One of the key challenges for experts and negotiators of IIAs is aligning these agreements with climate change goals and the provisions of the UN Framework Convention on Climate Change and the Paris Agreement. While there is broad consensus that significant investment is required to meet climate change mitigation and adaptation goals, a major policy challenge remains: how to handle the over 2,600 IIAs currently in force, many of which incorporate ISDS provisions.

First, the evidence on a crucial policy question is inconclusive: whether IIAs attract FDI flows. As a result, the international community now finds itself with a substantial body of treaties that seem to be ineffective in facilitating the trillions of US dollars needed for climate-related investments. Some states have responded by negotiating agreements focused solely on facilitation, excluding both protection standards and ISDS.

Second, the evidence suggests that IIAs appear to be somewhat effective only in the context of natural resource investments, including fossil fuel projects. Some research claims that investments in sectors with a high degree of sunk costs respond more strongly to IIAs, while history shows that investors in oil and mining played a crucial role in imagining and lobbying for IIAs and ISDS. However, this potential and limited effectiveness easily becomes a liability, as the world must drastically reduce or eliminate subsidies and other benefits for fossil fuel investments to meet climate goals.

Third, IIAs can create a regulatory chill effect, where governments delay or reconsider climate mitigation actions—such as phasing out fossil fuels—due to fears of ISDS litigation. Research indicates that some states could face substantial financial risks from such litigation, while those that do act still face the looming threat of large awards in favour of investors.

These issues partly stem from the broad scope of IIAs, which protect all types of investments, including those in fossil fuels. This scope problem is not new: sovereign debt was previously excluded, special rules were later created for the financial sector, and, more recently, tobacco was removed from some IIAs. Developing countries, moreover, have long argued that IIAs should prioritize protecting investments that genuinely contribute to host country development.

One policy option is to exclude fossil fuel investments from the scope of current and future IIAs. This objective can be achieved through carve-outs or other graduated methods. Reforming 2,600 treaties is daunting, but it is also difficult to define fossil fuel investments and allow flexibility for removing other types of investments that may conflict with climate goals, while also accounting for different national circumstances. Some developing countries still rely almost exclusively on fossil fuel investments. Those that are detrimental to achieving the SDGs, especially those tied to new greenhouse gas emissions, should also be excluded from IIAs as part of climate-related considerations.

A recent Asia-Pacific Economic Cooperation report identifies an IIA practice that could help limit IIAs’ scope of application. The key lies in distinguishing between admission of investments and the specific approval of investments for protection under an IIA. Specific approval is different from—and in addition to—the legality requisite of an investment. Through this mechanism, governments could select projects aligned with development and climate priorities for IIA and ISDS protection, while admitting other investments without offering protection. Several ASEAN countries have IIAs with specific approval mechanisms.

For example, Article 4 of the 2009 ASEAN Comprehensive Investment Agreement states that a “covered investment” must not only comply with laws and regulations but, where applicable, be “specifically approved in writing” by the relevant authority.

This specific approval mechanism aligns with the bottom-up approach of the Paris Agreement, which relies on each state’s nationally determined contributions (NDCs). Governments are expected to implement reforms to meet their NDCs, which in the field of investment policy could include reforming or terminating IIAs. A way of ensuring that IIAs do not protect investments misaligned with each country’s NDCs is to grant states policy space not to protect those investments.

The Paris Agreement’s Enhanced Transparency Framework could be used to monitor how states use IIAs and ISDS, ensuring alignment with Article 2.1.c and their NDCs. Biennial reports under this framework could list the projects specifically approved for the purposes of IIAs and ISDS protection. Pressure from states and civil society would keep the use of IIAs and ISDS at bay.

If IIAs serve no public policy function, termination seems the most reasonable course of action. However, states unwilling to take this step should consider adopting specific approval mechanisms in their existing and future IIAs. Moving from protecting almost all investments to granting this privilege to specific projects based on concrete policy reasons would turn ISDS on its head.

Reimagining IIAs and ISDS in this way may ultimately serve states and civil society better than investment contracts or other protection mechanisms. In a world without IIAs, it is reasonable to expect that some foreign investors would still have access to international arbitration through contracts. Like the proposal here, contractual protection would also be specific and granted because of concrete policy reasons. But there are several problems with the space of investment contracts. Contract-based investment arbitration is essentially confidential, not just the arbitral proceedings and awards. Civil society has no access to many of these contracts, and discussions over investment contract principles are also less transparent and attract less public attention, especially when compared to discussions over ISDS reform. In addition, arbitrators deciding these cases will likely come from the bar of commercial arbitrators, few if any public international lawyers; these commercial arbitrators, for instance, have recently incorporated principles of IIAs into contract-based investment arbitration through some creative interpretation.

Ultimately, if states are willing to offer international protection to specific foreign investors and investments, IIAs and ISDS may work better than contract-based arbitration. This approach offers governments a policy tool to facilitate desirable investments while minimizing some of the negative impacts associated with international arbitration. It creates policy space to protect only selected investments, but this space is constrained by NDCs, other climate obligations, and potentially international human rights standards. This bottom-up strategy has proven successful in international climate negotiations, and it is plausible that investors would be incentivized to meet climate and SDG targets in an effort to obtain IIA and ISDS protection, facilitating not only investments but also sustainable investments.

Author

Nicolás M. Perrone, Professor of Economic Law, School of Law, Universidad de Valparaíso, Chile.