As states intensify their efforts to adopt climate protection measures, they encounter a paradox. International investment agreements (IIAs), initially devised to foster economic stability, are being used by investors to impede climate policies. To illustrate, the Netherlands was engaged in litigation with German energy conglomerates RWE and Uniper, following the phase-out of coal-fired power plants in accordance with its climate change commitments. Similarly, Italy was compelled to defend itself against a substantial legal challenge after it prohibited offshore oil drilling, resulting in a €250 million compensation to the UK-based oil company Rockhopper.
Clashing Agendas – IIAs and Climate Policy
The issues of investment protection and environmental measures have been the subject of considerable interest for some time. A significant number of investor-state disputes have arisen from measures implemented with the objective of mitigating the impact of economic activities on the environment. However, climate change has introduced a new dimension to these debates as there is a pressing need to address systemic issues.
At the core of the debate are international investment agreements and their impact on the legislative space of states. When investors are empowered to challenge crucial climate protection measures through direct litigation against governments in international arbitration, it not only undermines the state’s sovereignty but also impedes what is arguably the most pressing challenge facing today´s international society: effective climate change mitigation.
When Protection Turns Problematic
IIAs represent the primary legal framework through which host states promote foreign direct investment (FDI), which is undoubtedly an indispensable tool for promoting economic growth and sustainable development. These agreements typically impose four key obligations on governments regarding the treatment of foreign investors: (1) ensuring non-discrimination between domestic and foreign investors; (2) ensuring non-discrimination among foreign investors from different states; (3) providing a minimum standard of fair and equitable treatment (FET); and (4) offering compensation in cases of treaty violation.
In this regard, the doctrine of pacta sunt servanda, or, in other words, agreements must be kept, serves to highlight key concerns surrounding future expectations and the delicate balance between private and public interests. Central to the investment treaty regime is the protection of foreign investors’ expectations, which arbitral tribunals have deemed fundamental. This stems from the interpretation of treaty provisions, particularly those related to FET, as safeguarding the legitimate expectations investors held at the time of their investment. However, these expectations may be jeopardized by regulatory measures introduced after the investment was made.
Legitimate expectations have been widely invoked at the merits stage in investment arbitration to assess the legality of state conduct, leading to damage awards ranging from $2.1 million to $1.2 billion. Investors may claim breaches of the FET standard by arguing that state climate measures either disrupted their legitimate expectations or undermined guaranteed regulatory stability and predictability within the legal and investment framework. However, neither the investor’s right nor the state’s right to regulate is absolute. In balancing these rights, tribunals must weigh the investor’s legitimate expectations with the state´s duty to protect the public interest.
Regulatory Chill – A Barrier to Green Governance
There have been a number of such investor claims in Investor-State Dispute Settlement (ISDS) arising from government actions necessary to achieve environmental objectives and the number is likely to increase as governments step up their efforts to tackle climate change. An article published in Science in 2022 sought to quantify the potential scale of claims from oil and gas investors in response to climate-related government policies. The authors‘ analysis estimated that these claims could reach up to $340 billion which can divert millions of dollars from government budgets, and thus exacerbate the budgetary constraints.
Government officials are well aware of, and deeply concerned about, the possibility of investor-state disputes and the uncertainty surrounding the significant financial impact that their regulatory decisions might have. Essentially, policy-makers often consider potential conflicts with foreign investors before even starting to draft new regulations, placing more emphasis on avoiding such disputes than on developing effective regulations in the public interest. This phenomenon, known as “regulatory chill,” consists of two main elements. The first is the proven financial burden that comes from governments being held responsible for breaching treaties. The second is the considerable expense associated with the legal proceedings themselves. In fact, costs per ISDS case already average in the tens of millions. For developing countries in particular, this can represent an additional burden that could intensify the chilling effect.
Sustainable Reform
As illustrated, states are confronted with the challenge of ensuring the predictability and security of the investment environment for foreign investors while simultaneously maintaining a certain degree of policy autonomy. Indeed, this raises the question whether IIAs and climate change efforts can coexist.
One potential course of action is to withdraw from investment treaties. In this respect it is noteworthy that several European Union Member States have already declared their intention to unilaterally denounce the Energy Charter Treaty (ECT) on the grounds that the treaty, even with the proposed modernization, is incongruous with the urgent necessity for climate change policies. Nevertheless, when one considers the fundamental importance and benefits of foreign investment for states in many respects, which are precisely promoted by such agreements, it becomes evident that this is not a sustainable solution for every state at the root of the problem. So which alternative exists?
In March of this year, the Organization for Economic Co-operation and Development (OECD) hosted its annual Investment treaty conference on the topic of “Supporting the Global Energy Transition: Methods to align investment treaties with the Paris Agreement”. The delegates engaged in discussion with a particular focus on the possibility of carve-outs related to climate change measures of fossil fuel investments. Carve-outs are provisions that either (1) remove certain sectors from the scope of coverage of the IIA or (2) prevent ISDS claims in relation to specific sectors or measures and thus eliminate the basis for State liability to pay compensation.
However, as Paine and Sheargold have observed, this may appear to be a comprehensive exemption. In this respect, it can be argued that the exclusion of certain categories of measure from the scope of treaty coverage or from ISDS may result in the potential for abuse by states, who may seek to exploit the carve-out to enable protectionist or unfair treatment of foreign investors. In order to prevent such misuse, any carve-out should be accompanied by a non-exhaustive definition of the type of measures that it is intended to cover and be limited to measures that are adopted in good faith.
Conclusion and Outlook
In the context of climate change, IIAs can be seen as a double-edged sword. On the one hand, they can facilitate investment in sustainable development, such as green technologies. However, on the other, they may be employed by investors to challenge regulatory measures aimed at reducing greenhouse gases. To ensure that the investment protection does not come at the expense of the environment, it is imperative that IIAs undergo reform. One potential avenue for reform is the use of carve-outs. These can be incorporated in new treaties, added as amendments to existing IIAs, or implemented through a plurilateral opt-in treaty that modifies IIAs among participating states. Nevertheless, addressing the pressing issue of protecting climate measures from investor-state claims under IIAs should not be delayed until a broad multilateral consensus is reached.
Zitiervorschlag: Stegenwallner, Lasse, The Role of International Investment Agreements in Hindering Climate Change Mitigation Efforts, JuWissBlog Nr. 69/2024 v. 15.10.2024, https://www.juwiss.de/69-2024/
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