The North American Free Trade Agreement (NAFTA) created one of the world’s largest free trade areas, linking over 450 million people and producing over $17 trillion in goods and services. Notably, NAFTA helped establish a more stable and predictable environment for foreign investors.

One of NAFTA’s most famous chapters is Chapter 11, otherwise known as the Investor-State Dispute Settlement (ISDS) chapter. ISDS chapters are consistently found in a large number of modern trade agreements across the globe.

Using NAFTA’s Chapter 11 as an example, we will explore how ISDS works, and why being knowledgeable about it is important to global investors and international businesses.

What NAFTA’s ISDS does:

NAFTA’s Chapter 11, like most ISDS chapters in trade agreements, establishes obligations for the parties’ treatment of investors and their investments.

If those obligations are breached by a foreign government, investors can seek to have these obligations and/or standards enforced by bringing a claim under NAFTA’s Chapter 11.

Once a claim is made, a tribunal will be established pursuant to Chapter 11, which will determine if the established standards and/or obligations have been breached and whether the investor may be entitled to recover monetary damages.

What are the main Chapter 11 obligations?

1. National Treatment states that a host country must provide NAFTA investors and their investments with treatment that is no less favourable than they provide to domestic investors/ investments in similar circumstances. This means that Canada, for instance, must treat Mexican and American investors no less favourably than it treats Canadian investors.
2. Most Favored Nation (MFN) states that a host country must treat NAFTA investors and their investments no less favourably than investors of any other non-Party nation. This means that Canada, for instance, must treat Mexican and American investors no less favourably than it treats investors from countries that are not part of NAFTA.
3. Expropriation provides that a host country may not expropriate, directly or indirectly, the investment of another Party in its territory without payment of fair compensation. In other words, Canada could not expropriate an American or Mexican investment without providing proper compensation to the investor.

Who can bring a claim?

In order to commence a Chapter 11 claim, one must be an “investor of a Party”. In other words, the investor must be from one of the countries who are part of NAFTA (Canada, Mexico or the United States).

For instance, a Russian investor doing business in Canada could not bring a claim under NAFTA Chapter 11 because he is not an “investor of a Party” to NAFTA, meaning he is not an investor from either Canada, the U.S. or Mexico.

A Canadian investor doing business in the U.S. or Mexico, however, would have standing to bring a claim as an “investor of a Party”, that being Canada.

An “investor” can be any citizen (corporate or individual) of any of the three Party countries (Canada, Mexico, U.S.), who has an investment in one of the three Party countries, but cannot bring a claim against his/her own country. In other words, a Canadian investor could not bring a claim against Canada, but could bring one against the U.S. or Mexico.

Who are the Parties?

NAFTA Chapter 11 allows investors, whether corporate or individual, to bring a claim against one of the three Parties’ governments. This is the only avenue through which private individuals or corporations may seek damages or start a claim against a foreign government entity.

Therefore, returning to the example above, a Canadian investor doing business and/or investing in the U.S. could bring a NAFTA Chapter 11 claim against the U.S. government if the U.S. government has breached any of the obligations outlined in the Chapter.

How it works

In order to start a claim, one of the obligations listed in Chapter 11 must be breached (i.e. national treatment, MFN, expropriation, etc.). If an investor does put forward a claim under NAFTA Chapter 11, they are essentially starting an arbitration process.

Typically, the tribunal will consist of a panel of three arbitrators. One arbitrator is appointed by each party, and the third presiding arbitrator is appointed by agreement between the disputing parties.

Although there are many general criticisms of ISDS, it still remains an important element to consider when doing business and/or investing abroad.

The ISDS chapter in a trade agreement of a country where you are considering doing business or investing could act as a shield against any arbitrary foreign government measures that would negatively impact your business.

For more information on Chapter 11 and how it might apply to your business, contact Catherine Walsh.

Has NAFTA’s Chapter 11 or any other trade agreement’s ISDS impacted your business?

The post NAFTA’s controversial Chapter 11: What’s an ISDS and why does it matter? appeared first on Trade Ready.

If it’s doing either, are you aware of how the political risks of these markets can threaten your bottom line?

If you’re not clear about the hazards, or if you recognize them but don’t manage them systematically, you’re not alone. According to recent research, many businesses—both in Canada and abroad—don’t do nearly enough to reduce their exposure to political risk in emerging markets. These risks include:

• Import/export restrictions
• Foreign exchange restrictions
• Breach of contract by a foreign government
• Changes in laws and regulations
• Expropriation
• Civil disturbance and other forms of political violence

As Canadian firms look for new business abroad, especially in emerging markets, the urgency of managing these risks will steadily increase. Many businesses, in fact, are now confronting these hazards and are deeply concerned about them.

As just one example, a 2013 survey of more than 450 multinationals that operate in emerging markets revealed that political risks are already affecting their bottom lines. One in five of these companies had suffered a loss from civil disturbance during the previous three years, one in four from foreign exchange restrictions and one in three from breach of contract by a foreign government. And the situation is likely to get worse, not better.

Other research now places political risk among the top 10 hazards facing organizations today.

Given these developments, it’s a puzzle that so many businesses pay so little attention to political risks. This is even more surprising when you consider that effective political risk management can provide important benefits such as:

• A better understanding of how political events could affect your investments.
• The ability to seize opportunities in markets that could be very profitable, but involve political risks.
• The ability to make better decisions about how to reduce your political risks.

To sum up: By not managing your political risks effectively, you may expose your company to severe losses while losing out on some important advantages. This, obviously, doesn’t make a lot of sense.

Four steps to managing political risk

The key to protecting yourself is to have a clearly defined strategy for managing your political risk, with a formally designated risk manager who’ll watch for these hazards and find ways to deal with them. One of the most common strategies is a four-step process based on identification, measurement, mitigation and monitoring.

1. Identify your risks

Through your risk manager, you gather pertinent information about the types of political risk your company faces, or is likely to face, in the target country.

The objective here is to find out how political conditions may affect your goals in the market.

Next, you identify the political risks that most threaten these goals. Seizure of assets might be a low-ranked hazard if you’re only exporting to the country from Canada, for example, but potentially a serious one if you bring valuable assets into an emerging market to perform contract work on the ground.

2. Measure your exposure

You rank the risks you’ve identified and measure your exposure to each one. This involves attaching numbers to the risks to reflect their potential financial effects on your company. These measurements will help determine whether the risk level of a market is within your tolerance, thus helping you decide whether to enter it.

3. Mitigate your risks

You take measures to lower the probability of a risk and to reduce its effects if it becomes a reality. How you do this will be determined by the nature of your company.  If you’re making an investment, for example, you could work with local partners whose familiarity with their market can help you avoid problems. To help protect you if trouble hits, you could purchase insurance that covers political risks.

4. Monitor your risks

Once you’ve established how your risk management process will work, you set up routines for reporting, evaluation and review. There should be formal channels for regularly reporting political risk issues, both upward to senior management and downward to the personnel who manage your on-the-ground operations. These routines should become part of your normal business activity, and your risk manager must make sure that they don’t fall into disuse as time passes.

As you’ll recognize by now, setting up a risk management process isn’t a trivial undertaking, and you may not have the internal resources to create the system you need.

In this case, you can turn to outside experts. There are numerous private-sector agencies that specialize in providing their clients with detailed information on political risks in world markets, and in helping companies establishing their political risk management systems.

Even companies with effective political risk management, however, may find that some markets leave them more exposed than is comfortable. In these cases, insurance can fill the gap.

Export Development Canada (EDC) has a full suite of insurance solutions that can help both investors and exporters cover many types of political risks when they are doing business in emerging markets.

Want to learn more about managing political risk in emerging markets? Visit EDC and download the new guide to Managing Political Risk.

The post Four steps to managing political risk in emerging markets appeared first on Trade Ready.

International trade is a risk/reward business. There can be greater payment, logistical, regulatory and political risks when dealing with overseas suppliers and customers. Nevertheless, your business will reap rewards if you can develop a competitive global supply chain, penetrate profitable export markets with quality products and services, while successfully managing the increased risks.

Payment risks caused by defaulting customers can be minimized with letters of credit and other financial instruments. Logistical risks can be managed by selecting experienced shipping companies and engaging with skilled logistics professionals. Regulatory risks can be identified if you hire qualified legal counsel upfront and not wait until a violation has occurred.

Political risks are harder to deal with. Contrary to conventional wisdom, political risks are not just a “Third World” problem. You can face unexpected political risks even when dealing with advanced economies. Managing these risks can be tricky. You have to act like a chess player or hockey goalie and anticipate where the next move or shot will be coming from.

There are many types of political risks. Most of them are covered by the political risk insurance policies offered by Export Development Canada (EDC) to Canadian exporters. American exporters can obtain similar policies from the Overseas Private Investment Corporation (OPIC).

1)    War and civil unrest

The most obvious political risks are wars, sustained civil unrest and major acts of terrorism which destroy or severely hamper the ability to conduct commerce in the foreign country.

2)   Expropriation without just compensation

Expropriation is another form of political risk. It occurs when the foreign country arbitrarily confiscates or “nationalizes” assets, often without due process of law and without paying just compensation to the business owners. Prominent examples from the 1960s and 1970s include Fidel Castro’s seizure of U.S. companies’ sugar plantations in Cuba, and Salvador Allende’s seizure of U.S.-owned copper mines in Chile.

3)    Trade losses due to embargoes

The imposition of an embargo against a foreign country can bring your company’s imports or exports to a screeching halt. The most long standing example is the United States’ embargo against Cuba, which was imposed in 1962 and continues today with limited exemptions. When I was practicing law in Chicago, the U.S. imposed an embargo against Iran when Iranians took American embassy personnel hostage in Teheran. One of our clients suffered significant losses when its perishable goods in ocean transit could not enter Iran.

4)    Environmentally influenced political risks

In the past, weather, pollution and over-fishing were not commonly viewed as political risks. However, seas are rising, storms are increasing in their intensity, industrial pollution crosses international borders, and ocean fisheries are in steep declines due to the actions of particular countries. The political risk category may be broadened to encompass these emerging environmental issues.

5)    Trade disrupting sanctions

Today, the most common political risk disrupting international trade flows is the imposition of sanctions against one country by another country. Sanctions have become an increasingly favored political tool to punish other governments which violate international law, abuse human rights and/or otherwise engage in behavior harmful to the country imposing the sanctions. Sanctions are a form of economic warfare which hurt the innocent civilians in a country much more than the leaders of the country, as was the case with the long standing sanctions against Iraqi dictator Saddam Hussein – however, the ethical aspects of sanctions are beyond the scope of this article.

Sanctions are typically more limited or targeted than a full embargo. They may include visa bans for individuals, freezing of the assets of individuals, companies and the foreign government, prohibitions on commercial dealings and trade in specific commodities, cessation of arms sales, cancellation of international cooperation meetings and joint military exercises, and restricting the sanctioned government’s access to financing and debt relief. In severe cases, sanctions morph into complete embargoes and even naval blockades and no-fly zones, inching closer to military conflict.

Clearly, sanctions are authorized under international laws and the laws of the countries involved. For example, both Canada and the United States have domestic legislation setting forth the criteria for and the mechanics of sanctioning another country either unilaterally or in concert with the United Nations, other countries or the much spoken of but always illusive ‘international community’.

Sanctions can be devastating for commercial businesses because they are often imposed in an unpredictable manner and sometimes with lightning speed by politicians anxious to appear forceful on the world stage but perhaps unconcerned about the impact on particular businesses selling commercial goods that are totally unrelated to the political crisis. An example involves the current situation in Ukraine where Canada, the U.S. and the EU have issued sanctions on numerous persons as a result of the corruption of the former Ukrainian government and Russia’s military incursion into Crimea. For example, it is possible that companies based in the West which were legally selling commercial goods to one or more of the now sanctioned persons in Ukraine could suffer severe financial losses through no fault of their own.

It is my understanding that the political risk insurance offered to Canadian exporters by the EDC and to American exporters by OPIC does not cover losses incurred because of the imposition of sanctions by the Canadian or U.S. governments respectively. It only covers losses caused directly by the actions of a foreign government. There may be some private insurers covering this sanctions risk but these two government agencies do not.

Insure your trade interests

The cautionary advice is to obtain political risk insurance to protect your exports where available and affordable. Like all types of insurance, there are exclusions from coverage. You should be very familiar with the policy coverage and exclusions. You also need to keep a close watch on the political and economic developments in the countries you are exporting to. You have to be your own “futurist” and predict when your exports may be disrupted by political risk, especially the increased use of sanctions by your own government.

In a globalized economy, it is unlikely that sanctions will not cause some “blowback” on the sanctioning country’s exporters. This is something that politicians need to pay attention to and avoid taking precipitous or ill-considered actions which damage their own country’s businesses. I am not suggesting that governments in Canada or the U.S. ignore violations of international law and human rights by other countries. I am only suggesting that overly broad sanctions may not be the wisest foreign policy tool because of the negative impact on the sanctioning country’s international trading companies’ legitimate business.

The post Don’t let these 5 political risks sink your exports appeared first on Trade Ready.