s and early 1990s, changes in political preferences and the financial crisis led to policy reversals in the 2000s which triggered a series of investment disputes.
The impact of international investment agreements on public services
Scope of investment agreements
International investment agreements, such as Bilateral Investment Agreements (BITs) and investment chapters in regional trade agreements, usually define their scope on the basis of an illustrative or exhaustive list of different forms of assets. Unlike trade agreements (such as the World Trade Organization’s General Agreement on Trade in Services) investment agreements do not exclude governmental activities from their scope of application. The impact of investment law on public services regulation is therefore not filtered through limitations in the scope of application of investment agreements. In addition, many investment agreements include “concessions” in their lists of assets. The withdrawal of concessions, or the alteration of the terms of concessions regarding the provision of public services, such as gas, water or electricity distribution, have been the subject of a number of investor-state dispute settlement proceedings.
Protection against expropriation
Investment agreements protect against direct and indirect expropriation. In the context of public services, regulatory expropriation (regulatory taking) is of particular interest. The term denotes regulatory measures that generally aim at public interests but also deprive the investor of the commercial value of the investment. Arbitral tribunals have struggled to delineate legitimate regulation for public policy purposes, which would not trigger compensation, from regulatory measures with unjustifiably detrimental effects on the investor, which would require compensation. Most often tribunals referred to the degree or the extent of the interference with the investor’s rights. For example, the Azurix tribunal stated that “the issue is not so much whether the measure concerned is legitimate and serves a public purpose, but whether it is a measure that, being legitimate and serving a public purpose, should give rise to a compensation claim”. Hence, measures taken for regulatory purposes in public services can amount to indirect or regulatory expropriations if they adversely affect the investor’s assets in such a way that it deprives the investor of the value of the investment.
Standards of treatment
Apart from protection against expropriation, investment treaties usually require fair and equitable treatment of the investor. Fair and equitable treatment is often defined with regards to legitimate expectations of the investor, which, for example, may be upset by sudden or fundamental changes of the law relevant to the respective investment. In addition, the fair and equitable standard relates to the stability, predictability and consistency of the legal and business environment. In this context, reference is often made to the object and purpose of investment treaties to create favourable conditions for investments. Tribunals have concluded that guaranteeing a stable and predictable investment climate is one of the central purposes of these agreements.
The fair and equitable treatment standard has been at the heart of a number of investment disputes concerning water distribution, such as Suez v. Argentina. Here the tribunal was of the opinion that, despite the extraordinary circumstances of the Argentine financial and economic crisis, the provincial authorities were confined to exercising their regulatory discretion in accordance with the terms and conditions of the agreed regulatory framework. This shows that tensions between the requirements of this standard and government regulation of public services may arise if the fair and equitable treatment standard inhibits necessary adjustments and changes in the legal framework that the investor did not expect, or that are considered irrational or unjustifiable by the investment tribunals.
Another typical element of investment treaties that is relevant to regulating public services are so-called “umbrella clauses”. They usually require the host state to fulfil “any other obligations” it may have entered into with regard to investments protected under the respective treaty. An important issue concerning the umbrella clause is whether it covers obligations under state-investor contracts, such as concession agreements. If this is the case, an investor may not only challenge direct violations of the principles of international investment agreements, but also breaches of investment contracts in an investor-state dispute settlement proceeding. The scope of the umbrella clause is of specific concern in the context of public services regulation, because investments in infrastructure (networks, grids, etc.) are usually large-scale projects that require elaborate and detailed contracts (usually concessions) between the state and the investor. Often these contracts contain a regulatory framework specific to the project and encompass commercial aspects, as well as elements of public power (administrative contracts). In light of the complexity of these contracts and the various legal fields they address, it is of great importance how claims arising from them will be adjudicated.
Areas of contention
The imposition of the obligations of international investment agreements may lead to conflicts with government policies and activities aimed at the regulation of public services, in particular if governments use ad hoc-measures and instruments addressing single cases that affect the operation of an existing investment. If the regulations are in place before the investment is made, and if the regulations are applied in a transparent and non-discriminatory manner, the potential for conflict between investment agreements and public services regulation seems less acute. However, the regulation of public services responds to changing needs of a society, to changes in public policies or to unforeseen problems that occur during the duration of an investment project. In these cases, the regulatory framework agreed upon and known to the investor before making the investment may be inadequate to deal with those changes and unforeseen events. International investment law places a heavy burden on governments if they intervene with instruments not envisaged by the investor or in an unexpected manner. As seen in the water privatisation cases, issues of price and quality control are often at the heart of the relevant disputes. Price and quality regulation are, however, among the most important areas of the regulation of public services as they determine the conditions of the access of citizens to these services.
Potential for harmony?
Can international investment agreements also support the provision of public services? As the provision of public services is underfunded in many countries, the lack of funding and investment could be compensated through the attraction of capital from abroad. Consequently, foreign direct investment in public services could contribute to the provision of high quality services. In fact, in all water service disputes, the investor was initially invited into the country assuming that the investment would have a positive impact on the supply and distribution of drinking water. It could, therefore, be argued that investment agreements can have a positive impact on the provision of public services if they contribute to the attraction of foreign investment in those sectors. However, it is unclear whether investment agreements are positively linked to the attraction of foreign direct investment. Consequently, the question whether investment agreements may have a positive impact on the provision of public services depends on the circumstances of each individual case.
The impact of investment law on the regulation of public services is especially relevant in the context of decisions taken in specific situations, often in reaction to unforeseen changes in public policies, investor performance or the general economic or financial conditions in the country. While investment tribunals generally seem to accept the necessity to regulate public services, they are less tolerant to changes reacting to exceptional situation and unforeseen developments. Yet, the reaction to such changes is a fundamental element of the regulation of public services which can also be based on considerations of democratic decision-making within a given society. The approach of many investment tribunals towards cases involving public services therefore needs to be modified if they want to balance investor rights with the requirements of public services regulation.
Author: Markus Krajewski is professor of public and international law at the University of Erlangen-Nürnberg (Germany). This essay is based on a chapter to appear in Bungenberg / Griebel / Hobe / Reinisch (eds), International Investment Law, to be published.
 Suez, Sociedad General de Aguas de Barcelona S.A. and Interagua Servicios Integrales de Agua S.A. v. Argentine Republic, ICSID Case No. ARB/03/17, Decision on Liability, 30 July 2010, para. 216.
 Azurix Corp. v. Argentine Republic, ICSID Case No. ARB/01/12, Award, 14 July 2006, para 310.
 Suez, Sociedad General de Aguas de Barcelona S.A. and Interagua Servicios Integrales de Agua S.A. v. Argentine Republic, ICSID Case No. ARB/03/17, Decision on Liability, 30 July 2010, para 227.
 See UNCTAD, The Role of International Investment Agreements in Attracting Foreign Direct Investment to Developing Countries (UNCTAD, 2009), p. 33.