The EU-China Investment Agreement as seen from Europe: achievements with shortfalls

After seven years of negotiations, the European Union (EU) and the People’s Republic of China (China) concluded in principle the EU-China Comprehensive Agreement on Investment (CAI) on December 30, 2020. The European Commission has stated in a press release that the CAI "will be the most ambitious agreement [on investment] that China has ever concluded with a third country". Whereas the EU has indeed succeeded to achieve significant milestones, this cannot hide the fact that it has not fully achieved essential objectives it set itself at the beginning of the negotiations in January 2014. At that time, the EU's stated aim was to establish a coherent legal framework for EU-China investment relations by replacing the then existing 26 (now 25) heterogenous and outdated bilateral investment treaties (BITs) between EU Member States and China. The new agreement was intended to go significantly beyond the existing BITs by improving the protection of EU investments in China, lowering market access barriers for European investors in China and levelling the playing field for EU businesses in China.

With respect to investment protection the EU's aim was to replace the existing BITs with a uniform legal framework with modern protection standards and dispute settlement arrangements. For the EU, the latter includes the establishment of an investor-state dispute settlement (ISDS) mechanism with a two-instance investment court system (ICS), to be replaced in the longer term by a multilateral investment court (MIC). The CAI that has now been concluded in principle, does not include specific provisions on investment protection, however. The EU and China only agreed to "endeavour to complete" negotiations on investment protection and investment dispute settlement within two years of signing the CAI. This means that the EU has failed, at least for the time being, to achieve its central objective of modernising and replacing the investment protection rules of the existing BITs between EU Member States and China.

International investment agreements traditionally do not contain any provision to liberalise market access. Neither do the existing BITs between EU Member States and China. However, from the beginning of its negotiations with China, the EU has emphasised that an ambitious market access liberalisation was to be a core objective of the agreement. Although the specific scope of market access commitments of the two parties has not yet been made public, the EU has reportedly achieved both a binding of existing unilateral market liberalisations and the making of substantial new market access commitments by China. Binding China’s hitherto unilateral market liberalisation removes it (to some extent) from the discretion of Chinese domestic politics, prevents backsliding and reduces uncertainty on market access conditions for EU companies. And it allows the EU to resort to the state-to-state dispute settlement (SSDS) mechanism agreed in the CAI in case of a breach of these commitments. China's commitments on new market access openings and the elimination of equity caps or joint venture requirements are reported to relate to both manufacturing, including the important automotive sector, and several services sectors. The latter are reported to include, inter alia, numerous business services, cloud services and computer services, financial services, environmental services, and maritime and air transport-related services. Some of these commitments appear to be quite narrow or subject to specific limitations, however. Still, taken together, China's additional market access commitments could, if consistently implemented, provide substantial new investment and business opportunities for EU companies.

With respect to the EU's objective of levelling the playing field in China, the CAI includes commitments that relate to several long-standing requests of European companies. They relate to forced technology transfers, the transparency and fairness of administrative processes and regulation, the transparency of subsidies (in service sectors), and state-owned enterprises (SOEs).

With respect to technology transfers, the CAI prohibits investment requirements that force technology transfers and prohibits interference with freedom of contract in technology licensing. With respect to administrative procedures and regulations, it includes a broad set of transparency rules for regulatory and administrative measures as well as rules on procedural fairness and the right to judicial review. Licensing and qualification requirements and procedures will have to be "clear", "impartial" and "made public in advance". Overall, the agreed disciplines on these two issues appear to be quite significant. Several of the commitments listed are not new, however, but have been pledged by the Chinese government before. Whether they can actually achieve the intended improvements for European companies in practice, will depend on their consistent implementation and enforcement. Whether their binding in the CAI and the agreed SSDS mechanism are suitable to ensure this in practice remains to be seen.

With respect to subsidies the CAI's disciplines are much weaker and clearly insufficient. They are limited to transparency obligations on subsidies related to a specified list of services sectors only (complementing the WTO rules on transparency on subsidies related to goods). There are, however, no specific rules that would a priori prohibit or restrict any specific subsidies that could have a negative impact on the other Party's investment interests. In case of disputes related to subsidies the Parties can only make use of a specific consultation procedure that lacks any real enforcement power. The CAI's general SSDS mechanism does not apply to subsidies.

Another important but highly controversial issue in the negotiations was the regulation and treatment of SOEs. Here the EU has achieved to bring substantive new regulations into the agreement. The CAI requires SOEs (broadly defined) to act in accordance with commercial considerations and not to discriminate foreign investors in their purchases and sales of goods or services, when engaging in commercial activities. The CAI also includes important transparency and information obligations about the operation and governance of SOEs that are believed to violate the agreed obligations. If the problem is left unresolved, the parties may resort to the agreed SSDS mechanism. In addition, the CAI requires that all regulators act impartially and that laws and regulations are enforced in a non-discriminatory manner against all companies, including SOEs. While these obligations are, for sure, important steps, they do not imply that Chinese SOEs will have the same legal status as private Chinese companies or even foreign companies. They do not address or even reduce many forms of preferential treatment of Chinese SOEs by the Chinese government (such as specific subsidies or tax exemptions or their preferential access to capital and other production factors) either. And the CAI will not prevent Chinese SOEs to be increasingly politicised for the pursuit of China's ambitious industrial policy goals. As these include the acquisition of advanced technologies through outward direct investments of Chinese SOEs, the SOEs' privileges will not only continue to disadvantage EU companies investing in China but may increasingly also give SOEs investing in Europe an unfair advantage over their competitors on European markets.

In addition to the three main objectives mentioned above, the EU later introduced the inclusion of sustainable development principles for environment and labour as a fourth objective into the ongoing CAI negotiations. Here China and the EU agree not to use environmental and labour standards for protectionist purposes, not to lower these standards in order to encourage investments, and to respect their international obligations in the relevant treaties. In particular, they commit to effectively implement the Multilateral Environmental Agreements (including the UN Framework Convention on Climate Change and the Paris Agreement) and ILO (International Labor Organization) Conventions that they have already ratified. So far, China has only ratified four out of eight core conventions. With respect to the two fundamental ILO Conventions on forced labour that China has not yet ratified, there is only the almost meaningless commitment to "make continued and sustained efforts on its own initiative" to pursue their ratification, however. Whereas the general SSDS mechanism of the CAI does not apply to sustainable development matters, the CAI creates a specific consultation mechanism, including the possibility to involve the civil society, to establish a panel of independent experts and to publish its examination report, to address disagreements related to the implementation of the sustainable development commitments. The CAI would be the first bilateral agreement in which China makes such commitments – even though these commitments are overall still weak and lack teeth.

In summary, the CAI does promise significant improvements regarding market access and a more level-playing field for European companies in China. But the EU has not been able to achieve everything it aimed for. The EU failed, at least for the time being, in establishing modern investment protection standards and ISDS. While the CAI includes sustainable development principles for environment and labour, the related provisions are overall still weak. Moreover, China's additional market access commitments remain selective and its commitments with respect to subsidies are weak and clearly insufficient. In addition, many of China's commitments are actually not entirely new, but have already been granted before, either unilaterally or as part of multilateral agreements. Still, once the CAI with its agreed transparency requirements and enforcement and conflict resolution mechanisms enters into force, it will be easier for the EU to request China to implement these commitments and more difficult for China to unilaterally withdraw its now binding liberalisation steps. At a time of considerable tension in the EU-China economics and political relationship and increasing geopolitical conflicts, this is an advantage that should not be easily dismissed.

Moreover, the adoption of the CAI does not mean that the EU has to be content with the improvements stipulated therein and that it should simply accept the remaining shortcomings in China's treatment of European investments or in China's economic policy more generally. The EU should continue to try to induce China to further level the playing field for European companies and to commit to additional policy reforms. This can be done through additional bilateral negotiations, such as the negotiations on investment protection already agreed in the CAI, as well as through multilateral negotiations in the framework of the WTO or together with the US and other allies. In addition, the EU could also take unilateral actions to, for example, further improve its investment screening regulations, implement the foreign subsidies instrument currently being discussed at EU level or, in extreme cases, even use its new possibilities recently adopted by the Council to impose sanctions for human right violation and abuses.

Coverfoto: © Christie Kim on Unsplash

The Kiel Focus series presents papers on current economic policy topics. Their authors are solely responsible for their content and their views or any policy recommendations they may make do not necessarily represent the views or recommendations of the Institute.