introduction

With the continuous advancement of the "Belt and Road" initiative, Chinese enterprises have made positive contributions to promoting the high-quality development of the "Belt and Road", achieving high-level opening up, and accelerating the construction of a new development pattern by exploring and opening up new era models in the fields of direct investment and other investment and financing. At the same time, the complex political and legal environment has put Chinese companies in political risks that are very different from traditional business risks and have a far-reaching impact. Political risks may not only lead to delays in construction periods, cost overruns, but may even lead to a complete failure of the project. Effective political risk management is not only a defensive measure, but also a prerequisite for project financing and long-term success.

This article will discuss the mitigation mechanism of political risks, focusing on analyzing the application of various legal tools from the theoretical basis to the practical operation level, and strive to provide a set of practical and forward-looking legal response solutions for Chinese companies that "go global".

1. Political risks under the background of the "Belt and Road"

In the context of the Belt and Road Initiative, Chinese investors usually face host governments or authorized entities that play the role of both commercial entities and sovereign institutions, which is also one of the main sources of political risks, as host countries may use their public power to circumvent their specific obligations under the contract. Therefore, analysis of political risks requires a broad classification beyond conventional classification and into its legal nature.

(I) Risks of Government Behavior

This type of risk stems from the measures by which the host government or its authorized entities exercise their sovereignty or administrative powers, is the most common and relatively difficult to control in the Belt and Road Initiative, with the main forms:

1. Expiration: refers to the host government directly announces that the project assets will be nationalized, or gradually weakens the project's economic value or deprives investors of control through seemingly legal regulatory measures, which in fact achieves the effect of expropriation.

2. Legal changes: means that after the contract is signed, the host country may promulgate new laws and regulations, or undergo significant changes in the official interpretation and application of existing laws and regulations, which will have a substantial adverse impact on the project's compliance costs, operating models or profitability.

3. Restrictions on exchange, trade and transfer: refers to the host government (or, in specific circumstances, a third-party government) through legislative or administrative measures to block the free cross-border flow of funds, goods or technologies related to the project, thereby creating substantial obstacles to the economic feasibility or normal operation of the project, including restrictions on exchange and transfer, embargo, import and export control, etc.

4. Government breach: refers to the failure of the government department or state-owned entity as a party to the contract (for example, the authorized party in the concession agreement, the power purchaser in the power purchase agreement) to perform its key contractual obligations under the project agreement. How to elevate such superficial "commercial default" to the level protected by international law is also one of the core issues discussed in point 2, item (3) of Part II of this article.

Because in the "Belt and Road" project, the host government often holds multiple positions, both as the grantor of the franchise rights, the power purchaser, or the cooperative construction party of infrastructure projects, and also undertakes sovereign supervision functions such as planning approval, environmental protection supervision, and tax collection and management. This kind of multiple roles naturally has conflicts of interest, which also provides operational space for them to evade contractual obligations through "regulatory" means. Therefore, when preventing political risks, it is not enough to simply identify behavior. What is more important is to design a set of institutional mechanisms to effectively restrict the government from breach of contract in the name of supervision and ensure the true enforceability of contract rights.

(II) Risk of political violence

Such risks directly threaten the safety of project personnel and tangible assets and are often more destructive. It mainly includes: war (regardless of declaring war or not), invasion, hostile acts; civil war, revolution, rebellion, coup; terrorist acts; and political riots, riots or civil unrest.

Unlike "government behavior risk", "political violence risk" is usually not directly implemented by the government, but occurs in the context of the failure of state governance or the collapse of order, and is initiated by non-state actors. Therefore, when analyzing the consequences of such events at the legal level, the focus is on judging whether the host country should bear national responsibilities. In Edshi v. Hungary, the tribunal made it clear that the “comprehensive protection and security” clause in the investment agreement is not an absolute responsibility. The host government does not assume liability for all violence that occurs on its territory, and its obligations are usually limited to taking all reasonable and prudent measures to prevent and stop damages against foreign investment.

In other words, when the project is damaged by political violence, whether investors can obtain compensation in accordance with the law depends on whether it can prove that the host country has clearly dereliction of duty or failed to fulfill its protection responsibilities in advance. On the contrary, if the act of vandalism is directly caused by government forces or official forces, such as in Asia Agriculture v. Sri Lanka, government forces caused unnecessary wanton damage to foreign investment projects, then the determination of government responsibility is clearer.

Therefore, when facing different types of political risks, investors should realize that the legal response paths of government behavior and political violence are not the same. The former is usually a claim for breach of contract by the host country, while the latter is mostly based on its failure to fulfill its protection obligations or claims exemption through force majeure clauses. Understanding this fundamental difference is the starting point for establishing an effective legal risk response system.

2. Identification of political risks: Pre-investment of investment legal due diligence

Comprehensive and in-depth legal due diligence is the basis for the identification and assessment of political risks, and its importance is self-evident. Taking the case of Metclyde v. Mexico as an example, after obtaining all permissions from the Mexican government for building a waste landfill, the investor failed to fully adjust and respond to the opposition power and willingness of the local municipal government, which eventually led to the complete termination of the project by the local government on the grounds of establishing an "ecological protected area". This case fully demonstrates that high-level political commitments cannot replace specific and trivial legal and regulatory due diligence at the implementation level of the project.

Therefore, targeted adjustments should be made to the scope of legal due diligence reports based on different countries and projects. Especially in countries or regions with high political risks, political risk due diligence should include at least the following content:

(I) Due diligence on macro-political risks

At the macro level, due diligence is designed to comprehensively evaluate the host country's investment environment and legal framework, including:

(II) Due diligence on micro-political risks

Due diligence at the micro level focuses on the project itself and usually includes:

The previous legal due diligence report provides investors with a list of potential risks, providing targeted basis for subsequent investment decisions, contract negotiations and risk transfers (such as purchasing policy insurance, transferring risks through subcontracts, etc.).

3. Optimize the contract terms

For investors, carefully constructed contracts are the most direct and effective legal tool to protect their own rights and interests. As Chinese companies' role in the Belt and Road Initiative changes from simple engineering contractors to investors, financing parties and operators, their risk management strategies also need to shift from the traditional "risk aversion" model to the "risk pricing and allocation" model to ensure that when political risks occur, the project's financial model and long-term cash flow can be protected to the greatest extent.

(I) List of political risks from force majeure to "precision"

Traditional international engineering contract templates (such as FIDIC series contracts) provide a framework with force majeure as the core when dealing with political risks. The basic logic is that political risk events exceed the reasonable control of both parties to the contract, so neither party should bear the liability for breach of contract.

However, for investors, these international engineering contract templates have obvious limitations: they have relatively general definitions, single relief measures, and it is difficult to cover all risk exposures of investors, and afterwards, they often require a long and complex argument on whether the specific event meets the elements of force majeure (i.e., unforeseeable, and insurmountable).

A more precise approach is to set clear definitions in the contract, such as "Political Force Majeure Event" or "Political Risk Event" and list specific events based on the results of previous due diligence, so that this definition can not only cover traditional political violence such as war and riots, but also include specific government actions, such as:

Once any event contained in the definition occurs, you can directly contact the relief mechanism preset by the contract, and there is no need to conduct complex causal relationships and responsibility determinations, greatly improving the certainty and enforceability of the contract.

(II) From "cost compensation" to "economic status guarantee"

The remedies provided by the international engineering model contract are mainly to "compensate for losses" through extension of construction periods and conditional compensation for direct costs. This relief model is basically fair to traditional engineering contractors, but it is obviously insufficient for investment projects or franchise projects that need to repay huge bank loans through long-term stable income, because the main risk faced by the project is cash flow interruption, which makes it unable to repay its debts.

To ensure that the cash flow and economic status of the project company can be effectively guaranteed regardless of the political risk event, a targeted prevention mechanism is needed to be introduced into the contract.

1. Introduce a presumptive compliance mechanism

When political violence or government-specific behaviors cause the project to be physically unavailable, investors face the risk of cash flow disruption, at which point, providing direct cost relief alone cannot solve the problem that the project company is unable to repay the principal and interest of the loan.

To this end, the "presumed performance" ( ) clause can be introduced. Taking the power purchase agreement as an example, such clauses stipulate that if the power plant cannot release electricity due to political force majeure events (such as intentional damage to the power grid and the government's failure to supply fuel), the power purchaser (usually a state-owned power company) is still obliged to pay the project company the electricity bills it should pay as if it had normally generated electricity according to the price agreed in the contract. This mechanism cleverly transforms the financial consequences of political risk events from "income loss" to "income guarantee", thereby ensuring its stable cash flow, used to cover operating costs and repay loans.

2. "Change situation" and "Economic balance" clauses

Many political risk events will not directly cause the project to cease operations, but will fundamentally shake the economic foundation on which it depends. For example, host countries generally tighten environmental protection standards in order to deal with climate change, or the host country's macroeconomic policy adjustments have caused a sharp depreciation of their own currencies, weakening the ability of project revenue denominated in local currency to repay principal and interest after converting into foreign currencies.

Such risks will undermine the economic balance of the contract, and if the contract is continued to be performed according to the original conditions, it will be "obviously unfair" to one party. This is exactly the issue that the "change of situations" () principle in international contract law needs to be dealt with. Therefore, investors can introduce "situation change clauses" or "economic balance clauses ( )". This type of clause usually sets a quantitative triggering threshold (for example, if the project cost increases or revenue decreases by more than 10% due to legal changes), once triggered, the two parties will be forced to negotiate in good faith within a certain period of time (such as 90 days), in order to restore the initial economic balance of the contract by adjusting the charging standards, extending the franchise period, and providing government subsidies. If negotiation fails, the dispute may be submitted to a preset expert or arbitral tribunal for a ruling.

(III) Termination compensation formula and safe exit

When political risk events continue for a long time, resulting in the inability to achieve the purpose of the contract and trigger the contract termination clause, the calculation method of the compensation amount after termination becomes the last line of defense to protect investors and lenders.

The termination of the international engineering contract template is usually intended to compensate the contractor for the value of the work completed and the reasonable cost of evacuation, but this does not protect the investor's equity input and expected returns. To ensure that investors and lenders can exit safely, the contract termination compensation formula triggered by political risk events should cover the following parts:

The combination of these three parts constitutes a progressive security guarantee system: first, protect the creditors, second, protect the principal of shareholders, and finally cover the reasonable returns of shareholders, providing investors and lenders with an expected and contractual exit path in the worst case, greatly reducing the overall risk of the project and improving the financingability of the project.

4. Seek protection of international treaties

When the contract counterparty itself is a sovereign state, investors can try to combine contractual rights with international investment treaty protection to provide a "double insurance" for the host government's performance of their obligations, thereby better protecting their own interests.

(I) "Umbrella Protective Terms": A Bridge from Commercial Default to Treaty Default

The first guarantee lies in the contract itself. As mentioned above, through carefully designed contractual terms, the broad commitments of the government can be translated into specific lawsuits legal obligations. In addition, when there is a strong intergovernmental investment agreement, investors may also agree that the government's behavior under this contract should comply with the terms of "fair and just treatment" in the relevant investment agreements. This "contract internalization" method provides investors with a higher and more objective international standard for measuring government performance in future commercial arbitration, thereby enhancing the protection of the contract itself.

However, even the most rigorously worded contracts can be violated, and the host country's domestic judicial system may not necessarily provide timely and impartial relief to foreign investors. At this time, the second guarantee is to "escalate" contract disputes to the level of international law through international investment treaties. The key legal tool to achieve this upgrade is the "umbrella protection clause" ( ) contained in some bilateral investment agreements. This clause aims to place all commitments made by the State party to investors (including commercial commitments in specific contracts) under the "umbrella" of international treaties. The “umbrella protection clause” provides investors with an important legal path: converting “commercial defaults” from host governments or state-owned entities into “treaty defaults” protected by international investment law, allowing investors to bypass the host country’s domestic judicial system that may be partial or inefficient and seek relief directly on the platform of international arbitration. This mechanism is fully interpreted in the classic SGS v. Pakistan case and is also reflected in China's own treaty practice. For example, the Agreement between the Government of the People's Republic of China and the Government of the Federal Republic of Germany signed in 2003 on Promoting and Mutual Protection of Investments includes the standard "umbrella clause".

These two guarantees complement each other, allowing investors to choose the most favorable path to protect their rights based on the specific nature of the dispute and the pros and cons of different dispute resolution mechanisms.

(II) The evolution of Chinese investors and ISDS

In the past, Chinese companies had a relatively conservative attitude towards using the investor-state dispute settlement (ISDS) mechanism to resolve investment disputes. However, the situation has changed significantly in recent years. Since the case of Hong Kong investor Xie Yeshen, a Hong Kong investor, sued Peru, as the first case of Chinese investors in the Center for International Investment Dispute Resolution (ICSID), more and more Chinese companies have begun to actively use treaty weapons to protect their rights and interests. In the case, investors successfully argued that the strict law enforcement measures of the Peruvian tax authorities constituted an indirect collection without compensation.

Recent cases have shown an acceleration of this trend. The iconic significance is the case of a Chinese company v. Sweden. In this case, a Chinese company filed an ICSID arbitration based on the Agreement between the Government of the People's Republic of China and the Government of the Kingdom of Sweden on Mutual Protection of Investment, claiming that Sweden violated treaty obligations such as fair and just treatment. This shows that Chinese investors' rights protection path has entered a new stage, beginning to challenge the complex regulatory measures taken by developed countries in sensitive areas under the pretext of national security.

The following table lists the more representative bilateral investment agreements signed by China in different eras. The changes in the ISDS terms reflect the evolution of China from passive, prudent to active and skillful in the field of ISDS:

(Table 1: Evolution of Investor-State Dispute Resolution Terms in China's Bilateral Investment Agreement)

From the above table, it can be seen that the intensity of treaty protection that investors can obtain depends largely on the content of the bilateral investment agreement signed by the host country and China, once again highlighting the importance of conducting in-depth "treaty due diligence" in the early stages of investment decision-making.

V. Application of policy insurance

If due diligence is to "identify risks" and optimize contracts is to "distribute risks", then policy insurance is the ultimate barrier for investors to alleviate political risks after exhausting business and legal means. In the practice of the "Belt and Road", China Export Credit Insurance Corporation (hereinafter referred to as "CICC") plays an important role as the only policy-based export credit insurance institution.

CITIC Insurance’s “Overseas Investment Insurance” product is designed to hedge political risks, and its coverage mainly includes expropriation, war and political riots, exchange restrictions and government defaults. For investors, policy insurance has strategic value beyond loss compensation:

First, it is a powerful credit enhancement tool. CITIC Insurance's intervention can effectively divest potential catastrophic financial losses caused by political events from the balance sheets of investors and commercial banks. For lenders, CITIC Insurance means that the principal and interest of the loan can be repaid, thereby increasing the overall credit rating and financingability of the project.

Secondly, obtaining insurance from CITIC Insurance is often a key prerequisite for financing large-scale and high-risk projects. Without CITIC Insurance's policy, commercial lenders often require other credit enhancements with equivalent effectiveness to cover political exposure, such as sovereign guarantees provided by the host finance ministry or shareholder guarantees provided by the parent company, both of which are often more difficult to obtain.

Finally, CITIC Insurance's intervention also brought about an informal protection mechanism. The host government will realize that once CITIC Insurance provides insurance for the project, any adverse behavior (such as default or disguised expropriation) may arise from no longer just commercial disputes. Once CITIC Insurance compensates under the policy, it will inherit the investor's claim through subrogation rights. At this time, the host government will face not only a company, but a financial institution that represents China's national credit. This potential deterrence is itself an effective risk barrier.

Of course, investors also need to realize that its main disadvantage is that the premium is relatively high, so it needs to be fully considered in the project financial model. It is worth noting that when evaluating project risks and determining premiums, CITIC Insurance will also pay close attention to the degree of improvement of the risk allocation clauses in the project contract. A complete contract itself will become an important basis for obtaining favorable insurance conditions, further reflecting the close connection between legal risk management.

6. Conclusion

To sum up, in order to effectively manage the political risks in the "Belt and Road" project, it is recommended that Chinese "go global" enterprises adopt a systematic and multi-level legal strategy, including:

For Chinese companies navigating the complex environment of the "Belt and Road", proactive and precise allocation of political risks is not only a legal compliance task, but also a core strategy to ensure the feasibility, financing and ultimate success of overseas projects.

Notes:

For example, in the case of Maitclyde v. United States of Mexico (v. The , ICSID Case No. ARB(AF)/97/1), the tribunal pointed out that even without a formal expropriation ordinance, a series of regulatory acts designed to hinder project operations constitute indirect expropriation if its combined effect deprives investors of their economic interests. Similarly, in Tektronix v. Mexico ( , SA v. The , ICSID Case No. ARB (AF)/00/2), the tribunal stressed that judging expropriation should primarily examine the ultimate impact of government measures on investors, and that if a measure actually deprives all or most of the value of the investment, it can be considered indirect expropriation, whether or not it is subject to public policy considerations.

For example, in Eiser and Solar S.à rlv of Spain (ICSID Case No. ARB/13/36), the tribunal held that even if the state has the right to adjust its regulatory policies, it must not fundamentally overturn specific commitments made to attract investment, otherwise it would violate the principle of "fair and just treatment" under international investment treaties.

For example, in CMS v. Argentina (CMS Gas v. The , ICSID Case No. ARB/01/8), the arbitral tribunal held that the Argentine government's foreign exchange control measures directly violated its treaty obligation to guarantee free transfer of capital under BIT. Although Argentina used the "critical situation" as the defense of its breach of contract, the arbitral tribunal held that the situation in Argentina in this case had not yet met all the harsh conditions for citing the "critical situation" to defend against it in international law, and therefore it cannot be exempted from its liability for compensation.

For example, in Urban Group Co. Ltd. v. of Yemen, ICSID Case No. ARB/14/30), Beijing Urban Construction Group signed a contract with the Yemen Civil Aviation and Meteorological Bureau to undertake the construction of the new terminal project of Yemen Sanaa International Airport. From 2014 to 2015, a large-scale civil war broke out in Yemen, and Sanaa Airport and surrounding areas became targets of air strikes, and the project site was seriously affected. Investors believe that their investments were actually destroyed due to war and civil strife, and that the Yemeni government failed to fulfill its obligation to protect under the BIT. Although the case was ultimately not decided on issues such as jurisdiction, this case is still a representative case where the risk of political violence directly destroys large infrastructure projects.

ADC & ADC & ADMC v. The of , ICSID Case No. ARB/03/16

Asian Ltd. (AAPL) v. The of Sri Lanka, ICSID Case No. ARB/87/3

v. The , ICSID Case No. ARB(AF)/97/1

For details, please refer to the fourth part of this article.

For example, whether investors are allowed to directly resort to international arbitration (such as ICSID) and whether there are prerequisites for resorting to arbitration (such as having to proceed in the host court first), see point (2) of Part IV of this article for details.

In the case of Xie Yeshen’s lawsuit against Peru (Tza Yap Shum v. The of Peru, ICSID Case No. ARB/07/6), the target company acquired by the investor may have had tax compliance issues before the acquisition, which laid hidden dangers for the subsequent "strict law enforcement" of Peru authorities.

In SGS Société Générale de SA v. The of , ICSID Case No. ARB/01/13, the key is how to interpret the "umbrella clause" in BIT. The tribunal believes that the "umbrella protection clause" "elevates" the commercial commitments made by the State party (and its authorized entities) to investors in specific contracts to the protection level of international treaties. Therefore, when the Pakistani government violates its “commitment” to payments in the contract, it not only violates one contractual obligation, but also a treaty obligation under the BIT. This allows an original "government breach" to be resorted to international arbitration as a violation of international treaties.

Article 2 of the Agreement between the Government of the People's Republic of China and the Government of the Federal Republic of Germany on the Promotion and Mutual Protection of Investments (Promotion and Protection of Investments): "A Party shall abide by any commitments it has made to invest in its territory by the other Party. (Each Party shall any it has into with to in its by of the other Party.)

Tza Yap Shum v. The of Peru, ICSID Case No. ARB/07/6

ICSID Case No. ARB/22/2

Special statement: