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University of Otago Law Theses and Dissertations |
Last Updated: 25 September 2023
Doing its BIT: How International Investment Law can support the twin goals of phasing-out carbon-intensive investments and incentivising future low-carbon alternatives
A dissertation submitted in partial fulfilment of the degree of Bachelor of Laws (with Honours) at the University of Otago - Te Whare Wānanga o Ōtākou.
21 October 2022
ACKNOWLEDGEMENTS
First and foremost, thank you to my supervisor Dr Tracey Epps. I am immensely thankful for your encouragement, support and practical outlook. Thank you also to Peter Barnett for your valuable industry insight.
Thank you to Mum, Dad and Frances for unwavering support and love. I would not be here without you!
To my friends and flatmates, for so many great memories over these past five years.
TABLE OF CONTENTS
Table of Abbreviations 4
Introduction 5
Chapter 1: Background on Climate Change and International Investment Law 7
Chapter 2: How Might IIL Impact the Phase-Out of Carbon-Intensive Investments? 19
Chapter 3: How Might IIL Incentivise Future Low-Carbon Investments? 36
Chapter 4: Analysis and Proposal for Reform 49
Conclusion 61
Bibliography 62
TABLE OF ABBREVIATIONS
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BIT
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Bilateral Investment Treaty
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CCS
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Carbon Capture and Storage
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CPTPP
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Comprehensive and Progressive Agreement for Trans-Pacific Partnership
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ECT
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Energy Charter Treaty
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ETS
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Emissions Trade Scheme
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FET
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Fair and Equitable Treatment
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FTA
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Free Trade Agreement
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ICSID
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International Centre for Settlement of Investment Disputes
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IIA
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International Investment Agreement
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IIL
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International Investment Law
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IMF
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International Monetary Fund
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IPCC
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Intergovernmental Panel on Climate Change
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ISDS
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Investor-State Dispute Settlement
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MFN
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Most-Favoured Nation
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NAFTA
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North American Free Trade Agreement
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NT
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National Treatment
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OECD
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Organisation for Economic Co-operation and Development
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PPD
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Police Powers Doctrine
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UNCITRAL
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United Nations Commission on International Trade Law
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UNCTAD
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United Nations Committee on Trade and Development
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UNFCCC
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United Nations Framework Convention on Climate Change
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VCLT
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Vienna Convention on the Law of Treaties
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INTRODUCTION
Climate change is widely regarded as the greatest threat facing the world today.1 If emissions are not urgently reduced, the world will suffer significant and irreversible changes.2 To achieve the Paris Agreement goal of limiting warming to 2°C,3 fundamental changes are required. Among these is a major shift in international finance flows. In particular, a two-part process is necessary. Carbon-intensive investments must be phased out and low-carbon investments take their place.4
This paper examines how international investment law (IIL) may impact these twin processes. Specifically, it asks if ILL can support the twin goals of phasing-out carbon- intensive investments while incentivising future low-carbon alternatives. Divesting carbon- intensive investments appears to require state centric IIL, while incentivising low-carbon investments demands high levels of investor protection.
Four chapters are used to answer the research question:
1 IPCC “The evidence is clear: the time for action is now. We can halve emissions by 2030” (4 April 2022) IPCC Newsroom < https://www.ipcc.ch/2022/04/04/ipcc-ar6-wgiii-pressrelease/>.
2 V Masson-Delmotte and others Climate Change 2021: The Physical Science Basis - Summary for Policy Makers. Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC, 2021) at 4
3 Paris Agreement on Climate Change [2016] ATS 24 (opened for signature 22 April 2016, entered into force 4 November 2016), art 2(1)(a).
4 See Priyadarshi R Shukla and others Climate Change 2022: Mitigation of Climate Change - Summary for Policy Makers. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC, 2022), Chapter C; and Anja Ipp “Regime Interaction in Investment
Arbitration: Climate Law, International Investment Law and Arbitration” (12 January 2022) Kluwer Arbitration Blog <http://arbitrationblog.kluwerarbitration.com/2022/01/12/regime-interaction-in-investment-arbitration- climate-law-international-investment-law-and-arbitration/> .
Ultimately, this paper concludes that IIL as it stands cannot support both climate-alignment processes. While effective at encouraging low-carbon investment, it may well be a significant handbrake on phasing-out high-carbon alternatives. Reform is necessary.This dissertation makes a unique contribution to the literature by combining two distinct areas of research. There has been plenty of academic discussion about how IIL might hinder the carbon phase-out. To a significantly lesser extent, there has been some consideration of how IIL might encourage low-carbon investments. To date, however, few authors have examined how these competing interests may interact. If IIL is to succeed in climate-orientated reform, whilst retaining a cohesive set of principles, this dialogue must occur.
CHAPTER ONE
Background on Climate Change and International Investment Law
There is now no doubt human activities are warming the earth, oceans, and atmosphere.5 Greenhouse gas emissions, in particular carbon dioxide, have already increased the earth’s average temperature by 1°C and warming could reach 5.7°C if emissions continue unabated.6 Emissions are also causing widespread changes to the earth’s natural systems, including ocean acidification, glacial retreat and sea level rise.7 Unless there is a deep and rapid reduction in emissions, the planet will continue to warm and these changes intensify.8
The 2015 Paris Agreement categorised climate change as an ‘urgent threat’.9 The Parties agreed to hold warming to ‘well below’ 2°C above pre-industrial levels and to pursue efforts to limit the increase to 1.5°C,10 recognising that meeting these goals would significantly decrease the risks and impacts of climate change.11 Achieving them, however, will require massive changes. Peak emissions must be reached by 2025 and total emissions cut by 25 per cent and 43 per cent to achieve 2°C and 1.5°C respectively.12 There is an urgent need for change.
One of the key ways to reduce emissions is to make finance flows climate-friendly. Indeed, the third goal of the Paris Agreement is to make “finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”13
Finance is critical because of the capital-intensive nature of low-carbon technologies.14 The energy and industrial sectors in particular, which together account for 58% of global
5 Masson-Delmotte and others, above n 2, at 4.
6 At 5 and 15.
7 At 5 and 8.
8 At 14 and 18.
9 Paris Agreement on Climate Change, above n 3, preamble.
10 Article 2(1)(a).
11 Article 2(1)(a).
12 IPCC, above n 1.
13 Paris Agreement on Climate Change, above n 3, art 2(1)(c).
14 Shukla and others, above n 4, at 32.
emissions,15 require significant levels of capital to transition to green alternatives.16 Finance is especially important in developing countries, which are both most at risk of increasing emissions and least able to afford low-carbon solutions.17 These countries will necessarily require international finance to transition to a low-carbon economy.18 Equally, discouraging traditionally high levels of investment in high-carbon investments is essential to ensure no new emissions sources emerge. This can present a challenge because higher emissions have historically been linked to higher profits, making high-emission investment more attractive.19Despite the critical role of finance in facilitating the green transition, progress towards finance flows climate-orientated is slow.20 The IPCC estimates low-carbon financial flows are between three and six times below what is required,21 and by some estimates the yearly ‘clean-energy investment gap’ is USD 800 billion.22 Although there are a range of reasons for this deficit, both commentators and businesses alike have consistently pointed to the laws on foreign investment as a key reason.23 Foreign investment laws are especially influential in climate funding because it is private companies, rather than governments, that are the main funders of the green transition.24 Private equity already accounts for some 49% of climate finance, and this number is only likely to increase.25
The rules that govern how countries treat foreign direct investment are found in a network of international treaties, referred to collectively as international investment law. At its core, IIL
15 Shukla and others, above n 4, at 12.
16 Aitor Ciarreta, Maria Paz Espinosa and Cristina Pizarro-Irizar “Is green energy expensive? Empirical evidence from the Spanish electricity market” (2014) 69 Energy Policy 205 at 206 and 214.
17 Jan Christoph Steckel and others “From climate finance toward sustainable development finance” (2017) 8 Wiley Interdiscip Rev Clim Change 1 at 1 – 2.
18 This is recognised in the Paris Agreement on Climate Change, above n 3, arts 9 and 11.
19 Timo Busch and others “Corporate Carbon and Financial Performance Revisited” (2022) 35 Organ Environ 154 at 167.
20 Shukla and others, above n 4, at 17.
21 At 51.
22 D McCollum and others “Energy investments under climate policy: a comparison of global models” (2013) 4(4) Clim Change Econ 1 at 33 – 37.
23 Shukla and others, above n 4, at 51; and Kimberley Botwright and others Delivering a Climate Trade Agenda: Industry Insights (World Economic Forum, September 2021) at 7.
24 Daniel M Firger and Michael B Gerrard “Harmonizing Climate Change Policy and International Investment Law: Threats, Challenges and Opportunities” in Karl P Sauvant (ed) Yearbook on International Investment Law & Policy 2010 – 2011 (Oxford University Press, Oxford, 2011) ch 13 at 40.
25 Steckel and others, above n 17, at 2.
seeks to encourage foreign investment by providing a stable and predictable investment environment.26 It is said to grow the host State’s economy by encouraging investment that would not have otherwise occurred, and to help facilitate the spread of new technology.27 IIL requires investors to bear the commercial risks of investing in a foreign country.28 It focuses instead on controlling for political risks, such as a new government which fails to honour previous contracts. The high upfront costs and long pay-back period of many foreign investments, especially in extractive industries such as mining and oil and gas production, means protection from political risks is especially important.29 Overseas investors generally have limited ability to exit a country in the face of a changing regulatory landscape, and it has been traditionally argued they also have limited ability to influence a host State’s political system to prevent unfavourable changes.30 IIL therefore provides investors with increased certainty and a powerful incentive to leave the protection of their home State and move their money overseas. Historically, IIL has been particularly important at encouraging investment in developing countries by compensating for less developed domestic legal and political protections.31
Understanding the history of IIL can provide useful insight into why it allocates rights and responsibilities between the State and the investor in the manner it does today.32 There are many excellent texts on the subject,33 which trace the development of the law from its origins in ‘gunboat diplomacy’ through to the proliferation of modern Bilateral Investment Treaties (BIT) in the 1990s.34 For this dissertation, it is sufficient to note that while IIL is sometimes
26 Surya P Subedi International Investment Law: Reconciling Policy and Principle (2nd ed, Hart Publishing, Portland, 2012) at 216.
27 Emily Osmanski “Investor-State Dispute Settlement: Is There a Better Alternative?” (2018) 43 Brook J Int'l L 639 at 642.
28 Rudolf Dolzer and Christoph Schreuer Principles of International Investment Law (Oxford University Press, Oxford, 2008) at 3.
29 At 3 and 6.
30 Subedi, above n 26, at 216.
31 Anatole Boute “The Potential Contribution of International Investment Law to Combat Climate Change” (2009) 27(3) JERL 333 at 338.
32 C L Lim, Jean Ho and Martins Paparinskis International Investment Law and Arbitration: Commentary, Awards and other Materials (2nd ed, Cambridge University Press, Cambridge, 2021) at 2.
33 See for example Kate Miles “International Investment Law: Origins, Imperialism and Conceptualising the Environment” (2010) 21 Colo J Int’l L & Pol’y 1; and Subedi, above n 26.
34 Campbell McLachlan, Laurence Shore and Matthew Weiniger International Investment Arbitration: Substantive Principles (2nd ed, Oxford University Press, Oxford, 2017) at 1.02; and Dolzer and Schreuer, above n 28, at 15 - 16.
held up to be ‘neutral’ or ‘inevitable’ in whose interests it protects, history shows it is anything but.35 It has been systematically developed by capital-exporting states to favour their business and political interests.36 Previous attempts at reform have tended to be swiftly shut down, as capital-exporting states asserted their international dominance or economic conditions required reforming nations to accept foreign investment even when ideologically opposed.37
Today, the substantive rules on foreign investment are set out in BITs and the investment chapters of Free Trade Agreements.38 While BITs were traditionally entered into between developed and developing countries, many modern agreements containing investment chapters cover a whole region.39 One treaty in particular, the Energy Charter Treaty, is worth noting because it regulates foreign investment in the energy sector for 51 countries and has been at the centre of the intersection between climate law and international investment law for the past three decades. 40 There are now some 2231 BITs in force globally, and a further 335 treaties with investment provisions.41 These treaties form the substantive rights granted to investors when investing in a foreign state. While the wording of each treaty is slightly different, there is a remarkable degree of consistency in the language used.42 Therefore, it is possible to present a comprehensive analysis of the main standards usually agreed to.43
Any disagreements which arise between the investor and the host State under an IIA are settled in Investor-State Dispute Settlement (ISDS).44 Some treaties provide a range of different
35 Miles, above n 33, at 2 and 10.
36 Subedi, above n 26, at 7; and Miles, above n 33, at 13.
37 Dolzer and Schreuer, above n 28, at 15; and Lim, Ho and Paparinskis, above n 32, at 1.
38 Subedi, above n 26, at 2; and Dolzer and Schreuer, above n 28, at 15 – 16.
39 See for example the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) [2018] NZTS 10 (opened for signature 8 March 2018, entered into force 30 December 2018).
40 Energy Charter Treaty 2080 UNTS 100 (opened for signature 17 December 1994, entered into force 16 April 1998); and Sarah Brewin and Lukas Schaugg Modest Modernization or Massive Setback? An analysis of the Energy Charter Treaty agreement in principle (International Institute for Sustainable Development, August 2022) at [1.0].
41 United Nations Conference on Trade and Development “Investment Dispute Settlement Navigator” (31 December 2021) UNCTAD Investment Policy Hub <https://investmentpolicy.unctad.org/investment-dispute- settlement>; and United Nations Conference on Trade and Development “International Investment Agreements Navigator” (9 June 2022) UNCTAD Investment Policy Hub <https://investmentpolicy.unctad.org/international- investment-agreements>.
42 This ‘convergence’ in drafting can be largely attributed to the most-favoured-nation standard, discussed below, which requires that treatment granted to one State is granted to all other States. McLachlan, Shore and Weiniger, above n 34, at 1.07.
43 At 1.07.
44 Lim, Ho and Paparinskis, above n 32, at 88.
arbitration forums where ISDS can occur,45 while others specify one or two preferred institutions.46 The most common is the International Centre for Settlement of Investment Disputes. It provides the rules of arbitration, as well as for the establishment of an ad hoc tribunal to hear each claim and give meaning to the provisions of the IIA.47 As per the Vienna Convention on the Law of Treaties, tribunals must interpret provisions in accordance with their ordinary meaning and in light of their object and purpose.48 If this process leads to an outcome which is ambiguous or manifestly absurd, arbitrators may refer to supplementary materials such as the preparatory work of the treaty.49 Because each tribunal is constituted for each particular case, ISDS does not have a formal system of precedent.50 In practice, however, tribunals will often follow earlier decisions.51 Awards are binding and not subject to appeal.52
There is broad agreement in the literature about which investor protection standards are likely to be relevant for climate-related ISDS, both for the carbon-phase out and for incentivising low-carbon alternatives.53 This section will briefly outline each one.
Expropriation is the taking of private property by the government.54 While the state can expropriate under international law, IIAs attach certain conditions which must be met before it
45 See for example the Sri Lanka Model Bilateral Investment Treaty, which provides for six different forums. Sri Lanka Model Bilateral Investment Treaty, art 8(2).
46 See for example Chapter 11 of the ASEAN-Australia-New Zealand Free Trade Agreement which specifies ICSID and UNCITRAL as the available arbitration forums. ASEAN-Australia-New Zealand Free Trade Agreement [2010] NZTS 1 (signed 27 February 2009, entered into force 1 January 2010).
47 Dolzer and Schreuer, above n 28, at 35.
48 Vienna Convention on the Law of Treaties 1155 UNTS 331 (opened for signature 23 May 1969, entered into force 27 January 1970), art 31.
49 Article 32.
50 Dolzer and Schreuer, above n 28, at 35.
51 See for example Saipem S.p.A v The People’s Republic of Bangladesh (Decision on Jurisdiction) ICSID ARB/05/07, 21 March 2007 at [67].
52 International Convention on the Settlement of Investment Disputes between States and Nationals of Other States (signed 18 March 1965, entered into force 14 October 1966) 575 UNTS 159, art 53.
53 See for example Martin Dietrich Brauch “Reforming International Investment Law for Climate Change
Goals” in Michael Mehling and Harro van Asselt (eds) Research Handbook on Climate Finance and Investment Law (Edward Elgar Publishing, Cheltenham) (forthcoming) at [2.2.1]; Boute, above n 31, at 349; Meredith
Wilensky “Reconciling International Investment Law and Climate Change: Potential Liability for Climate Measures under the Trans-Pacific Partnership” (2015) 45 Envtl L Rep News & Analysis 10683 at 10685; and Bradley J Condon “Climate Change and International Investment Agreements” (2015) 14(2) Chinese JIL 305 at 306.
54 Dolzer and Schreuer, above n 28, at 89.
can legally do so.55 Article 6(2) of the Sri Lankan Model BIT contains a representative expropriation clause:
Investments by nationals or companies of either Contracting Party shall not be expropriated... except for a public purpose and against prompt and effective compensation.56
There are three broad inquires when considering a claim of illegal expropriation.57 Firstly, the investor must hold a right capable of expropriation. This normally takes the form of property, contractual or shareholder rights.58 Second, there must be an ‘expropriation’ meaning the investor was ‘substantially deprived’ of their property or effective control of their investment.59 Expropriation can either be ‘direct’, where the investment is seized through transfer of legal title,60 or ‘indirect’, where the investor retained title but loses effective control.61 Substantial deprivation is generally easy to prove in cases of direct expropriation, but harder for indirect expropriation where deprivation can occur through a series of small actions.62 The substantial deprivation inquiry usually focuses on the loss of economic benefit and control.63 In CMS Gas Transmission Company v Argentina for example, the investor was not ‘substantially deprived’ because they retained day-to-day control of their company.64 On the other hand, in Antoine Goetz v Burundi, the revocation of a ‘free-zone’ was tantamount to expropriation because the investor had to halt all activities and could no longer make a profit.65 Importantly it is the effect of the State’s regulatory measure, rather than the intention, which is relevant to assessing ‘substantial deprivation’.66The third enquiry is legality. The state will face potential liability for illegal expropriation,67 but can ‘legally’ expropriate provided the following three factors are met:68
55 Lim, Ho and Paparinskis, above n 32, at 399.
56 Sir Lanka Model Bilateral Investment Treaty, above n 45, art 6(2).
57 Lim, Ho and Paparinskis, above n 32, at 399; and Dolzer and Schreuer, above n 28, at 399.
58 Lim, Ho and Paparinskis, above n 32, at 401.
59 Kristoffer Roheim Justad “Will International Investment Law hinder climate change mitigation?” (LLM Thesis, University of Oslo, 2021) at 22.
60 Crystallex International Corporation v Bolivarian Republic of Venezuela (Award) ICSID ARB(AF)/11/2, 4 April 2016 at [667].
61 Subedi, above n 26, at 120 – 123.
62 Middle East Cement Shipping and Handling Co. S.A. v Arab Republic of Egypt (Award) (1990) 7 ICSID Reports 178 at [107].
63 Dolzer and Schreuer, above n 28, at 101.
64 CMS Gas Transmission Company v The Argentine Republic (Award) (2005) 44 ILM 1205 at [263].
65 Antoine Goetz and others v Republic of Burundi (I) (Award) (2000) 15 ICSID-FILJ 457 at [124].
66 Tecnicas Medioamientales Tecmed S.A. v The United Mexican States (Award) (2003) 43 ILM 133 at [116].
67 Dolzer and Schreuer, above n 28, at 91.
68 Lim, Ho and Paparinskis, above n 32, at 414.
In general then, whenever a state nationalises property or takes measures which substantially deprive an investor of the economic benefit of their investment, they will be liable for compensation. The exception is where a taking is part of a government’s regulatory or ‘police powers’.72 This issue will be developed in Chapter Two, but for now it is sufficient to note the line between ‘legitimate regulation’ and ‘expropriation’ is unclear.73 Recent decisions have struggled to balance the competing interests of the State’s right to regulate against the ownership rights of the investor.74 Indeed there is ‘no consensus, or even general guideline for debate and refinement, on the scope and indicia of a State’s police powers’,75 and it is therefore unclear just how much control a state has over foreign investments within its borders.
The national treatment obligation requires host States to treat overseas investors no less favourably than local investors.76 Similarly, MFN requires that foreign investors are not treated any less favourably than investors from third-party states.77 The underlying purpose of these obligations is to ensure a ‘level playing field’ for investors in similar circumstances.78 While NT and MFN are less important than they once were,79 they still form a foundational part of IIL. Article 3(1) of the German Model BIT provides a representative clause:
69 ADC Affiliate Limited and ADC & ADMC Management Limited Claimants v The Republic of Hungary (Award of Tribunal) ICSID ARB/03/16, 2 October 2006 at [432].
70 Dolzer and Schreuer, above n 28, at 91 and 92.
71 ADC Affiliate Limited v The Republic of Hungary, above n 69, at [435].
72 Lim, Ho and Paparinskis, above n 32, at 418; and Dolzer and Schreuer, above n 28, at 109.
73 Boute, above n 31, at 349.
74 See for example Lg&E Energy Corp. Lg&E Capital Corp. Lg&E International, Corp. v Argentine Republic (Decision on Liability) (2007) 46 ILM 36 at [189] - [200].
75 Lim, Ho and Paparinskis, above n 32, at 431.
76 Brauch, above n 53, at 2.2.1.
77 Brauch, above n 53, at 2.2.1.
78 McLachlan, Shore and Weiniger, above n 34, at 7.268.
79 Lim, Ho and Paparinskis, above n 32, at 396.
Neither Contracting State shall in its territory subject investments owned or controlled by investors of the other Contracting State to treatment less favourable than it accords to investments of its own investors or to investors of any third State.80
All NT and MFN clauses apply once the investor has established their investment. Some also apply to the pre-investment stage, effectively creating a right of entry into the host State’s market.81 A common approach to determining whether NT has been breached is the test set out in Saluka Investments BV v Czech Republic.82 It asks three questions:a) Are the local and foreign investments ‘in like circumstances’?
Tribunals have taken widely varying approaches to determining ‘like circumstances’.83 While Methanex Corporation v United States adopted a narrow approach which held only identical comparators were ‘like’,84 the tribunal in Occidental Exploration and Production Co. v Ecuador considered any company operating commercially as ‘like’.85 An increasingly popular approach is to recognise only those companies which directly compete with each other.86 For example, even though sugar and artificial sweeteners are not the same product, they compete ‘face-to-face’ in the same market and are therefore ‘like’.87
b) Is the foreign investment treated less favourably?
This is normally uncontentious, given unfavourable treatment is clear on the facts.88 It is however important to note tribunals will generally look at the best treated local company as the basis for comparison.89 Examples of less favourable treatment include issuing a permit to one company and not to another or increasing tax on a foreign-owned company.90
80 German Model Bilateral Investment Treaty 2008, art 3(1).
81 Dolzer and Schreuer, above n 28, at 179.
82 Saluka Investments BV v The Czech Republic (Partial Award) (2006) 5 ICSID Rep 274 at 313.
83 Lim, Ho and Paparinskis, above n 32, at 374.
84 Methanex Corporation v United States of America (Final Award of the Tribunal on Jurisdiction and Merits)
(2005) 44 ILM 1345 at Part IV, Chapter B at [17] and [19].
85 Occidental Exploration and Production Company v The Republic of Ecuador (Final Award) LCIA UN 3467, 1 July 2004 at [173].
86 Lim, Ho and Paparinskis, above n 32, at 377.
87 This was the situation in Archer Daniels Midland Company and Tate & Lyle Ingredients Americas, Inc. v The United Mexican States (Award) ICSID ARB(AF)/04/5, 21 November 2007 at [202] and [204].
88 Lim, Ho and Paparinskis, above n 32, at 379.
89 At 379.
90 At 380.
Host States may escape liability and justify their actions if they were taken on ‘rational grounds’, although it is uncertain what these grounds include.91 While Pope & Talbot Inc. v Canada concluded measures adopted by the Canadian government were reasonably justified because they provided for new entries into the market and reduced the threat of retaliatory tariffs,92 tribunals in other cases have rejected the same arguments.93 Some tribunals consider reasonable justification to be part of the ‘like circumstances’ test rather than a stand-alone issue.94The process for determining a breach of MFN follows much the same process.95 In the case of MFN however, the comparison is between investors from different overseas states.96 The most contentious issue is usually determining what obligations granted to third parties also apply to the foreign investor.97 This is relevant because investors unhappy with rights granted under one treaty will look to other treaties and try to claim the benefit of the rights in that treaty. The mainstream view has been substantive rights can be invoked.98 In an investor-state dispute under the Chile-Malaysia BIT, for example, the Malaysian investor was entitled to rely on substantive obligations contained in BITs Chile had also concluded with Denmark and Croatia.99 However, recent developments have questioned this position. In particular, authority has held the very presence of different obligations across BITs may exclude the possibility of investors being ‘like’.100
Fair and equitable treatment is the most basic investor protection.101 It is a broad standard that ‘fills the gaps’ between other substantive obligations and, due to its flexible nature, has become
91 Dolzer and Schreuer, above n 28, at 181.
92 Pope & Talbot Inc v The Government of Canada (Award on the Merits of Phase 2) Lord Dervaird, Benjamin Greenberg, Murry Belman, 10 April 2001 at [87] and [93].
93 Lim, Ho and Paparinskis, above n 32, at 383.
94 See for example Parkerings-Compagniet AS v Republic of Lithuania (Award) ICSID ARB/05/8, 11 September 2007 at [363].
95 Lim, Ho and Paparinskis, above n 32, at 384.
96 Dolzer and Schreuer, above n 28, at 188.
97 At 188.
98 At 190.
99 MTD Equity Sdn. Bhd. and MTD Chile S.A. v The Republic of Chile (Award) ICSID ARB/01/7, 25 May 2004 at [104].
100 Lim, Ho and Paparinskis, above n 32, at 387.
101 McLachlan, Shore and Weiniger, above n 34, at 1.37.
the most relied-upon investor protection provision.102 Its flexibility and popularity have also caused controversy, as it is increasingly difficult to predict its range of potential applications.103A commonly cited definition of FET is set out in Tecmed v Mexico.104 The tribunal held the host State must provide:
... treatment that does not affect the basic expectations that were taken into account by the foreign investor to make the investment. The foreign investor expects the host State to act in a consistent manner, free from ambiguity and totally transparently in its relations with the foreign investor, so that it may know beforehand any and all rules and regulations that will govern its investments, as well as the goals of the relevant policies and administrative practices or directives, to be able to plan its investment and comply with such regulations.105
While the FET standard continues to evolve and grow, some key obligations can be grouped together.a) Procedural propriety, transparency and due process
The host State must follow the principles of natural justice. It must be clear and communicative, and provide a robust and fair process when making decisions.106 The judiciary, executive and legislative are all subject to this obligation.107 In Tecmed, for example, Mexico breached FET because the local authorities had not provided the investor a chance to comment on the decision to revoke a crucial licence.108
b) Arbitrary and discriminatory treatment
In CMS v Argentina, the tribunal ruled “any measure which might involve arbitrariness or discrimination is in itself contrary to fair and equitable treatment”.109 States can avoid making arbitrary decisions by properly considering all relevant information and using sound judgement.110
102 Justad, above n 59, at 31; Dolzer and Schreuer, above n 28, at 122; and McLachlan, Shore and Weiniger, above n 34, at 1.37.
103 Dolzer and Schreuer, above n 28, at 148.
104 Tecnicas Medioamientales Tecmed S.A. v The United Mexican States, above n 66.
105 At [154].
106 McLachlan, Shore and Weiniger, above n 34, at 7.192.
107 Dolzer and Schreuer, above n 28, at 142.
108 Tecnicas Medioamientales Tecmed S.A. v The United Mexican States, above n 66, at [162].
109 CMS Gas Transmission Company v The Argentine Republic, above n 64, at [290].
110 See for example Lg&E Energy Corp. Lg&E Capital Corp. Lg&E International, Corp. v Argentine Republic (Decision on Liability), above n 74.
The requirement of good faith is fundamental to IIL and necessarily extends to FET.111 Host States must act in good faith towards the investor, and not deliberately damage or undermine their investment.112
d) Legitimate expectations and regulatory stability
A final requirement is for the State to meet the investor’s legitimate expectations and provide a degree of stability in the legal and business framework.113 Some tribunals have described these protections as the ‘dominant’ standard within FET,114 and their rapid growth over the past decade has attracted critical comment from those who view it as giving effect to the investor’s subjective hopes.115
The following two factors have been particularly crucial in assessing if a breach has occurred:116
The stability requirement applies not only to the mechanics of the regulatory framework, but also its underlying goals.117 The focus is on the expectations the investor had when they first invested and, accordingly, historical investments may attract a different set of expectations than recent ones.118 That is not to say any expectation will give rise to a FET claim. As the tribunal noted in Saluka Investments v Czech Republic, investors’ expectations “must rise to the level of legitimacy and reasonableness in light of the circumstances”.119 Equally, “no investor may reasonably expect that the circumstances prevailing at the time the investment is made remain totally unchanged.”120 Determining a
111 Dolzer and Schreuer, above n 28, at 6.
112 At 144.
113 Saluka Investments BV v The Czech Republic, above n 82, at [302] and [303].
114 At [302].
115 Lim, Ho and Paparinskis, above n 32, at 340.
116 McLachlan, Shore and Weiniger, above n 34, at 7.165.
117 Bayindir Insaat Turizm Ticaret Ve Sanayi A.Ş. v Islamic Republic Of Pakistan (Decision on Jurisdiction)
ICSID ARB/03/29, 14 November 2005 at [240].
118 Tecnicas Medioamientales Tecmed S.A. v The United Mexican States, above n 66, at [154].
119 Saluka Investments BV v The Czech Republic, above n 82, at [304].
120 At [305].
breach of legitimate expectations is therefore an exercise in balancing the rights of the investor to rely on assurances against the right of the host State to regulate.CHAPTER TWO
How Might IIL Impact the Phase-Out of Carbon-Intensive Investments?
To limit global warming to 1.5°C and avoid the most serious impacts of climate change, the world must drastically reduce its greenhouse gas emissions and transition to a low-carbon economy.121 As noted in the introduction, this will be achieved by simultaneously phasing out carbon-intensive assets and replacing them with low-carbon alternatives.122 This Chapter considers how investment treaties may impact the first part of this process, namely the phase- out of carbon-intensive investments. There is a strong body of literature which suggests IIL may significantly impair the ability of governments to undertake this process.123
The scale of emissions reduction required to meet the Paris Goals is huge.124 While it is easy to believe only oil and gas businesses will be impacted, the reality is every sector will be required to change in some way.125 Almost all businesses, from the production of cars and steel right through to agriculture, will need to change their business practices.126 In some industries, such as coal extraction, many businesses will be required to cease operating entirely.127
Ultimately, it will fall to governments to set the regulations which drive the carbon phase- out.128 While some private entities will voluntarily reduce emissions, most supply-side changes
121 Paris Agreement on Climate Change, above n 3, 2(1)(a); and Masson-Delmotte and others, above n 2, at 14 and 18.
122 Ipp, above n 4.
123 See for example Brauch, above n 53; Lise Johnson “International Investment Agreement and Climate Change: The Potential for Investor-State Conflicts and Possible Strategies for Minimizing it” (2009) 39 Envtl L Rep News & Analysis 11147; and Kate Miles “International Investment Law and Climate Change: Issues in the Transition to a Low Carbon World” (paper presented to the Inaugural Conference of the Society of International Economic Law, Geneva, July 2008).
124 IPCC, above n 1.
125 IPCC, above n 1
126 Simon Dietz and others TPI State of Transition Report 2020 (Transition Pathway Initiative, March 2020) at 17 and 26.
127 The coal industry needs to keep 80% of current reserves in the ground to meet the Paris Agreement goals. C McGlade and P Ekins “The Geographical Distribution of Fossil Fuels Unused when Limiting Global Warming to 2°C” (2015) 517(7533) Nature 186 at 187.
128 Lise Johnson and Brooke Güven “International Investment Agreements: Impacts on Climate Change Policies in India, China and Beyond” in Kevin P Gallagher (ed) Trade in the Balance: Reconciling Trade and Climate Policy (The Frederick S. Pardee Center, Boston, 2016) 50 at 50.
are necessarily driven by central and regional governments which are required to take action under international climate agreements.129 The range of regulatory tools governments may use is broad, but likely policies include carbon pricing, revocation of permits, prohibitions on certain goods, moratoria on extractive industries and the removal of incentives.130 While these policies are essential to avoiding climate catastrophe, their implementation may also be detrimental to individual businesses. Many businesses will become uneconomical, and a host of existing assets will have reduced or no capital value.131 In this way, government policy will have a direct impact on the value of private businesses. Where government actions result in a significant reduction in value, assets may be deemed ‘stranded’.132When stranded assets and unprofitable businesses are owned by foreign investors who are protected by IIAs, governments may well face ISDS claims. The share of emissions produced by foreign-owned companies is surprisingly high, with a recent IMF paper concluding foreign investors are responsible for up to 30 per cent of emissions in some sectors.133 This is particularly true in the construction, transport and utility industries.134 Foreign investors who produce emissions and are impacted by climate regulation may use ISDS to try and recover the lost value of their business. For example, investors may claim they have been treated unfairly, deserve compensation or are entitled to more compensation than they received.135
The number of stranded assets covered by IIAs is potentially very large. Recent analysis, for example, shows 75 per cent of all foreign-owned coal-fired power plants at risk of stranding are covered by at least one ISDS treaty.136 The vast extent of this protection can largely be
129 Miles, above n 123, at 9; and Lise Johnson “FDI, international investment agreements and the sustainable development goals” in Markus Krajewski and Rhea Tamara Hoffmann (eds) Research Handbook on Foreign Direct Investment (Edward Elgar Publishing, Cheltenham, 2019) 126 at 138.
130 Miles, above n 123, at 9; and Johnson, above n 129, at 138.
131 “How some international treaties threaten the environment” The Economist (online ed, London, 5 October 2020).
132 Kyla Tienhaara and Lorenzo Cotula Raising the cost of climate action? Investor-state dispute settlement and compensation for stranded fossil fuel assets (International Institute for Environment and Development (UK), 2020) at 1.
133 Maria Borga and others Measuring Carbon Emissions of Foreign Direct Investment in Host Economies
(International Monetary Fund, WP/22/86, May 2022) at 16.
134 At 22.
135 Bradford S Gentry and Jennifer Ronk “International Investment Agreements and Investments in Renewable Energy” in Leslie Parker and others (eds) From Barriers to Opportunities: Renewable Energy Issues in Law and Policy (Yale School of the Environment, New Haven, 2007) 25 at 27.
136 Tienhaara and Cotula, above n 132, at [24].
attributed to the care many carbon-intensive businesses have taken to structure their investments to receive IIA coverage.137 Indeed, law firms have admitted to advising fossil-fuel investors to “audit their corporate structure and change it, if needed, to ensure they are protected by an investment treaty”.138 More ominously, carbon-intensive firms have also been advised to rearrange their global ownership structures based on “which treaty would best protect the company from climate-related measures”.139 In this way, corporate law firms and high- emission corporations are working together to expand protection for assets well beyond that which might be expected based just on the Parties to IIAs.As well as covering a wide range of assets, the monetary value of ISDS claims arising from the carbon phase-out is also potentially very large. A recent article in Science, for example, assessed the potential ISDS claims arising from upstream oil and gas projects where exploration permits had been granted but no extraction could occur if the Paris Goals were to be met.140 That paper put worldwide potential liability for such projects at between USD 60 and 234 billion,141 depending on oil prices, with a further USD 106 billion if projects currently under development were also cancelled.142 Claims may be especially large in developing countries, where carbon-intensive assets are often less far through their productive lives and therefore phase-out regulations have a larger financial impact.143 ISDS has already proved to be very lucrative for carbon-intensive industries, with the average pay out for fossil fuel investors of USD 600 million some five times higher than the average for non-fossil fuel investors.144 Additionally, seven of the highest ten ISDS awards ever granted have been to fossil fuel companies or shareholders.145
137 Kyla Tienhaara “Regulatory Chill in a Warming World: The Threat to Climate Policy Posed by Investor- State Dispute Settlement” (2018) 7 TEL 229 at 239.
138 Jones Day “Climate Change and Investor-State Dispute Settlement” (February 2022) Jones Day < https://www.jonesday.com/en/insights/2022/02/climate-change-and-investorstate-dispute-settlement>. See also Matthew Coleman and others “Foreign Investors’ Options to Deal with Regulatory Changes in the Renewable Energy Sector” Steptoe & Johnson LLP <https://www.steptoe.com/en/news-publications/foreign-investors- options-to-deal-with-regulatory-changes-in-the-renewable-energy-sector-1.html>; and Sam Volkmer, Michel Selim Djandji and Taylor Gillespie “Energy Transition and Investor-State Disputes” (8 April 2022) White & Case <https://www.whitecase.com/insight-alert/energy-transition-and-investor-state-disputes>.
139 Jones Day, above n 138.
140 Kyla Tienhaara and others “Investor-state disputes threaten the global green energy transition” (2022) 376 Science 701.
141 At 702.
142 At 703.
143 Lea Di Salvatore Investor-State Disputes in the Fossil Fuel Industry (International Institute for Sustainable Development, December 2021) at [39].
144 At 17.
145 Tienhaara and Cotula, above n 132, at 15.
The types of ISDS claims governments might expect to face following the introduction of climate policies are demonstrated by a host of recent cases. Table 1 highlights a selection of such cases, along with the amount claimed and the subject of the dispute. Their number is only likely to increase as governments implement increasingly stringent legislation to comply with Paris obligations.146
|
Case Name
|
Applicable Treaty
|
Subject of Dispute
|
Amount Claimed and
Outcome
|
|
Vattenfall v Germany (I) (2009)147
|
ECT
|
Environmental restrictions on coal-fired power plant
|
USD 1.4 billion (settled for unknown amount)148
|
|
Lone Pine v Canada (2013)149
|
NAFTA
|
Government moratorium on fracking
|
CAD 250 million 150
(pending)151
|
|
Rockhopper v Italy (2017)152
|
ECT
|
Government ban on oil and gas exploration within 12nm of the
coastline
|
Unknown (pending)153
|
|
Westmoreland v Canada (2018)154
|
NAFTA
|
Compensation over phase- out of coal-fired power plant
|
CAD 470 million155 (case dismissed on
jurisdiction)156
|
|
ECT
|
Compensation over phase- out of coal-fired powerplant
|
€1.4 billion158
(pending)159
|
146 Tienhaara and others, above n 140, at 702.
147 Vattenfall AB, Vattenfall Europe AG, Vattenfall Europe Generation AG v Federal Republic of Germany (Award) ICSID ARB/09/6, 11 March 2011.
148 United Nations Conference on Trade and Development, above n 41.
149 Lone Pine Resources Inc. v The Government of Canada (Notice of Arbitration) ICSID UNTC/15/2, 6 September 2013.
150 At 58.
151 United Nations Conference on Trade and Development, above n 41.
152 Rockhopper Italia S.p.A., Rockhopper Mediterranean Ltd, and Rockhopper Exploration Plc v Italian Republic ICSID ARB/17/14.
153 United Nations Conference on Trade and Development, above n 41.
154 Westmoreland Mining Holdings LLC v Government of Canada (Final Award) ICSID UNCT/20/3, 31 January 2022.
155 At [94].
156 At [252].
157 RWE AG, RWE Eemshaven Holding II BV v The Kingdom of the Netherlands (Request for Arbitration)
ICSID ARB/21/4, 20 January 2021.
158 At [16].
159 United Nations Conference on Trade and Development, above n 41.
|
Uniper v Netherlands (2022)160
|
ECT
|
Compensation over phase- out of coal power plant
|
Unknown (pending)161
|
|
Alberta Petroleum Marketing Commission v United
States
|
NAFTA (legacy claim)
|
Cancellation of KeyStone XL oil pipeline
|
CAD 1.3 billion163 (pending)
|
Table 1: Selection of recent climate-related ISDS claims. Adapted and updated from Tienhaara and others.164
As can be seen, the sums claimed by investors are large and often relate directly to regulation which is essential to meeting the Paris Goals. The RWE case is particularly noteworthy because it demonstrates how investors might use investor protection standards. The case originated from the Dutch Government’s decision to phase-out coal-fired power plants by the year 2030,165 some 25 years earlier than investors expected when first investing.166 RWE allege the decision:
RWE claim at least €1.4 billion in damages.170 While their success is by no means guaranteed, the case is a powerful demonstration of how foreign investors might use IIAs to challenge the carbon phase-out.
160 Uniper SE, Uniper Benelux Holding B.V., and Uniper Benelux N.V. v The Kingdom of Netherlands (Claimant’s Memorial) ICSID ARB/21/22, 20 May 2022.
161 United Nations Conference on Trade and Development, above n 41.
162 Alberta Petroleum Marketing Commission v The Government of the United States of America (Notice of Intent to Submit a Claim to Arbitration), 9 February 2022.
163 At [40](2).
164 Kyla Tienhaara and others “Investor-state disputes threaten the global green energy transition (Supplementary Materials)” (2022) 376 Science at 5 and 6.
165 RWE AG, RWE Eemshaven Holding II BV v The Kingdom of the Netherlands, above n 157, at [13].
166 At [14].
167 At [50].
168 At [53] and [68].
169 At [57].
170 At [89].
This section analyses the key legal arguments likely to apply in carbon phase-out ISDS litigation. While IIL’s lack of precedent might somewhat limit the strength of predictions that can be made,171 important conclusions can still be drawn. Perhaps more importantly, governments must make decisions facing this same uncertainty.
Many policies may give rise to expropriation claims. For example, it has been suggested an effective solution to climate change would be to nationalise all carbon-intensive industries to keep fossil fuels in the ground.172 This may well constitute direct expropriation. Other, less drastic, policies could constitute indirect expropriation.173 For example, some States have banned the use of coal to produce electricity.174 Although affected investors retain technical ownership of their investments, a ban may effectively deprive them of their economic use and enjoyment.175 Likewise, policies such as emissions standards, emission trading schemes and carbon taxes may also significantly impact profitability and therefore be expropriatory.176 While governments can always legally expropriate by paying compensation, the nature of the climate crisis and the scale of government intervention necessary means many governments may seek to avoid paying compensation entirely. This possibility is discussed in the below Police Powers Doctrine analysis.
It is normally uncontentious that an investor has a right capable of expropriation. Therefore, the first question a tribunal is likely to ask is whether the investor has been ‘substantially
171 Fiona Marshall, Aaron Cosbey and Deborah Murphy Climate Change and International Investment Agreements: Obstacles or Opportunities? (International Institute for Sustainable Development, March 2010) at [4.0].
172 Brauch, above n 53, at [2.2.1].
173 Wilensky, above n 53, at 10685.
174 Justad, above n 59, at 26.
175 Marshall, Cosbey and Murphy, above n 171, at [4.2.4].
176 Kyla Tienhaara and others, above n 164, at Table S3.
deprived’.177 Tribunals have tended to approach this question consistently,178 by asking whether the use and enjoyment of the investment has been significantly reduced.179 For example, an investor in a coal-fired power plant which can easily be retrofitted to burn biofuels may still have use and enjoyment of their asset. However, if the plant was left with no commercial purpose, the investor may well have been substantially deprived of their investment.180 It is somewhat uncertain how much deprivation is ‘substantial’.181 However, given that tribunals have previously held high taxes, the revocation of permits and interference with contracts as sufficient to constitute substantial deprivation, the bar may not be especially high.182 In all likelihood, the intensity of change needed to meet net-zero will cause significant deprivation. There is therefore a strong prima facie expropriation claim for many government carbon phase-out regulations.
Whether an investor is entitled to compensation for expropriation will depend on the Police Powers Doctrine. At its core, the PPD asserts governments are not liable for loss arising from regulations made for genuine public purposes.183 The difficulty is there is ‘no agreement’ regarding its scope and its application has varied widely across tribunals.184 The following three-part characterisation of previous approaches can, however, provide a helpful framework for analysis.185
a) Sole Effects Doctrine
The Sole Effects Doctrine is essentially a rejection of the PPD.186 Under the Doctrine, the impact of a government measure on an investor is the only relevant consideration. A tribunal
177 See Chapter 1.3.1.
178 Marshall, Cosbey and Murphy, above n 171, at [4.2.4].
179 CMS Gas Transmission Company v The Argentine Republic, above n 64, at [262].
180 Marshall, Cosbey and Murphy, above n 171, at [4.2.4].
181 Gentry and Ronk, above n 135, at 68.
182 Firger and Gerrard, above n 24, at 28.
183 Noam Zamir “The Police Powers Doctrine in International Investment Law” (2017) 14 Manch J Int Econ Law 318 at 318.
184 Prabhash Ranjan and Puskkar Anand “Determination of Indirect Expropriation and Doctrine of Police Power in International Investment Law: A Critical Appraisal” in Leila Choukroune (ed) Judging the State in International Trade and Investment Law: Sovereignty Modern, the Law and the Economics (Springer, Singapore, 2016) 127 at 127.
185 Firger and Gerrard, above n 24, at 27; and Oliver Dominic Barron “The Police Powers Doctrine and
International Investment Law: Dusting off an old concept in the pursuit of sustainable development” (LLB (Hons) Dissertation, Victoria University of Wellington, 2018) at [55].
186 Barron, above n 185, at [55].
applying this Doctrine will refuse to examine the purpose behind a measure because only the effect is important.187 Thus, in Metalclad v Mexico, the tribunal held it need not “consider the motivation or intention” of an Ecological Decree to find the Decree “would, in and of itself, constitute an act tantamount to expropriation”.188While the Doctrine is not often explicitly labelled in tribunal reasoning, the underlying principles are frequently applied. In Perenco Ecuador v Ecuador, for example, the Ecuadorian Government specifically relied on the PPD to justify its actions.189 The tribunal disregarded their argument, however, preferring to decide the case by looking only at the impacts of the measure. In effect, the tribunal applied the Sole Effects Doctrine without labelling it as such.190 If a tribunal were to apply the Doctrine, almost all climate policies would constitute expropriation and require payment of compensation. Any measure which caused ‘substantial deprivation’ of an investment would be covered, including any carbon tax or ETS which had the effect of making a carbon-intensive business uneconomical.
b) Moderate Police Powers Doctrine
The moderate PPD accepts the State’s ability to regulate without compensation, but only when regulation is proportional.191 Tribunals applying this approach will look to balance the regulation’s purpose against the impact on individual investors, and ensure it is proportionate and not excessive.192 In Phillip Morris v Uruguay for example, the tribunal concluded measures taken to limit the sale of tobacco were proportionate given the importance of protecting public health and the limited effect on the claimant’s business. 193
Predicting how a moderate PPD might apply to climate change claims is somewhat difficult, given it involves a balancing exercise. It does appear the impact on profitability is a key consideration.194 While climate change mitigation is an important public policy objective, it must be weighed against the impact on the investor. If the burden falls on all businesses equally, the measure is likely proportional and the government not liable for compensation. If, however,
187 Ranjan and Anand, above n 184, at 131.
188 Metalclad Corporation v The United Mexican States (Award) ICSID ARB(AF)/97/1, 30 August 2000 at [111].
189 Perenco Ecuador Limited v The Republic of Ecuador (Decision on Remaining Issues of Jurisdiction and on Liability) ICSID ARB/08/6, 12 September 2014 at [650].
190 Ranjan and Anand, above n 184, at 150.
191 Ranjan and Anand, above n 184, at 145.
192 Marshall, Cosbey and Murphy, above n 171, at [4.2.4].
193 Philip Morris Brands Sàrl, Philip Morris Products S.A. and Abal Hermanos S.A. v Oriental Republic of Uruguay (Award) ICSID ARB/10/7, 8 July 2016 at [306] and [307].
194 At [306].
the burden falls excessively on just one or two businesses, the outcome may well be different. The problem is that many economies have just one or two major carbon emitters who will be disproportionately impacted by climate regulation. In the Netherlands, for example, all coal- fired power plants happen to be owned by foreign investors.195 Because government regulations will disproportionately impact these investors, they will likely fall foul of a moderate PPD.
The third approach gives States almost unlimited ability to regulate without compensation, provided regulations are made for a bona fide public purpose.196 This approach is best demonstrated by Methanex where the tribunal held, as a matter of international law, non- discriminatory regulations made for a public purpose are not expropriatory.197 A handful of modern IIAs have also explicitly adopted a broad PPD. The CPTPP, for example, states “non- discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives... do not constitute indirect expropriations, except in rare circumstances”.198 A broad PPD would be very beneficial for the carbon phase-out, giving states almost unfettered ability to implement policy provided there was a rational connection with emissions reduction.
However, for the majority of agreements that do not contain such an explicit clause, it is unlikely a tribunal would apply a broad PPD. As both arbitrators and scholars have argued, a broad PPD is ‘conceptually odd’ and ‘not intellectually viable’.199 On one hand, as explained in Chapter One, in most treaties public purpose is one of the three pillars for legal expropriation which requires compensation.200 Yet, on the other, the broad PPD excuses all compensation whenever a regulation is made for a public purpose, by deeming the measure to not be expropriatory at all. As Vivendi v Argentina noted, “if public purpose automatically immunises the measure from being found to be expropriatory, then there would never be a compensable taking for a public purpose”.201 Assuming a broad PPD is not intellectually viable, a tribunal will likely apply either of the first two approaches. As demonstrated, both could create
195 RWE AG, RWE Eemshaven Holding II BV v The Kingdom of the Netherlands, above n 157, at [12].
196 Marshall, Cosbey and Murphy, above n 171, at [4.2.4].
197 Methanex Corporation v United States of America, above n 84, at Part IV, Chapter D, para 7.
198 Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), above n 39, Annex 9- B(3)(b).
199 Zamir, above n 183, at 332; and Ranjan and Anand, above n 184, at 137.
200 See Chapter 1.3.1.
201 Compañía De Aguas Del Aconquija S.A. (Formerly Aguas Del Aconquija) and Vivendi Universal S.A. (Formerly Compagnie Générale Des Eaux) v Argentine Republic (I) (Award II) ICSID ARB/97/3, 20 August 2007 at [7.5.21].
government liability for breaching expropriation standards when implementing climate regulations.
MFN and NT claims will likely arise when high and low-carbon investments are treated differently. For example ‘food miles’ regulations, which tax food depending on how far it has travelled, may be challenged under MFN if the tax rate is based on the country of origin.202 Likewise, an NT claim might be brought against a tax on high-emission vehicles if low- emission vehicles are produced locally and high emissions vehicles overseas.203 Further claims could also arise if an investor was denied permission for an investment, based on improving climate science, but the same investment had previously been approved for a different investor.204 Alberta Petroleum Marketing Commission v United States is such a case.205 The Commission alleges the revocation of the Keystone XL pipeline was a breach of NT because other pipelines owned by US investors were previously approved.206 If US-funded pipelines were approved, they argue, Canadian-funded pipelines must also be approval.
It is usually easy for an investor to prove less favourable treatment. Therefore, the key question will be whether an investment is ‘in like circumstances’. As Chapter One showed, tribunals have taken divergent approaches to this question. However, two main approaches can be identified with each creating different potential liability for the host State.
a) Comparison solely on ‘competitors’
Under this approach the main focus for comparison is the product sold, rather than how it is made.207 For example, in SD Myers v Canada, the tribunal focussed on the nature of the
202 Wilensky, above n 53, at 10692.
203 Marshall, Cosbey and Murphy, above n 171, at [4.2.2].
204 Johnson and Güven, above n 128, at 52.
205 Alberta Petroleum Marketing Commission v The Government of the United States of America, above n 162.
206 At [36].
207 Johnson, above n 129, at 140.
business relationship and whether the entities were in competition.208 Likewise, in Archer Daniels v Mexico, investors were ‘like’ because they competed in the same market and were subject to the same regulatory regimes.209 This approach is grounded in the belief that MFN and NT obligations are designed to protect companies operating in the same market from unfair discrimination210. Under this approach, most high and low-carbon investments would be ‘like’. High and low-emissions vehicles, for example, would likely be competitors because they both provide transport and sell to the same consumers.211 As such, any regulation which treated two investors differently based on their carbon-intensity may well breach MFN and NT provisions if they happen to come from different countries.b) Legitimate regulatory purpose
This approach attempts to strike a better balance between investment protection and government autonomy, by deeming investments not to be ‘like’ when a difference in treatment is reasonably justified.212 This approach was used in Parkerings v Lithuania.213 Parkerings alleged Lithuania had breached its MFN obligations by rejecting their application to build a carpark but allowing another investor to build a similar carpark nearby. According to Parkerings, the carparks were in ‘like circumstances’ because they were in similar locations and conducting the same business.214 The tribunal however disagreed, holding that:
“the situation of the two investors will not be in like circumstances if a justification of the different treatment is established.”215
Specifically, justifications could include the environmental, cultural and social impacts of projects.216 Because Parkerings’ proposed carpark was on a UNESCO World Heritage Area, there were legitimate environmental and cultural grounds for treating the two investments differently. Accordingly, they were therefore not ‘like’ or subject to MFN.217Applying the regulatory purpose approach would give host States significantly greater ability to differentiate between investments based on emissions profiles. High and low-emission
208 S.D. Myers Inc. v Government of Canada (Partial Award) (2000) 40 ILM 1408 at [251].
209 Archer Daniels Midland Company and Tate & Lyle Ingredients Americas, Inc. v The United Mexican States, above n 87, at [202] and [204].
210 Marshall, Cosbey and Murphy, above n 171, at [4.2.2].
211 At [4.2.2].
212 Dolzer and Schreuer, above n 28, at 181.
213 Parkerings-Compagniet AS v Republic of Lithuania, above n 94.
214 At [363].
215 At [375].
216 At [392].
217 Parkerings-Compagniet AS v Republic of Lithuania, above n 94, at [396].
vehicles, for example, would not be ‘like’ because their distinct environmental impacts create a clear justification for differential treatment.218 Some caution is still necessary, however, because the balancing nature of this approach means it would be open to a tribunal to conclude particular measures adopted were not an appropriate way to reach the government’s goal.219
As States become more aware of the climate crisis, many have begun to include climate provisions in their IIAs. The parties to the ECT, for example, have reached an agreement in principle to modernise the Treaty by carving out fossil-fuel protection and increasing the host State’s right to regulate.220 MFN provisions may allow investors to circumvent these new climate provisions because tribunals have repeatedly allowed investors to use MFN provisions to access more favourable language contained in other treaties.221 In MTD Equity v Chile, for example, an investor successfully gained access to the protections contained in two investment treaties other than its own.222 While it is difficult to predict how a tribunal might decide this issue, there is a distinct possibility investors could use MFN to circumvent climate-friendly IIAs.
FET is the investor protection most likely to create liability for host States, due to its evolving nature and broad wording.223 While States can manage the risk in areas such as due process and good faith through sound consultation and communication, legitimate expectations is more difficult. Legitimate expectations therefore pose the biggest threat. As countries phase-out carbon-intensive assets, it is almost certain some of the basic expectations investors considered when making their investment will be affected.224 For example, if an investor is forced to close
218 Gentry and Ronk, above n 135, at 68.
219 Wilensky, above n 53, at 10692.
220 “Modernisation of the Treaty” (24 June 2022) Energy Charter Treaty
<https://www.energychartertreaty.org/modernisation-of-the-treaty/>.
221 Brauch, above n 53, at [2.2.1]; and Marshall, Cosbey and Murphy, above n 171, at [4.2.2]. 222 MTD Equity Sdn. Bhd. and MTD Chile S.A. v The Republic of Chile, above n 99, at [104]. 223 Johnson, above n 123, at 11152.
224 Miles, above n 123, at [30].
a new manufacturing plant to comply with unexpectedly high updated emissions standards, their legitimate expectations may well have been breached.225 Similar situations are likely to arise from many other government policies including changes to subsidy regimes, moratoria, production limits, and the revocation of permits and licences.226 Even carbon taxes or ETS requirements which hamper an investor earning a reasonable return may breach legitimate expectations.227
The first way legitimate expectations may be generated is through a direct promise or representation. If an investor can show evidence of such a promise being breached, they are likely to succeed in a FET claim.228 However, not all representations are sufficient to create legitimate expectations. Tribunals have generally held that political statements carry little weight, while promises made directly to the investor are more compelling.229 Promises must be targeted to specifically induce investment and may need to be formal.230 While they can be implicit or explicit, explicit representations are normally easier to prove.231 Although some modern treaties provide further guidance on what factors are important,232 in most cases it is up to the tribunal.
RWE’s recent claim against the Dutch Government provides a useful case study. RWE allege they were induced into building a new coal-fired power plant by government representations, and had legitimate expectations the plant could operate until 2050.233 RWE claim legitimate expectations based on the Netherlands’ stated desire to use coal as a bridging mechanism to the energy transition, statements emissions would be regulated through an ETS rather than moratoria and legislation which permitted coal electricity until 2050.234 On its face, it is
225 Marshall, Cosbey and Murphy, above n 171, at [4.2.3].
226 Johnson and Güven, above n 128, at 50.
227 Justad, above n 59, at 33.
228 McLachlan, Shore and Weiniger, above n 34, at 7.165.
229 Justad, above n 59, at 35; and Yulia Levashova “Fair and Equitable Treatment and Investor’s Due Diligence Under International Investment Law” (2020) 67 NILR 233 at 236.
230 Levashova, above n 229, at 235 - 237.
231 Emmanuel T Laryea “Legitimate Expectations in Investment Treaty Law: Concept and Scope of
Application” in Julien Chaisse, Leila Choukroune and Sufian Jusoh (eds) Handbook of International Investment Law and Policy (Springer, Singapore, 2020) 97 at 99.
232 The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), above n 39, is one such treaty.
233 RWE AG, RWE Eemshaven Holding II BV v The Kingdom of the Netherlands, above n 157, at [57].
234 At [60].
difficult to see how such promises could support legitimate expectations, given they are broad political statements not directed at a company specifically. However, RWE also received permits from the Government before it built the plant.235 It is arguable those permits could be elevated to the level of expectations given they, according to RWE, were ‘granted for an unlimited time and expressly confirmed the overriding public interest’ in the plant’s construction.236 A second example of representations which may create legitimate expectations are ‘stabilisation clauses’, which guarantee investors a stable and unchanged regulatory environment.237 Despite being contained in contracts with the host State, they may be specific enough to create a stand-alone legitimate expectation.238 Such clauses are widely used, especially in developing countries and carbon-intensive industries,239 and may therefore create significant liability.
The second way legitimate expectations may be generated is from the state’s requirement to provide a stable business environment.240 While investors cannot expect regulations to be ‘frozen in time’, the government must ensure, at least to some degree, there are no serious and fundamental changes to the regulatory environment.241 Tribunals have typically considered two factors to be particularly important:242
Climate change may well engage both factors. Net-zero requires a massive reduction in emissions, which in many cases will require huge changes to the underlying regulatory environment.243 Governments will need to cap emissions, for example, which may be severe
235 At [60].
236 At [60].
237 Marshall, Cosbey and Murphy, above n 171, at [4.2.5].
238 Investors may also litigate breaches of stabilisation clauses through IIL Umbrella Clause provisions, however these Clauses are outside the scope of this paper. Marshall, Cosbey and Murphy, above n 171, at [4.2.5].
239 Andrea Shemberg Stabilization Clauses and Human Rights (International Finance Corporation, 27 May 2009) at [17], [32], [52] and [64].
240 Marshall, Cosbey and Murphy, above n 171, at [4.2.3].
241 Levashova, above n 229, at [236].
242 Eiser Infrastructure Limited and Energia Solar Luxembourg S.A R.I v Kingdom of Spain (Award) ICSID ARB/13/36, 4 May 2017 at [365].
243 Firger and Gerrard, above n 24, at 28 and 29.
enough to breach the expectation of stability given investors could once emit as much as they wanted.244 Where investments are rendered unprofitable by regulations, the claim is twice as strong. For example, an unforeseen carbon tax which rendered coal-fired power plants uneconomical may well breach the expectation of regulatory stability.At its core, regulatory stability represents a legitimate expectation to continue emitting CO2. Whether this expectation is reasonable will turn on a few factors, including how much the investor knew at the time the investment was made.245 It is hard to see how investors today could legitimately expect to continue emitting CO2, given climate change is common knowledge and it is widely accepted massive reform is necessary to solve it. However, investments made a long time ago may be different.246 The scale of changes required today may well be so vast that no prudent investor could have predicted it when the investment was made. Additionally, although modern climate thinking has been around since at least the UNFCCC in 1992,247 many countries in the decades since have continued to encourage carbon- intensive investment.248 The lack of historical action means some investors may well have reasonably expected they could continue to emit indefinitely.
Argentina’s financial crisis of the early 2000s provides a useful example of how tribunals may assess carbon phase-out cases. Despite suffering a crippling social and economic crisis, Argentina was deemed to remain under an obligation to keep providing a stable business environment.249 Moreover, compensation obligations were not diminished merely because there was a crisis.250 If Argentina’s social emergency was insufficient to diminish regulatory stability claims, the climate emergency may well be the same.251 Accordingly, governments could be liable for breaching legitimate expectations when they begin to take significant steps towards the carbon phase-out. The successive failure of governments to take meaningful action only strengthens investors’ claims.252
244 At 29.
245 Laryea, above n 231, at 99.
246 Boute, above n 31, at 369.
247 Wilensky, above n 53, at 10691.
248 Tienhaara and others, above n 140, at 702.
249 Miles, above n 123, at [20].
250 At [20].
251 At [21].
252 Tienhaara and others, above n 140, at 703.
The foregoing discussion demonstrated how the carbon phase-out might create ISDS liability for governments, but that the outcome of any particular case is uncertain and depends significantly on the interpretation of individual tribunals.253 What is more certain, however, is just the mere threat of ISDS liability is likely to have a ‘chilling’ effect on the implementation of climate regulations.
Regulatory chill occurs when an investor uses ISDS to challenge a host State regulation that other countries are also considering implementing.254 Those other countries may then delay implementing the regulation until the outcome of the case is known. For regulatory chill to hamper government regulation, investors do not need to win.255 Rather, just the mere threat of liability in the period before the tribunal makes its decision is often sufficient to hamper government action.256 There are two reasons why regulatory chill might constrain the otherwise sovereign power of governments:
253 Tienhaara and others, above n 140, at 701.
254 Tienhaara, above 137, at 237 – 239.; and Kyla Tienhaara and Martin Dietrich Brauch “The Energy Charter Treaty: To "modernize" or to exit?” in Webinars on Investment Law and Policy (International Institute for Sustainable Development webinar, January 2020).
255 Tienhaara, above 137, at 237; and Wilensky, above n 53, at 10684.
256 See for example the Phillip Morris cases, where countries delayed introducing plain-paper packaging until the outcome of various ICSID cases were known. Commentary available at Tienhaara, above 137, at 237, examining the cases of Philip Morris Brands Sàrl, Philip Morris Products S.A. and Abal Hermanos S.A. v Oriental Republic of Uruguay, above 193; and Philip Morris Asia Ltd v The Commonwealth of Australia (Award on Jurisdiction and Admissibility) UNCITRAL PCA 2012-12, 17 December 2015.
257 Tienhaara and Cotula, above n 132, at 16.
258 Tienhaara and others, above n 140, at 701.
259 Tienhaara and Cotula, above n 132, at 17.
260 Wilensky, above n 53, at 10695.
261 Tienhaara and Cotula, above n 132, at [2].
262 Wilensky, above n 53, at 10695.
The threat of regulatory chill is not just theoretical. Indeed, real-world examples demonstrate it is already having a significant impact.265 In 2017, for example, France attempted to introduce regulations phasing-out fossil-fuel extraction by 2040 and prohibiting the extension of any existing oil and gas concessions.266 After giant Vermilion threatened the Government with a billion-dollar ECT claim, however, France was forced to back down and the final regulations were significantly weaker than those originally proposed.267 Similarly, Denmark reportedly delayed its moratorium date for oil and gas extraction because of ‘companies suing governments for fossil fuel phase-out laws’.268 More recently, Climate Minister James Shaw acknowledged that New Zealand was unable to join the climate-reform orientated ‘Beyond Oil and Gas Alliance’ as a core member for fear doing so would ‘run afoul of investor-state settlements’.269Regulatory chill is likely to be most pronounced in governments which have already suffered loss under ISDS or have a wavering political commitment to solving climate change.270 Even if governments do not completely abandon their climate agenda, regulatory chill may prevent them implementing the most controversial aspects. In the end, either outcome is disastrous for the planet.
263 Di Salvatore, above n 143, at [18].
264 At [20].
265 Tienhaara, above 137, at 239.
266 Volkmer, Djandji and Gillespie, above n 138.
267 Volkmer, Djandji and Gillespie, above n 138; and Lora Verheecke and others Red Carpet Courts: 10 Stories of How the Rich and Powerful Hijacked Justice (Corporate Observatory Europe, The Transnational Institute and Friends of the Earth Europe/ International, June 2019) at 35.
268 Elizabeth Meager “Cop26 targets pushed back under threat of being sued” (2 August 2022) Capital Monitor
<https://capitalmonitor.ai/institution/government/cop26-ambitions-at-risk-from-energy-charter-treaty- lawsuits/>; and Rachel Thrasher, Blake Alexander Simmons and Kyla Tienhaara “How treaties protecting fossil fuel investors could jeopardize global efforts to save the climate – and cost countries billions” (6 May 2022) The Conversation <https://theconversation.com/how-treaties-protecting-fossil-fuel-investors-could-jeopardize- global-efforts-to-save-the-climate-and-cost-countries-billions-182135>.
269 Tienhaara and others, above n 140, at 703; Thrasher, Simmons and Tienhaara, above n 268; and Meager, above n 268.
270 See for example Tienhaara, above 137; and Brauch, above n 53.
CHAPTER THREE
How Might IIL Incentivise Future Low-Carbon Investments?
Chapter Two demonstrated how IIL may pose a significant challenge to the phase-out of carbon-intensive investments. However, divesting high-carbon assets is only half the process of achieving the Paris Goals.271 Equally as important is encouraging low-carbon alternatives to take their place.272 Therefore, this Chapter considers how the obligations contained in IIAs may impact low-carbon foreign investment. While this question has received significantly less attention in the literature,273 its implications for averting climate disaster are just as important. There is a growing sense among both scholars and research organisations the restrictions IIL places on State behaviour may be important to incentivise low-carbon investment.274
At its most basic, low-carbon investment is the transfer of capital, products and services which results in significantly fewer emissions than would otherwise occur in a ‘business-as-usual’ scenario.275 The scale of low-carbon investment needed to meet the Paris Goals is huge. Estimates range from between USD 1.1 and 3.8 trillion per year until 2050 to meet net-zero,276 with a further USD 180 billion required by 2030 to finance adaption measures.277 While large- scale infrastructure such as electricity generation clearly requires low-carbon investment, all industries will require investment of some kind to become climate-friendly.278
271 Paris Agreement on Climate Change, above n 3, art 2(1)(a).
272 Net Zero by 2050 – A Roadmap for the Global Energy Sector (4th Revision) (International Energy Agency, October 2021) at 14.
273 Cambridge Research Group on Foreign Investment and the Environment “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022).
274 See for example Anatole Boute “Combating Climate Change Through Investment Arbitration” (2012) 35 Fordham Int Law J 614; World Investment Report 2010 (United Nations Conference on Trade and
Development, WIR10, July 2010); and Emma Aisbett “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022).
275 World Investment Report 2010, above n 274, at 103.
276 McCollum and others, above n 22, at 33 – 37; and Brauch, above n 53, at [2.1].
277 Brauch, above n 53, at [2.1].
278 See generally Shukla and others, above n 4.
The scale of expenditure required to meet net-zero necessarily means significant private sector investment is necessary.279 Public funds by themselves are simply not large enough and many governments, recognising this, have already shifted from funding low-carbon technologies themselves to merely encouraging private sector investment.280 As it stands some 49% of climate funding already comes from the private sector, and this number will only increase.281 While current low-carbon investment is still significantly below required levels, with the inclusion of the private sector there is more than sufficient global liquidity to achieve climate goals.282If private capital plays an important part in meeting net-zero, then foreign private capital is particularly critical. It is essential across the globe, but has particular significance in developing countries which have both the least access to capital and the greatest potential to abate emissions.283 Foreign private capital is important in two ways: 284
a) Capital injection
First and foremost, low-carbon investments need capital.285 A huge level of investment is needed to reach net-zero, and individual projects can be extraordinarily expensive. A large hydro power scheme, for example, can cost upwards of USD 1.8 billion.286 Many countries simply do not have sufficient domestic wealth to make that level of investment.287 Compounding this challenge is the typically higher cost of low-carbon investments compared to carbon-intensive alternatives. The average cost of low-carbon biomass electricity generation, for example, is $2,886/kw while petroleum generators only cost $795/kw.288 In nations struggling for capital, the natural outcome of this price difference is continued investment in high-carbon projects. Significant foreign investment is therefore required.289
279 Brauch, above n 53, at [2.1].
280 Firger and Gerrard, above n 24, at 41.
281 Cambridge Research Group on Foreign Investment and the Environment, above n 273.
282 Shukla and others, above n 4, at 51.
283 Steckel and others, above n 17, at 1.
284 World Investment Report 2010, above n 274, at 119; and Samuel Asumadu Sarkodie and Vladimir Strezov “Effect of foreign direct investments, economic development and energy consumption on greenhouse gas
emissions in developing countries” (2019) 646 Sci Total Environ 862 at 862.
285 Net Zero by 2050 – A Roadmap for the Global Energy Sector, above n 272, at 14.
286 Atif Ansar and others “Should we build more large dams? The actual costs of hydropower megaproject development” (2014) 69 Energy Policy 43 at 48.
287 World Investment Report 2010, above n 274, at 100.
288 “Construction cost data for electric generators installed in 2020” U.S. Energy Information Administration < https://www.eia.gov/electricity/generatorcosts/>.
289 World Investment Report 2010, above n 274, at 100.
b) Technology transfer
Equally important is the transfer of green technology.290 Green technology is essential to solving the climate crisis, by creating alternative ways of conducting otherwise high-emission activities. The definition of technology is broad, covering everything from products and intellectual property through to engineering, production and managerial skills.291 However, most of the world’s green technology is developed in just a few countries.292 Therefore, to meet climate goals, it is essential technology can be quickly and efficiently transferred to the countries that need it. Foreign direct investment is usually the most effective way to do this, given it is generally faster, cheaper and can effectively avoid skills, knowledge and resource shortages in host States.293 The provision of public transport is a pertinent example. It is well recognised that public transport has an essential role to play in phasing out emissions.294 However, most rapid mass-transit system providers are based in just a handful of countries and the technology is too complex for local firms to provide an alternative.295 Consequently, almost any city wishing to purchase a new public transport system must necessarily rely on foreign direct investment.
The importance of capital injection and technology transfer cannot be understated. Indeed, the Paris Agreement specifically emphasises ‘mobilising climate finance’ and ‘facilitating climate technology development and dissemination’.296 It is therefore essential the correct legal and regulatory conditions exist to incentivise low-carbon investment flows.
Low-carbon investments, however, face a unique set of risks which may hinder investment. Businesses always face uncertainty, and foreign investment inherently carries a certain amount of risk.297 With low-carbon investments, however, these risks are amplified in two ways:298
290 Friedemann Polzin “Mobilizing private finance for low-carbon innovation – A systematic review of barriers and solutions” (2017) 77 Renew Sustain Energy Rev 525 at 525 and 526.
291 World Investment Report 2010, above n 274, at 130.
292 In fact, more that 80% of the world’s Research and Development generally occurs in just 10 countries. World Investment Report 2010, above n 274, at 130.
293 World Investment Report 2010, above n 274, at 99; and Polzin, above n 290, at 525.
294 Shukla and others, above n 4, at 34.
295 World Investment Report 2010, above n 274, at 106.
296 Paris Agreement on Climate Change, above n 3, arts 9 and 11.
297 Dolzer and Schreuer, above n 28, at 3.
298 Boute, above n 31, at 334.
a) Low-carbon investments usually require government support to be viable
Low-carbon technologies generally compete in the same market as high-carbon alternatives.299 However, high-carbon investments have an inherent advantage because the damage they cause to the environment is rarely factored into the price consumers pay.300 In economics, this is known as a ‘negative externality of production’.301 Essentially, the production of a good creates a negative effect on society, but that cost is borne by society generally rather than the consumers of the specific good. The price paid for the polluting good is therefore significantly lower than its true cost. In contrast, consumers of cleaner alternatives receive no such benefit. They pay the full cost of the technology used to create less harmful production techniques, but receive no financial recognition for their positive contribution to the environment.302 The electricity market demonstrates this phenomenon. Burning coal creates significant environmental damage, yet this damage seldom factors in the cost of coal-fired electricity.303 Low-emission alternatives then face a real challenge in attempting to compete against coal, because the technology used to rectify the environmental harm usually makes it more expensive.304 In this way, society is effectively subsidising coal-powered producers at the expense of low-emission alternatives. Accordingly, the failure to internalise externalities often makes low-carbon investments significantly more expensive than their carbon-intensive competitors.
To overcome this price difference, some sort of government support is normally needed.305 In the electricity sector, for example, governments often provide a market intervention such as a guaranteed price (‘feed-in tariff’)306 or a cap-and-trade system (such as ‘tradeable certificates’) to make low-carbon power economically viable.307 Likewise Carbon Capture and Storage, the process of removing CO2 from the atmosphere, requires government subsidies of about USD 100 per tonne to become economical.308 While government support in both these sectors is
299 Gentry and Ronk, above n 135, at 52.
300 Clean Energy and Development: Towards an Investment Framework (The World Bank, May 2006) at 21.
301 Polzin, above n 290, at 528.
302 Clean Energy and Development: Towards and Investment Framework, above n 300, at 21.
303 At 21.
304 Polzin, above n 290, at 528.
305 Gentry and Ronk, above n 135, at 61.
306 A 2019 study found that feed-in tariffs were the single most effective policy instrument available to encourage foreign direct investment in renewable energy. Ronald Wall and others “Which policy instruments attract foreign direct investments in renewable energy?” (2019) 19 Clim Policy 59 at 59.
307 Gentry and Ronk, above n 135, at 61.
308 Brittany Tarufelli, Brian Snyder and David Dismukes “The Potential Impact of the U.S. Carbon Capture and Storage Tax Credit Expansion on the Economic Feasibility of Industrial Carbon Capture and Storage” (2021) 149 Energy Policy 112064 at 112074.
essential, it also presents unique risks. Subsidies are closely linked to political and economic fortunes and have a long history of being unilaterally changed.309 Banks, for instance, are less willing to lend to projects which rely on government subsidies because they are so easily revocable.310 Reliance on subsidies therefore creates a real risk for low-carbon investors, because even small changes can easily destroy an investment’s value.b) Low-carbon investments have unique financial structures and long payback periods
In addition to requiring government support, low-carbon investments face a uniquely risky financial profile.311 Because low-carbon investments usually depend on new technology, they typically have high upfront costs and long payback periods.312 CCS, for example, is characterised by expensive technology and a product that, given the current cost of carbon, will take decades to pay for itself.313 This financial profile often makes low-carbon investments unattractive from a purely financial perspective, requiring a higher return to make the investment worthwhile.314 The long payback period also increases exposure to political and economic changes, and the capital-intensive nature of many projects means investors are unable to quickly exit an investment when these changes occur.315
This risk is further amplified by the fact that many low-carbon industries are governed by poorly developed regulatory regimes, because they are so new.316 Therefore, not only are investors exposed for a long time, but the regulatory regimes contain significant room for future adjustment. These regimes are also at higher risk of interference because of the political nature of many low-carbon investments.317 Electricity, for example, has been called a ‘quasi-political’ right and many countries have previously taken drastic steps to ensure prices remain affordable.318 For investors, this means a high level of uncertainty and risk which is almost impossible to control.319
309 See for example Aisbett, above n 274, at [2.2]; and Boute, above n 31, 338 and 341.
310 Polzin, above n 290, at 528.
311 Aisbett, above n 274, at [2.2].
312 Gentry and Ronk, above n 135, at 58.
313 Tarufelli, Snyder and Dismukes, above n 308, at 112073 – 112075.
314 Polzin, above n 290, at 528.
315 Boute, above n 274, at 615 and 626.
316 World Investment Report 2010, above n 274, at 134.
317 Boute, above n 31, at 338.
318 At 338.
319 Dolzer and Schreuer, above n 28, at 3.
To compensate for higher risk, investors require a higher return. Where this cannot be achieved, they simply will not invest.320 Some guarantee of regulatory stability is therefore necessary to reduce risk and required returns,321 or else the risks faced by low-carbon investors are likely to be a significant handbrake on investment.
IIAs may well provide this guarantee. Although no empirical studies have directly examined whether IIAs incentivise low-carbon investment, studies investigating the impact of IIAs on FDI generally are a useful proxy. The evidence is undoubtedly mixed.322 However, there is an increasing body of literature to suggest IIAs may play an important role in encouraging FDI in certain circumstances.323 A 2020 study in the journal Mathematics, for example, found investment chapters contained in regional IIAs increased FDI by between 14.56% and 15.83%.324 Likewise, a widely cited 2010 paper concluded BITs had a “significantly positive” effect on increasing FDI flows.325 The underlying reasoning is simple. Investors are pulled towards investing in a country by a variety of ‘locational determinants’.326 Chief among these determinants are the policies and regulations of a host State. IIAs can increase FDI by protecting these determinants from expropriation or other unexpected change.327 A study of Middle Eastern and North African countries, for example, found that it was IIAs, rather than other factors which might influence investment such as infrastructure, human capital or trade openness, which had the strongest influence on increasing FDI.328
320 Boute, above n 31, at 334 and 337.
321 Boute, above n 274, at 614.
322 Joachim Pohl Societal benefits and costs of International Investment Agreements : A critical review of aspects and available empirical evidence (OECD, OECD Working Papers on International Investment 2018/01, January 2018) at 4.
323 See for example Ambareen Beebeejaun “The role of international investment agreements in attracting FDI to developing countries: An assessment of Mauritius” (2018) 60 IJLM 150 at 166; Rod Falvey and Neil Foster- McGregor “Heterogeneous effects of bilateral investment treaties” (2017) 153 Rev World Econ 631 at 650; Shi Li, Long Zhao and Hao Shen “Foreign direct investment and institutional environment: the impact of bilateral
investment treaties” (2021) 53(30) Appl Econ 3535 at 3545; and Muhammad Zubair Mumtaz and Zachary Alexander Smith “Do Bilateral Investment Treaties Promote Foreign Direct Investment Inflows in Asian Countries?” (2018) 18 IPRI Journal 78 at 108; and Marta Bengoa, Blanca Sanchez-Robles and Yochanan Shachmurove “Do Trade and Investment Agreements Promote Foreign Direct Investment within Latin America? Evidence from a Structural Gravity Model” (2020) 8 Mathematics 1882.
324 Bengoa, Sanchez-Robles and Shachmurove, above n 323, at 21.
325 Matthias Busse, Jens Königer and Peter Nunnenkamp “FDI promotion through bilateral investment treaties: more than a bit?” (2010) 146 Rev World Econ 147 at 171.
326 World Investment Report 2010, above n 274, 115.
327 Aisbett, above n 274, at [2.2]; and World Investment Report 2010, above n 274, at 115 and 116.
328 Mumtaz Hussain Shah “Bilateral Investment Treaties and Multinational Investors: Evidence from FDI in the MENA States” (2018) 12 Paradigms 94 at 99.
Evidence suggests IIAs may be most effective at encouraging investments with large sunk costs.329 Many low-carbon investments would fit this category. Large-scale investments require a high degree of regulatory stability,330 and an internationally binding guarantee supported by compensation provides investors with increased confidence against unexpected changes. Many businesses also highlight IIAs as an important aspect of their decision-making. The Asian Development Bank for example, which funds economic development projects, views IIAs as “an important policy tool to attract FDI”.331 Likewise, members of the OECD’s Business and Industry Advisory Committee place “great importance” on IIAs.332 IIAs increase the credibility of government commitments,333 and therefore improves investors’ willingness to invest in otherwise risky low-carbon investments.334 If IIL can incentivise FDI by reducing risk and lowering required returns, it has an important role to play in the climate response.335
Recent cases demonstrate how important IIAs can be in protecting, and therefore incentivising, low-carbon investment. Perhaps most notable is the ‘Spanish Renewables Saga’.336 In 1997 the Spanish government established a subsidy scheme to encourage investment in climate-friendly power, 337 by making a ‘durable’ and ‘lasting’ regulatory commitment to pay a guaranteed price for renewable electricity.338 The scheme was successful, with foreign investors constructing significant new renewable infrastructure.339 Following the 2008 financial crisis however, the subsidies became increasingly uneconomical for the government. To limit liability, Spain reduced the amount operators could claim by limiting operating hours, increasing tax and
329 Jonathon Bonnitcha Assessing the Impacts of Investment Treaties: Overview of the evidence (International Institute for Sustainable Development, September 2017) at 4 and 14; and Falvey and Foster-McGregor, above n 323, at 650.
330 Andrei V Zimakov and Evgeny V Popov “EU Clean Energy Transition And Challenges For International Investors: Comparative Review Of German Practice” (2021) 12(4) Comparative Politics Russia 47 at 54.
331 Asian Development Bank “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022) at [1].
332 Pohl, above n 322, at 33.
333 Dolzer and Schreuer, above n 28, at 22.
334 Gentry and Ronk, above n 135, at 52.
335 Aisbett, above n 274, at [2.2].
336 Amélie Noilhac “Renewable energy investment cases against Spain and the quest for regulatory consistency” (2020) 71 QIL 21 at 22 – 25.
337 Novenergia II - Energy & Environment (SCA) (Grand Duchy of Luxembourg), SICAR v The Kingdom of Spain (Final Arbitral Award) SCC 2015/063, 15 February 2018 at [78] – [103].
338 At [90]
339 Noilhac, above n 336, at 25.
placing expiry dates on subsidies.340 In 2014, the scheme was scrapped entirely.341 These changes, being both unexpected and fundamental to profitability,342 unsurprisingly resulted in a proliferation of cases under the ECT. To date there have been some 40 ISDS claims against Spain over its changes,343 and investors have prevailed in almost every one at a total cost of€825 million.344 As many investors argue, they simply would not have invested were it not for the government’s promises.345
The Spanish Saga is not unique. An Austrian investor is reportedly suing Germany following its decision to replace a subsidy scheme with a reverse-auction system where only the lowest bidder receives support.346 Similar cases have been brought against Latvia, Italy and Ukraine.347 Japan is also facing potential arbitration following changes to feed-in tariff rates which resulted in a spate of bankruptcies for solar investors. The Japanese case has particular significance, because it signals the expansion of this type of litigation into Asia.348 These cases are important because they demonstrate the willingness of governments to renege on promises made to the renewables sector. While governments must be able to make laws and regulate public spending, failure to honour previous commitments is likely to have a real impact deterring future investment. IIL is therefore important in providing investors with some degree of insurance and certainty.
A wide range of low-carbon investments are potentially protected by IIAs. While each agreement has its own definition of ‘investment’, the four Silini criteria are often used to determine the scope protection.349 These criteria are: assumption of risk, substantial
340 Novenergia II - Energy & Environment (SCA) (Grand Duchy of Luxembourg), SICAR v The Kingdom of Spain, above n 337, at [119] – [146].
341 At [147] – [152].
342 At [695].
343 Noilhac, above n 336, at 21.
344 At 21.
345 See for example Novenergia II - Energy & Environment (SCA) (Grand Duchy of Luxembourg), SICAR v The Kingdom of Spain, above n 337, at [153]; and 9REN Holding S.À.R.L. v The Kingdom Of Spain (Award) ICSID ARB/15/15, 31 May 2019 at [3].
346 Zimakov and Popov, above n 330, at 52.
347 Volkmer, Djandji and Gillespie, above n 138.
348 Leo Lewis “Hong Kong energy fund sues Japan in groundbreaking case” Financial Times (online ed, Tokyo, 3 March 2021).
349 McLachlan, Shore and Weiniger, above n 34, at 6.09.
commitment, sufficient duration, and significance for host State development.350 Many low- carbon investments fit easily within these criteria. For example, an electric vehicle factory would likely have no trouble obtaining protection given the unique risk profile, high start-up costs, long payback periods and crucial role in transitioning the economy.It is less certain whether ‘hybrid property’ might be covered.351 Hybrid property is the additional legal rights that attach to low-carbon investments, such as Tradeable Renewable Energy Certificates (TRECs) or Emissions Reduction Credits (ERCs).352 These rights are fundamental to most businesses, and therefore their protection under IIAs could be an important incentive. While they fit less easily within the Silini categories, there is evidence to support the proposition that hybrid property will be included within the definition of ‘investment’. Both commentators and tribunals have recognised ‘investment’ can extend to regulatory and contractual rights,353 and some IIAs such as the ECT specifically include ‘rights conferred by law or contract’.354
Direct expropriation occurs when a government directly seizes property from an investor. Low- carbon investments may be at heightened risk of direct expropriation, because their financial profile makes them an easy target for government opportunism.355 As demonstrated, many low- carbon investments have high start-up costs and low operating costs.356 While governments would often find the start-up costs unaffordable, the low operating costs make an attractive asset.357 Therefore, the temptation may be to seize investments once they are built. This temptation may be especially strong when a government is struggling to reach internationally agreed emissions targets or facing political pressure over the cost of a low-carbon industry. IIL
350 At 6.08.
351 Gentry and Ronk, above n 135, at 66.
352 At 27.
353 Boute, above n 274, at 627.
354 Energy Charter Treaty, above n 40, art 1(6)(f).
355 Mark A Jamison, Lynne Holt and Sanford V Berg “Measuring and Mitigating Regulatory Risk in Private Infrastructure Investment” (2005) 18(6) Electr J 36 at 37.
356 See Chapter 3.1.2.
357 Jonathan Bonnitcha “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022) at [21].
plays an important role in preventing governments from acting on this temptation, and providing compensation if seizure did occur.
In addition to direct expropriation, IIL may also protect investments against indirect expropriation. In particular, an investor may be able to challenge the modification of a government support scheme or subsidy. Thomas Wälde, for example, argues that failure to pay a subsidy amounts to indirect expropriation because the impact on a company’s cash-flow prevents it from operating effectively.358 In Wälde’s opinion, any subsidy withdrawn across an entire industry would constitute indirect expropriation. Governments considering changing a subsidy regime must therefore either pay compensation or face potential legal action.359
The issue with this argument, however, is that withdrawal of a subsidy is usually unlikely to be severe enough to meet the standard of ‘significant deprivation’.360 While changes to subsidies undoubtedly impact cashflow, tribunals have generally found the degree of interference with an investor’s business too small to be expropriatory.361 Even if government support is withdrawn, investors still retain day-to-day control, ownership and enjoyment.362 In the Argentinian cases, for example, investors in the gas, water and electricity sectors invested based on government commitments to pay certain tariffs.363 When these tariffs were withdrawn following economic collapse, out-of-pocket investors made claims for indirect expropriation.364 However, the tribunals held no expropriation had taken place. Investors retained ‘full ownership and control’ of the investments and,365 while less profitable, they were not substantially deprived of their investment. Based on these cases, it is difficult to see an indirect expropriation claim succeeding for changes to subsidies.
However, investors may be able to argue part of their investment should be singled out and treated separately, thereby increasing the chances of meeting the substantial deprivation threshold. Generally, tribunals have held expropriation can only occur when the entire
358 Thomas Wälde “Treaties and Regulatory Risk in Infrastructure Investment” (2000) 34 J World Trade 1 at 27.
359 At 27.
360 See Chapter 1.3.1.
361 Boute, above n 31, at 349 - 352.
362 Boute, above n 274, at 631.
363 Boute, above n 31, at 350 and 356.
364 See for example CMS Gas Transmission Company v The Argentine Republic, above n 64, 1205 at [256].
365 At [263].
investment loses value.366 In some cases however, tribunals have allowed aspects of an investment to be singled out and treated differently if specific parts with independent value can be identified. In Eureko B.V. v Poland for example, the tribunal permitted non-balance sheet ‘corporate governance rights’ to be separated because they held independent economic value.367 Arguably, many low-carbon investment incentives could be treated the same way. For example, both TRECs and ERCs have an inherent value given they are traded in recognised markets. If such rights were significantly modified by a government, there may be a strong case that they have been indirectly expropriated even if the investment as a whole was not subject to substantial deprivation. Such protection would create a powerful incentive for low-carbon investment by protecting the part of the asset most vulnerable to interference.
MFN and NT are likely to be less important in encouraging low-carbon investments, because changes to subsidies more naturally fit under FET and expropriation. Even then however, the case of Nykomb v Latvia demonstrates they may have a role to play.368 In 1997 a Swedish investor, Nykomb, agreed to construct a power plant and sell electricity to a Latvian State- owned electricity company.369 The electricity was to be priced using the same scheme as applied to local investors, which was based on a ‘base tariff’ and a ‘multiplier’ of 2.370 Soon after construction of the plant, however, Nykomb’s multiplier was unilaterally reduced to
0.75.371 The tribunal held this was discriminatory and a breach of NT, because local investors continued to receive the higher multiplier while Nykomb did not.372 The case is particularly relevant because the purpose of the incentive was to transform an obsolete electricity industry,373 much the same as modern climate subsidies. If financial or political pressures meant a government today stopped honouring subsidies to overseas firms, there would be strong precedent for compensation based on a breach of NT.
366 Occidental Exploration and Production Company v The Republic of Ecuador, above n 85, at [86] – [89].
367 Eureko B.V. v Republic of Poland (Partial Award) (2005) 12 ICSID Reports 335 at [145].
368 Nykomb Synergetics Technology Holding AB v The Republic of Latvia (Arbitral Award) SCC, 16 December 2003.
369 At [3.6].
370 Nykomb Synergetics Technology Holding AB v The Republic of Latvia, above n 368, at [1.1].
371 At [4.1].
372 At [4.3.2].
373 Boute, above n 274, at 642.
In addition to situations like Nykomb, MFN and NT could also be used to force governments to offer low-carbon investment opportunities and subsidies they otherwise would not have. Some investment treaties, especially those involving the US, Canada, Japan and Korea, contain ‘pre-establishment rights’ as part of MFN and NT.374 Such clauses require that overseas investors are offered the same market access rights as local investors.375 Potentially, a foreign low-carbon investor could use these clauses to force a country which is not taking steps to reduce emissions to accept their investment. Similarly, MFN and NT could also be used to ensure overseas companies have access to climate subsidies. If a government planned to only offer subsidies or incentives to local businesses, a foreign investor would have a strong case that investments in ‘like circumstances’ had been treated differently. The government would then have to either extend the subsidy or face the prospect of compensation. This could enhance the speed of both capital and technology transfer.
Finally, FET may be an important protection for low-carbon investors. In particular, investors could challenge changes to support schemes and subsidies as a breach of legitimate expectations. As noted in Sempra Energy International v Argentine Republic, legitimate expectations are particularly relevant when an investment is “attracted and induced by means of assurances and representations”.376 This is often the very purpose of government support schemes.377
The Spanish Renewables Saga provides a useful basis for understanding how legitimate expectations might arise in government support cases. Two factors emerge as important:378
A specific commitment is likely easy to prove. In NextEra Energy Global Holdings v Spain, for example, the tribunal was quick to conclude that letters and conversations from Spanish officials to NextEra which guaranteed “regulatory stability and visibility” crystallised as
374 Marshall, Cosbey and Murphy, above n 171, at [4.1].
375 Bilateral Investment Treaties 1995-2006: Trends In Investment Rulemaking (United Nations Conference on Trade and Development, February 2007) at 23.
376 Sempra Energy International v Argentine Republic (Award) ICSID ARB/02/16, 28 September 2007 at [298].
377 Boute, above n 274, at 635.
378 Noilhac, above n 336, at 37.
legitimate expectations.379 These expectations were based on identifiable and specific commitments and were breached when the regime was “fundamentally and radically changed”.380The standard for an expectation of general regulatory stability appears somewhat higher, although investors have still prevailed in almost every case.381 The host State must provide stability in the ‘essential characteristics’ of the regime, but there must be both a ‘radical transformation’ and a ‘significant’ deprivation in the value of the investment because some minor changes are inevitable.382 Where investors have not succeeded, timing has been crucial.383 If investors initiated their claim too early on in the process of regulatory change, they may not have suffered ‘substantial deprivation’.384 Likewise, if the investment occurred after fundamental changes had already been made, the investor may not expect stability.385 Ironically, this means investors may need to wait for substantial regulatory amendment before commencing action. However, it is also likely to reduce the chance of overly speculative challenges to day-to-day regulatory changes. Additionally, investors may also need to show they have undertaken sufficient investigation to ensure their expectations are well-grounded.386 In Stadtwerke München Gmbh v Spain, for example, the tribunal held that expectations are only reasonable when the investor has carried out “rigorous due diligence”.387 Low-carbon investors must therefore play an active role in ensuring their protection under IIL. Overall, providing investors ensure their timing is correct and undertake sufficient pre-investment investigation, FET is likely to be another powerful way to ensure governments honour their commitments.
379 Nextera Energy Global Holdings B.V. And Nextera Energy Spain Holdings B.V. v Kingdom of Spain (Decision on Jurisdiction, Liability and Quantum Principles) ICSID ARB/14/11, 12 March 2019 at [587], [588],
[592] and [599].
380 At [599].
381 Zoltán Víg “Legitimate expectations in the arbitral practice of green energy cases under the Energy Charter Treaty” (2021) 62 Hung J Leg Stud 115 at 127; and Noilhac, above n 336, at 22.
382 Eiser Infrastructure Limited And Energia Solar Luxembourg S.À R.I. v Kingdom of Spain (Award), above n 242, at [382]; and Novenergia II - Energy & Environment (SCA) (Grand Duchy of Luxembourg), SICAR v The Kingdom of Spain, above n 337, at [682].
383 Noilhac, above n 336, at 38.
384 This was the case in Charanne B.V. Construction Investments S.A.R.L. v The Kingdom of Spain (Final Award) SCC 062/2012, 21 January 2016.
385 This was the case in Isolux Infrastructure Netherlands, B.V. v The Kingdom of Spain (Award) SCC 153/2013, 17 July 2016.
386 Levashova, above n 229, at 238.
387 Stadtwerke München Gmbh, Rwe Innogy Gmbh, And Others v Kingdom of Spain (Award) ICSID ARB/15/1, 2 December 2019 at [264].
CHAPTER FOUR
Analysis and Proposal for Reform
This Chapter will analyse the preliminary conclusions of Chapters Two and Three, drawing out both conflicts and potential synergies. The overall message, however, is simple. IIL as it stands cannot fulfil both the roles it needs to in order to support climate goals. While it is effective at encouraging low-carbon investment, it may well act as a significant handbrake on the phase-out of carbon-intensive investment. The inescapable conclusion, therefore, is that the same substantive IIL protections must apply differently to high and low-carbon investments. While IIL generally is facing calls for change, the urgent threat of climate change justifies stand-alone reform.388
A comparison of Chapters Two and Three highlights many conflicting outcomes. Most fundamentally, the substantive protections which are so important to encourage low-carbon investment are also potentially detrimental to the phase-out of high-carbon investments. Indirect expropriation, for example, may protect government subsidies but could also hinder the effective introduction of a carbon tax.389 Likewise, MFN clauses may speed up green technology transfer in countries resistant to climate policy, but at the same time can be used to circumvent new climate-friendly IIAs.390 Three conflicts are particularly important.
Nowhere is the conflict more pronounced than legitimate expectations. Being an emerging and underdeveloped area of law,391 there is a high level of uncertainty as to how legitimate expectations might interact with climate regulation. Despite this uncertainty, the conflict is clear. Legitimate expectations may well be the largest IIL hindrance to carbon phase-out, by protecting investors’ expectations to continue emitting CO2 and preventing governments implementing climate policy.392 At the same time however, legitimate expectations is also a
388 Paris Agreement on Climate Change, above n 3, preamble; and Shukla and others, above n 4, at 51.
389 See Chapters 3.4.2 and 2.4.
390 See Chapters 3.5 and 2.5.3.
391 Lim, Ho and Paparinskis, above n 32, at 340.
392 See Chapter 2.5.
powerful tool for reassuring low-carbon investors that governments will not revoke promised support.393 From the perspective of solving climate change, these two outcomes are fundamentally at odds with each other.The issue of subsidies illustrates the problem well. Oil and gas subsidies have been recognised as one of the single largest contributors to climate change, and since the 1990s the literature has argued their phase-out is essential.394 Despite this, USD375 billion in fossil fuel subsidies still exist today.395 High-carbon investors may be able to claim a legitimate expectation to continue receiving such subsidies, under either a direct promise or ‘regulatory stability’ claim. The fact governments have continued to pay these subsidies, despite knowing their impact,396 only strengthens this argument.397 Equally, however, Chapter Three also demonstrated very clearly the inherent need for subsidies in incentivising the transition to a low-carbon economy. In that case, the protection of legitimate expectations may well play a powerful role in assuring investors that governments are committed to honouring subsidies into the future. FET is therefore both a help and hindrance to emissions reduction.
A second major conflict is damages. IIAs are generally silent on how to calculate damages, so tribunals have been free to use forward-looking valuation techniques such as discounted cashflow to produce staggeringly large awards.398 On one hand, these high damages are at the core of low-carbon investors’ protection. They provide confidence even the most expensive projects are covered and deter governments from unilaterally removing support. On the other hand, however, they have had a significant negative effect on phasing out carbon-intensive investments. Large awards have drained public finances in response to climate regulations and have created a notable chilling effect on government action.399 This is not to say fossil fuel
393 See Chapter 3.6.
394 Brauch, above n 53, at [3.2]; and Miles, above n 123, at 71.
395 “Global estimates on subsidies to fossil fuels” (2022) Fossil Fuel Subsidy Tracker
<https://fossilfuelsubsidytracker.org/>.
396 Fossil fuel subsidies appear to be firmly entrenched, despite general worldwide agreement as to how damaging they are. For example, attempts to negotiate restrictions on subsidies at the World Trade Organisation, as advocated by countries including New Zealand, have failed. Damien O'Connor “New Zealand leads the call for fossil fuel subsidy reform at the WTO” (16 December 2021) Beehive.govt.nz – the official website of the New Zealand Government <https://www.beehive.govt.nz/release/new-zealand-leads-call-fossil-fuel-subsidy- reform-wto>.
397 Tienhaara and others, above n 140, at 701 and 702.
398 Tienhaara and Cotula, above n 132, at 2, 17 and 19.
399 Wilensky, above n 53, at 10695.
companies have no right to compensation. Indeed, a fundamental tenet of most modern legal systems is compensation for government interference with private property.400 The problem is ISDS awards are often much higher than what is available under domestic law and, in the case of carbon-intensive projects in particular, bear little relationship to the amount invested.401
A third significant conflict is the allocation of risk. IIAs have been labelled a form of ‘free political risk insurance’ because investors receive compensation for changes in government policy without having to spend money to avoid the impacts of government policy themselves.402 In the climate change context, IIAs effectively grant high-carbon investors free insurance against the impact of climate regulations on their profits. From a business-incentives perspective, this is highly problematic. Free insurance decreases the chance of high-carbon investors modifying their behaviour to meet climate goals,403 because they know losses can be recovered.404 In some cases, they may delay modifying their behaviour to increase potential damages. In this way, IIL shifts the risk of climate regulations from the business causing the pollution onto the taxpayer at large.405 While low-carbon investments also receive the same ‘free insurance’, the implications are different. Low-carbon businesses do not require fundamental modification to become climate-friendly, so there is less chance a government will take action which prompts an investor to bring a claim. Furthermore, the public benefits from the low-carbon business through a reduction in emissions. Therefore, the allocation of risk is fairer.
While IIL must overcome significant conflicts to achieve climate goals, there is also significant potential for synergies or overlap if reform were to occur.
400 Thrasher, Simmons and Tienhaara, above n 268. 401 Thrasher, Simmons and Tienhaara, above n 268. 402 Johnson and Güven, above n 128, at 55.
403 In economics this is known as “moral hazard”, the idea that a person protected by insurance changes their behaviour because they have no incentive to avoid an otherwise undesirable outcome.
404 Tienhaara and Cotula, above n 132, at [15].
405 Bonnitcha, above n 357, at [1].
IIL generally is characterised by uncertainty, given the lack of precedent and the ad hoc nature of tribunals.406 As Chapters Two and Three demonstrate, the application of climate change policy to IIL is particularly uncertain. The evolving nature of climate science, as well as tribunal members’ general inexperience with climate cases, means it can be difficult to predict how a particular case might be decided.407 Increasing certainty would have a range of benefits. For low-carbon investors, it would provide added confidence government support would be protected.408 This, in turn, is likely to increase investment and technology transfer. Likewise, increased certainty may decrease the likelihood of high-carbon investors starting speculative ISDS cases. If high-carbon investors knew they were likely to lose, they would be less inclined to challenge government measures. Given both the cost and regulatory chilling effect of speculative cases, this could have a significant impact on nudging governments to implement policy reform.
A second potential synergy from reform is reducing inconsistency in international law. International law tends to suffer from ‘fragmentation’, where each area has its own distinct aims and processes.409 In the case of climate and investment law, this fragmentation is significant.410 While the Paris Agreement sets lofty goals as to the importance of international investment,411 neither regime engages with the details or mechanics of the other. This fragmentation leads to deep and reoccurring conflict, compromising the credibility, trustworthiness and validity of the law.412 At a higher level, fragmentation also undermines fundamental goals such as conflict avoidance and the stability of the world order.413 As recognised in the VCLT general article on interpretation, the solution to fragmentation is ‘systemic integration’.414 Systemic integration seeks to harmonise different areas of
406 Subedi, above n 26, at 190 and 196.
407 Boute, above n 274, at 617.
408 At 663.
409 Harro Van Asselt, Francesco Sindico and Michael A Mehling “Global Climate Change and the Fragmentation of International Law” (2008) 30 Law Policy 423 at 423.
410 At 423.
411 Paris Agreement on Climate Change, above n 3, arts 2(1)(a), 9 and 11.
412 Van Asselt, Sindico and Mehling, above n 409, at 425 and 426.
413 At 425.
414 Vienna Convention on the Law of Treaties, above n 48, art 31(3)(c); and Valentina Vadi “Beyond Known Worlds: Climate Change Governance by Arbitral Tribunals” (2015) 48 Vand J Transnatl L 1285 at 1343.
international law into a more cohesive whole, by ensuring interpretation is consistent across different international instruments. 415 By reforming IIL to integrate with climate law, fragmentation can be reduced. This in turn strengthens the legitimacy and effectiveness of both areas of law.
The practical case for reform is clear. If IIL is to assist in achieving net-zero, it must treat high and low-carbon investments differently. In addition to the practical case, however, environmental law also provides a strong theoretical justification. The polluter-pays-principle (PPP) is a normative doctrine of environmental law which states polluters should bear the cost of environmental damage they cause.416 It is founded on the principles of justice and responsibility and is generally acknowledged to be the most equitable distribution of costs.417 ISDS effectively reverses the PPP, by making the taxpayer compensate high-carbon investors when governments introduce climate regulation. This is problematic because it shifts the cost of pollution from the investor onto the taxpayer. Rather than being forced to internalise the costs of their pollution, high-emission companies are instead compensated for no longer being able to damage the environment. Ultimately, this makes low-carbon investments less competitive and creates an inequitable distribution of costs.
IIL generally is undergoing significant calls for reform, as scholars, governments and the community alike realise the law is producing undesirable results.418 The issues are both procedural and substantive, including the unpredictability of awards, the secrecy of decision- making, and the impact on society and the environment.419 In some countries, reform has already begun. Bolivia denounced ISDS in 2007 and has begun renegotiating all its BITs.420
415 Vadi, above n 414, at 1343.
416 Mizan R Khan “Polluter-Pays-Principle: The Cardinal Instrument for Addressing Climate Change” (2015) 4 Laws 638 at 640; and Wilensky, above n 53, at 10683.
417 Khan, above n 416, at 638 and 641.
418 Firger and Gerrard, above n 24, at 42.
419 Lim, Ho and Paparinskis, above n 32, at 581.
420 At 589.
Ecuador and Indonesia have followed suit, while India has also expressed reservations about the current system.421 The IIAs being negotiated today are significantly different to their historical counterparts. The United States-Mexico-Canada Agreement, for example, significantly reduces access to ISDS and removes some investor protection standards.422 It also requires 30 months of domestic dispute resolution before an ISDS case can be launched.423At the intersection of IIL and climate change specifically, there have been a wide range of reform proposals.424 These include dissolving IIL entirely,425 establishing a climate-based appeals mechanism,426 and ‘soft-law’ instruments which clarify the meaning of particular provisions in light of climate change.427 There are countless other proposals.428 While all valuable suggestions, the unique contribution of this paper is to narrow these options down significantly. As has been demonstrated, the substantive IIL protections must be retained but applied differently across different investments. Termination and soft-law options are therefore not feasible. What is required is a legal instrument which can distinguish between investments based on their carbon footprint. While IIL undoubtedly has broader issues which must be addressed at some stage, the urgent and existential threat of climate change arguably justifies standalone climate-based reform.
The ideal solution would be to terminate all IIAs and replace them with one global climate- orientated agreement on international investment.429 Such an agreement would differentiate between high and low-carbon investments, protecting climate-enhancing investments and denying protection to those which harm the atmosphere.430 A multilateral treaty is desirable because it increases certainty by applying one law to all countries and investors.431 It would
421 At 589 – 594.
422 At 598.
423 At 598.
424 Ipp, above n 4.
425 See for example Tienhaara and Cotula, above n 132, at [32]; Di Salvatore, above n 143,at [41]; and Tienhaara and others, above n 140, at 703.
426 Jeffrey Kucik and Andrew Shepherd “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022).
427 Vadi, above n 414, at 1343.
428 See for example Cambridge Research Group on Foreign Investment and the Environment, above n 273; Aisbett, above n 274; and Anne van Aaken and Tomer Broude “Submission to the OECD Public Consultation on Investment Treaties and Climate Change” (13 April 2022).
429 Johnson, above n 123, at 11159.
430 Bonnitcha, above n 357; and Vadi, above n 414, at 1343.
431 Johnson, above n 123, at 11159.
align with the Paris Agreement, and could include an appeals mechanism to increase consistency. The IISD’s “Treaty on Sustainable Investment for Climate Change Mitigation and Adaption” would provide a strong starting point if it was adapted from a bilateral to a multilateral instrument.432 This treaty is effective because it addresses both procedural and substantive issues, as well as rebalancing the distribution of rights between states and investors.433However, such a multilateral solution is almost guaranteed to fail. Many attempts to create a multilateral investment treaty have failed in the past,434 and a climate-enhancing investment treaty is unlikely to be any different. Negotiating any international instrument is a long and fraught process, and the power differences between capital-importing and exporting countries make IIL particularly difficult. The ECT, for example, began a process of reform in 2017 and only just reached an agreement in principle in 2022.435 Given the pressing nature of climate change, there is simply not time to wait for a multilateral instrument. As an added challenge, many IIAs have ‘self-defence mechanisms’ which make treaty termination technically problematic.436 Many contain ‘sunset’ clauses which grant protection to investors for another ten to twenty years upon termination.437 Therefore, terminating investment agreements to create a multilateral agreement may, ironically, extend the length of protection available to existing high-carbon investments.
A more pragmatic solution is necessary. Accordingly, this paper proposes a ‘Climate Annex’ which could be easily adopted by the parties to a BIT or other IIA. This Annex would define high and low-carbon investments separately, applying a special set of reduced protections to carbon-intensive investments but retaining the existing protections for low-carbon investments.
432 Nathalie Bernasconi-Osterwalder and others “Treaty on Sustainable Investment for Climate Change Mitigation and Adaptation” (12 December 2018) International Institute for Sustainable Development
<https://www.iisd.org/publications/treaty-sustainable-investment-climate-change-mitigation-adaptation>.
433 Sofia De Murard “The Treaty on Sustainable Investment for Climate Change Mitigation and Adaptation: A model to steer international law toward renewable energy investments and the low-carbon transition” (20 June 2020) International Institute for Sustainable Development <https://www.iisd.org/itn/en/2020/06/20/the-treaty- on-sustainable-investment-for-climate-change-mitigation-and-adaptation-a-model-to-steer-international-law- toward-renewable-energy-investments-and-the-low-carbon-transition-sofia-murard/>.
434 Lim, Ho and Paparinskis, above n 32, at 25.
435 Brewin and Schaugg, above n 40, at [1.0].
436 Brauch, above n 53, at [4.1].
437 Brewin and Schaugg, above n 40, at [5.2].
It would also amend the preamble to align with the Paris Agreement. While less cohesive than a multilateral agreement, its distinct advantage is the speed it can be implemented. If a few of the most influential capital-exporting countries adopted the Annex with their BIT partners, the rest of the world may well follow suit. As an added benefit, it avoids termination of IIAs and therefore does not trigger ‘sunset’ clauses. Such an Annex could be developed by an organisation with a strong international reputation, such as the OECD, World Bank or UNCITRAL.438 Because BITs tend to have such uniform language,439 it a likely a well-drafted Annex could apply to most BITs without modification. Changing FTAs with investment chapters may require more bespoke drafting, but the Annex’s principles would serve as a useful guide.There are unlikely to be significant legal barriers to adopting such an Annex. While IIAs are generally silent as to amendment,440 Articles 39 to 41 of the VCLT allow treaties to be modified and still remain in force.441 Both parties would need to formally agree on the modification, for example through an exchange of letters, as well as adopting the amendment through their domestic ratification process.442 Academic analysis also suggests that investors who invested before the amendment will be bound by the modified treaty.443 They can claim under the original treaty for actions taken pre-modification, but any actions which occur after modification will be regulated by the amendment.444 This view is supported by case law, where tribunals have consistently applied the modified treaty to acts taken after amendment.445
A Climate Annex could do the following:
438 Tienhaara and Cotula, above n 132, at 32.
439 McLachlan, Shore and Weiniger, above n 34, at 1.07
440 Federico M Lavopa, Lucas E Barreiros and M Victoria Bruno “How to Kill a BIT and not Die Trying: Legal and Political Challenges of Denouncing or Renegotiating Bilateral Investment Treaties” (2013) 16 J Int Econ Law 869 at 884.
441 Vienna Convention on the Law of Treaties, above n 48, arts 39 – 41; and Anthony Aust Modern Treaty Law and Practice (Cambridge University Press, Cambridge, 2007) at 263 and 264.
442 Robert Kolb The Law of Treaties (Edward Elgar Publishing, Cheltenham, 2016) at 198.
443 Lavopa, Barreiros and Bruno, above n 440, at 886.
444 At 886 – 888.
445 See for example Jan de Nul N.V. Dredging International N.V. v Arab Republic of Egypt (Award) ICSID ARB/04/13, 6 November 2008 at [134].
a) Insert “This agreement is to be interpreted in light of the Paris Agreement” into the preambleThe preamble is important to any treaty, being explicitly listed in the VCLT as a fundamental part of the interpretive process.446 Preambles set the tone for interpretation and allow parties to highlight important preliminary matters.447 By explicitly referencing the Paris Agreement, the Annex lifts climate law from a periphery issue to a matter which must be incorporated into the core of the adjudicatory process. This not only increases the likelihood of climate-friendly decisions, but also decreases the fragmentation between these two areas of law. The 2007 Norwegian Model BIT preamble already adopts this approach, requiring the BIT and provisions of international environmental agreements to be “interpreted in a mutually supportive manner”.448 The proposed addition would apply across the entire agreement, casting an interpretive lens on decisions made regarding all types of investments.
b) Create a process for differentiating between investments based on their carbon footprint
The Annex would then contain a process to define high and low-emission investments. The idea is to create a clear set of criteria which are unambiguous and difficult to challenge. The EU’s recent ‘Taxonomy’ regulation could prove useful. The Taxonomy takes a two-part approach to defining sustainability, requiring investments to meet at least one of six environmental principles and do no harm to the rest.449 The principles include climate change mitigation, climate change adaption, transitioning to a circular economy and pollution prevention and control.450 These principles could be adopted outright, or modified to include only climate principles. It would be up to the host State to apply the test to each investment. Host States could produce a general list of indicative low-carbon investments when the Annex was first adopted to provide some certainty, but this decision could be challenged by investors under an appeals process. Investments which failed the modified Taxonomy sustainability test would be defined ‘high-carbon’, and those that met the test ‘low-carbon’. Low-carbon investments would retain the existing protections of the agreement, but high-carbon investments have their protections limited.
446 Vienna Convention on the Law of Treaties, above n 48, art 31(2).
447 Rafael Leal-Arcas and others “The Contribution of Free Trade Agreements and Bilateral Investment Treaties to a Sustainable Future” (2019) 23 ZEuS 3 at 32.
448 Kingdom of Norway Model Bilateral Investment Treaty 2007, preamble.
449 “EU taxonomy for sustainable activities” (2022) European Commission
<https://finance.ec.europa.eu/sustainable-finance/tools-and-standards/eu-taxonomy-sustainable-activities_en>.
450 EU taxonomy for sustainable activities, above n 449.
Having differentiated investments based on carbon-intensity, the Annex would then limit damages for high-carbon investments to sunk costs only.451 Instead of leaving the calculation of damages up to tribunals, who often use discounted cashflow to produce huge awards, high- carbon investors would be limited to the costs spent building their assets. Damages would be further reduced if the State could prove some of these sunk costs had already been recovered by the investor. Sunk cost methodology is likely to lead to much smaller awards and therefore reduce speculative claims, reduce regulatory chill and increase the equitable distribution of costs. It may also reduce the likelihood of third-party ISDS funding, which would further reduce claims.452 With the prospect of lower awards, high-carbon investors are also less likely to avoid taking climate action in the hope of securing a favourable judgement in the future. While some may argue high-carbon investors should recover no damages, the provision for some damages would likely reduce resistance from the powerful fossil fuel lobby and is arguably more equitable, given high-carbon investors are probably entitled to at least some compensation.453 Limiting damages is perhaps the single most effective reform which could occur.454
d) Confirm climate regulation is not indirect expropriation
To be effective, the Annex must remove bona fide climate regulation from the reach of indirect expropriation. This could be achieved by inserting a provision which effectively grants host States a moderate or strong police powers doctrine.455 A host of modern treaties have already done this, and an adapted version of recently proposed changes to the ECT serves as a good example. The Climate Annex indirect expropriation clause could read:
“As a general rule, bona fide regulatory measures which affect high-carbon investors and are adopted with respect to climate change mitigation and adaption do not constitute indirect expropriation.”456
451 This is one of the proposals put forward by van Aaken and Broudem, above n 428.
452 For a more complete discussion on the role of third-party litigation funding in ISDS, see Brooke Güven and Lise Johnson “Third-Party Funding and the Objectives of Investment Treaties: Friends or foes?” (27 June 2019) International Institute for Sustainable Development <https://www.iisd.org/itn/en/2019/06/27/third-party- funding-and-the-objectives-of-investment-treaties-friends-or-foes-brooke-guven-lise-johnson/>.
453 Di Salvatore, above n 143, at [8].
454 Van Aaken and Broude, above n 428, at 4.
455 See Chapter 2.4.4.
456 Adapted from the proposed amendments to the definition of indirect expropriation in the Energy Charter Treaty - Modernisation of the Treaty, above n 220. See also Comprehensive and Progressive Agreement for
This clause is broad enough to empower states to adopt climate change regulation without fear of litigation, but narrow enough so as not to impact other areas of IIL more broadly.e) Reduce the scope of MFN and NT protection for high-carbon investors
As Chapter Two showed, MFN and NT provisions may prevent States from treating high and low-carbon investments differently if they happen to be from different countries. Solving this issue hinges on high and low-carbon investments being classified as not in ‘like circumstances’. This could be achieved by incorporating the following clause, which would require tribunals to adopt the ‘legitimate regulatory purpose’ test:457
“In the case of high-carbon investments, references to ‘like circumstances’ requires an examination of all the circumstances of the investment including the environmental impact, carbon footprint and any regulatory justification for the difference in treatment.”458
Tribunals would be forced to consider the whole circumstances of an investment, and accordingly, investments with different climate impacts would likely be treated differently.A second required change is to ensure investors cannot use MFN provisions to circumvent the new Annex, by accessing more investor-friendly protections contained in other existing agreements.459 The Annex could contain the following clause to address this issue:
“In the case of high-carbon investments, MFN protections only apply to international investment agreements which enter into force after the adoption of this Annex.”460
A version of this clause has already been adopted into other IIAs and is likely to effectively prevent investors from circumventing the other substantive changes contained in the Climate Annex.461 While investors could still use MFN to draw on future agreements, the assumption is that future agreements will be significantly more climate-oriented.
Trans-Pacific Partnership (CPTPP), above n 39, Annex 9-B(3)(b) which uses the phase “except in rare circumstances” as opposed to “as a general rule”.
457 See Chapter 2.5.2.
458 Adapted from Investment Agreement for the COMESA Common Investment Area (2007), art 17(2).
459 See Chapter 2.5.3.
460 Adapted from Lavopa, Barreiros and Bruno, above n 440, at 890.
461 At 881 and 890.
f) Limit the scope of legitimate expectations for high-carbon investors
Finally, the scope of legitimate expectations must be limited. Many modern investment treaties are already taking steps to limit the growth of legitimate expectations, with the United Kingdom
– New Zealand FTA excluding legitimate expectations entirely.462 The Climate Annex would
not need to go this far, but should significantly limit the type and extent of legitimate expectations claims high-carbon investors can make. The Annex could contain the following, which is adapted from the Peru-Australia Free Trade Agreement:
“Recognising the State’s right to regulate and the global consensus on climate change which has existed since the adoption of the UNFCCC, when a high- carbon investor challenges a Party’s climate-related actions:
the mere fact that a Party takes or fails to take an action that may be inconsistent with an investor’s expectations does not constitute a breach of Fair and Equitable Treatment.”463
Investors would then need to show something more than just legitimate expectations to succeed in a climate-related FET claim. For example, they may also need to show a breach of due process, good faith or procedural propriety.464 While drastic, this solution is necessary for effective reform. Arguably, it can also be justified by the growth of the FET standard in recent years which has gone well beyond what most countries believed they were signing up to.465By adopting all the proceeding suggestions together in one package, the Annex is likely to create a powerful and easily implemented solution to the problem of IIL and climate law. While not as effective as a multilateral treaty, it can be achieved within the timeframe necessary to avert climate disaster.
462 Brewin and Schaugg, above n 40, at [4.6].
463 Adapted from Peru-Australia Free Trade Agreement [2020] ATS 6 (opened for signature 12 February 2018,
entered into force 11 February 2020), art 8.6(4).
464 See Chapter 1.3.3.
465 Lim, Ho and Paparinskis, above n 32, at 334.
CONCLUSION
Climate change is the most pressing issue facing humanity. If emissions are not urgently reduced, irreversible changes will occur. Aligning financial flows with the Paris Agreement is a key part of the solution. High-carbon investments must be phased out and replaced with low- emission alternatives.
IIL has an important role to play in achieving these twin goals. As Chapters Two and Three show, however, IIL as it stands is unable to do both. High-carbon investors may well be entitled to large awards as a result of government climate regulation, including for indirect expropriation, breaches of MFN, NT, and legitimate expectations. In fact, just the possibility of awards is likely to have a significant chilling effect on government action. At the same time, however, those same protections are also essential to incentivising low-carbon investment. Low-carbon investments face unique risks, such as a reliance on government support and a unique financial profile, which makes them especially vulnerable to government interference. IIL provides important protection against expropriation and unfair treatment, thereby encouraging crucial low-carbon investment.
Urgent change is needed. In particular, IIL must be amended so the substantive protections apply differently to high and low-carbon investments. In an ideal world, the solution would be a multilateral climate-enhancing treaty. However, such an instrument is unlikely to be agreed upon within the timeframe necessary. Instead, a more pragmatic approach is required. This paper proposes a “Climate Annex”, which can be adopted between parties to IIAs. The Annex subjects high-carbon investments to a lower standard of protection, while retaining the existing protections for low-carbon investments. The strength of this proposal is that it has a hope of being implemented fast enough to make a material difference. If humanity is to avoid climate catastrophe, the time to act is now.
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