Policy Analysis

Can Investor-State Dispute Settlement Be Good for the Environment?

Renewable energy investors have been using investor-state dispute settlement mechanisms to fight cuts to subsidies in Europe, but this short-term gain may hinder states in their broader pursuit of environmental objectives like addressing climate change and pollution.

By Aaron Cosbey on April 12, 2017

Investment provisions in trade agreements and bilateral investment treaties are a hot topic for many, including in the environmental community. They were flashpoints in the civil society opposition to trade and investment agreements like the Trans-Pacific Partnership and the Canada-EU Comprehensive Economic and Trade Agreement (CETA).

But they have also been used extensively in recent years by renewable energy investors alleging poor treatment in their host countries. Under one treaty alone—the Energy Charter Treaty (ECT), an investment agreement focused on energy—there are now 32 such cases registered against Spain, and seven more each against Italy and the Czech Republic. Does this mean that the investor-state dispute settlement (ISDS) mechanisms in treaties like the ECT are good for the environment, protecting clean energy investments?

It’s complicated. While ISDS may be good for renewable energy investors, it may also hinder states in their broader pursuit of environmental objectives like addressing climate change (which is more than just clean energy) and pollution.

It’s definitely a good thing that the EU’s renewable energy investors have recourse to justice if they have been mistreated. In all three of those countries the host governments used strong incentives, including premium prices for renewably generated electricity (feed-in tariffs and feed-in premiums), to boost renewable energy investment, but then were forced to scale back those incentives, in some cases retroactively, when the response to them far exceeded expectations and budgets. Renewable energy investors have taken significant hits—one estimate for Spain pegged the costs of a 2013 regulatory change at EUR 1.7 billion. That kind of thing is terrible for the global dissemination of urgently needed technologies that already struggle to get financing, and that pay significant risk premiums.

The spectacle of host countries being dragged through costly arbitration has no doubt contributed to speedy learning by regulators and policy-makers

The spectacle of host countries being dragged through costly arbitration has no doubt contributed to speedy learning by regulators and policy-makers in the renewable energy space, some of whom are now using advanced regimes such as reverse auctions to manage procurement of renewably generated electricity.

Flaws in current investment treaties outweight benefits

But while investment treaties can have this sort of positive influence, the current ones are far from ideal for a slew of reasons. Like many such treaties, the ECT allows investors to either skip pursuing their grievances in domestic courts and go straight to international arbitration or to pursue both at the same time. Procedural standards are below national and international norms: no investment treaty has a proper appellate mechanism; none of the arbitrations are obliged to follow precedent in case law; and transparency is patchy at best. ISDS arbitrators are not drawn from a standing roster, but are instead nominated by the disputing parties, often drawn from the same firms that offer litigation services. This leads to glaring conflicts of interest in a multi-million dollar industry: arbitrators’ decisions on points of law could either expand or contract their firms’ prospective business in future arbitrations. And arbitrators’ decisions may, if they resonate with firms or states, get them repeatedly nominated (and well paid).

Moreover, the substance of the obligations in many investment treaties is problematic. As of this writing only two of the above ECT cases have seen decisions, only one has been made public (Charanne and Construction Investments v. Spain) and the rest will not even reveal the points of law at issue (did I mention transparency problems?). But it is clear that most will use the commitments on expropriation and fair and equitable treatment (FET) as primary arguments.

As noted by UNCTAD, FET has been variously defined by different tribunals as “a State’s obligation to act consistently, transparently, reasonably, without ambiguity, arbitrariness or discrimination, in an even-handed manner, to ensure due process in decision-making and respect investors’ legitimate expectations.” Interpretations have ranged from simple procedural fairness to an effective freeze on any regulatory changes that affect investors’ bottom lines.

A recipe for regulatory chill

Full expropriation is not an issue, but the renewable energy investor cases will probably all argue indirect expropriation. Like FET, this has seen a variety of interpretations, and the most dangerous of them hold that the public purpose involved is not relevant—it is enough to find that regulations have a significant impact on the investor’s bottom line. This is a recipe for regulatory chill.

These sometimes broadly interpreted obligations may be comforting for renewable energy investors. But there is less comfort for states trying to address climate change and other environmental issues outside the renewable energy space. The fundamental transition implied by addressing climate change may force states to be disruptive. In cases like TransCanada v. the USA (denial of oilsands pipeline permit), that kind of disruptive action was challenged as a violation of FET and expropriation provisions. Other sorts of disruptive environmental laws have been similarly challenged in Vattenfall v. Germany II (nuclear phase-out), Lone Pine v. Canada (Quebec’s fracking ban), Rockhopper v. Italy (offshore drilling ban) and others.

While FET and expropriation provisions may be good for renewable energy investors, they are seriously flawed and are a double-edged sword for the environment more broadly. So yes, investment agreements with ISDS might be a positive force for disseminating urgently needed renewable energy technologies (and we will have years to revisit this question as the dozens of ECT cases play out). But they may also stymie environmental progress in other areas. We could imagine much better tools for the job.