{"id":9497,"date":"2024-04-02T14:59:48","date_gmt":"2024-04-02T12:59:48","guid":{"rendered":"https:\/\/www.iisd.org\/itn\/?p=9497"},"modified":"2024-08-09T18:33:34","modified_gmt":"2024-08-09T16:33:34","slug":"investor-state-dispute-settlement-and-fossil-fuels-what-role-for-a-carveout","status":"publish","type":"post","link":"https:\/\/www.iisd.org\/itn\/2024\/04\/02\/investor-state-dispute-settlement-and-fossil-fuels-what-role-for-a-carveout\/","title":{"rendered":"Investor\u2013State Dispute Settlement and Fossil Fuels: What role for a carveout?"},"content":{"rendered":"

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Last week, the Organisation for Economic Co-operation and Development (OECD<\/span>) <\/span>hosted<\/span><\/a> its 9<\/span>th<\/span> annual Investment Treaty Conference on \u201cSupporting the Global Energy Transition: Methods to align investment treaties with the Paris Agreement.\u201d Delegates discussed carveouts from investor-state dispute settlement (ISDS<\/span><\/span>) of <\/span>climate change measures<\/span><\/a> or <\/span>fossil fuel investments<\/span><\/a> as possible options for reform. In this blog, we assess the implications of these options for climate policy and for broader efforts to reform international investment governance.\u00a0<\/span><\/p>\n

With global temperatures soaring to new heights, <\/span>surpassing 1.5\u00b0C above pre-industrial levels<\/span><\/a> on average over the entire year in 2023, the window to meet the Paris Agreement temperature target and avert the catastrophic consequences of climate change is rapidly narrowing. Central to climate change mitigation is the move away from fossil fuels \u2014 the primary driver of climate change. The <\/span>agreement at the 28th UN Climate Change Conference (COP 28)<\/span><\/a> to transition \u201caway from fossil fuels in energy systems\u201d reminds decision-makers across all sectors of the urgency of climate mitigation efforts. For international investment policy-makers, an important barrier to climate action is the powerful ISDS mechanism allowing fossil fuel companies to challenge such climate action on the basis of any of the over 2,500 investment treaties, including the Energy Charter Treaty (ECT<\/span>).\u00a0<\/span><\/p>\n

What is ISDS, and why is it an obstacle to climate action?<\/b><\/h2>\n

ISDS allows investors to bring direct claims against the states in which they have invested for alleged breaches of an investment treaty (agreements between two or more states). The claims are typically adjudicated by three-member arbitral tribunals with the power to render a binding and final arbitral award that is globally enforceable and not usually subject to appeal. By bringing ISDS claims, investors can also circumvent the national courts of the host state that are the primary guardians of national law.<\/span><\/p>\n

The fossil fuel industry has emerged as the <\/span>most prolific user<\/span><\/a> of this problematic system. ISDS has enabled fossil fuel investors to sue governments for actual and projected losses of profit to the tune of billions of USD, effectively challenging states\u2019 energy transition policies. <\/span>The average award to fossil fuel investors <\/span>amounts<\/span><\/a> to USD 600 million. According to a <\/span>conservative estimate<\/span><\/a>, \u201cglobal action on climate change could generate more than USD 340 billion in legal claims from oil and gas investors\u201d in the upstream sector alone.\u00a0<\/span><\/p>\n

The <\/span>ECT<\/span><\/a>, an energy-sector investment treaty spanning Europe and parts of Asia, has generated more ISDS proceedings than any other.<\/span> Investors have used the treaty to challenge government measures to <\/span>phase out coal-fired power generation<\/span><\/a> or permitting decisions for <\/span>offshore oil production<\/span><\/a> and <\/span>gas fracking<\/span><\/a>. In response to these developments, a growing number of states have decided to leave the treaty, <\/span>including <\/span>Germany<\/span><\/a>, <\/span>France<\/span><\/a>, <\/span>Poland<\/span><\/a>, <\/span>Luxembourg<\/span><\/a>, and <\/span>Slovenia<\/span><\/a>. Last month, the United Kingdom also announced its withdrawal from the treaty, <\/span>citing concerns<\/span><\/a> that remaining a member could \u201cpenalise\u201d it for its \u201cworld-leading efforts to deliver net zero.\u201d\u00a0<\/span><\/p>\n

In contrast to the salient ECT, a less visible global network of more than <\/span>2,500 bilateral investment treaties<\/span><\/a> (treaties between two states, BITs in short), often granting the same access to ISDS to fossil fuel investors, has received far less attention from policy-makers.<\/span> The wide range of BITs covers various sectors where investment should operate responsibly and is in urgent need of reform to advance sustainable development in all dimensions.<\/span><\/p>\n

A new reform initiative at the OECD<\/b><\/h2>\n

At the OECD conference last week, policy-makers considered, among other items, whether a \u201cclimate change carveout\u201d from ISDS could be a viable means to harness reform and ensure the alignment of investment governance with the objectives of the Paris Agreement. Many OECD member states, including climate leaders, maintain dozens of BITs, <\/span>extending \u201cinsurance\u201d<\/span><\/a> to outward fossil fuel investment worldwide by providing access to ISDS. <\/span>In a recent <\/span>OECD survey<\/span><\/a>, most state respondents considered Paris-alignment of investment treaties \u201cvery important\u201d but reported that almost none of their treaties excluded support for coal investments. Strikingly, 70% also reported that their governments had not analyzed their treaties\u2019 climate impacts.\u00a0<\/span><\/p>\n

At this stage, the OECD\u2019s work programme mainly provides a platform for informal exchange. Yet, as in previous processes, such as the Global Minimum Tax, states could grant the OECD a formal mandate to negotiate a binding instrument. It is therefore important to assess the implications of a carveout developed under the auspices of the OECD for climate policy and investment governance reform.\u00a0<\/span><\/p>\n

What is a carveout, and how could it tackle the ISDS and climate change issue?<\/b><\/h2>\n

The idea of a measure-specific carveout was introduced as an academic contribution by Joshua Paine and Elizabeth Sheargold to the conference. The contribution includes <\/span>proposed language<\/span><\/a> for treaties that would exempt \u201cclimate change measures\u201d defined as \u201crelated to reducing or stabilizing greenhouse gas emissions\u201d from the scope of ISDS<\/span>. <\/span>The authors suggest <\/span>that a list of concrete examples of measures could complement this definition.<\/span> The carveout would be accompanied by a two-tiered mechanism, allowing states facing an ISDS claim to request a joint decision by the environmental authorities of the home and the host state before an investor could proceed to ISDS. The proposal also suggests that the carveout could either be retroactively fitted (retrofitted) into existing investment treaties through a multilateral agreement or be used in the renegotiations of investment treaties.<\/span><\/p>\n

If widely adopted, effectively implemented, and combined with other reform measures, such a carveout could be a viable tool to protect governments\u2019 climate policy space against the looming threat of ISDS. To be effective, it would, however, have to overcome certain obstacles.\u00a0<\/span><\/p>\n

First, its effectiveness would depend on a broad subject-matter scope\u2014that is to say, the definition of what climate measures (\u201cmeasure-specific carveout\u201d) or sectors (\u201csector-specific carveout\u201d) are exempt. Second, the carveout would have to effectively prevent arbitral tribunals from assuming jurisdiction\u2014a task that has <\/span>proven difficult with similar carveouts related to tax policy<\/span><\/a> in the past. The proposed mechanism could address this issue if it fully prevents the constitution of arbitral tribunals in cases in which the carveout applies. Third, the practical effect of the carveout would depend on the breadth of its implementation\u2014that is to say, whether the carveout would be <\/span>retrofitted <\/span><\/i>into the plethora of existing BITs or implemented in a piecemeal, treaty-by-treaty manner. While the climate urgency demands the former, competition among capital-exporting states to protect outward investments may disincentivize such a broad implementation. A possible means to address this issue could include a ratification threshold in the multilateral agreement implementing the carveout. Fourth, to be aligned with climate science and the related urgency to reduce greenhouse gas emissions, the carveout would have to be implemented immediately.\u00a0<\/span><\/p>\n

A carveout should not detract from broader reform of the investment regime\u00a0<\/b><\/h2>\n

The proposal of a carveout emerges as a targeted damage control measure to address the recognized and urgent problem that ISDS poses to climate action. <\/span>This approach is pragmatic and focused, potentially allowing for the quick resolution of a major climate-related problem while leaving a range of important policy concerns related to ISDS and the investment treaty regime unresolved.\u00a0<\/span><\/p>\n

While this would be a huge step forward from a climate perspective, it remains paramount that the negotiation and implementation of a carveout, as discussed at the OECD, does not detract policy-makers from broader reforms that are crucial from other environmental, social, and human rights perspectives, including efforts undertaken at the<\/span> United Nations Conference on Trade and Development and <\/span>at the United Nations Commission on International Trade Law\u00a0 Working Group III<\/span><\/a>.\u00a0<\/span><\/p>\n

A climate change carveout, yes, but don\u2019t stop there!\u00a0<\/b><\/h2>\n

States can use a carveout as a narrow and rapid way to mitigate the chilling effect of the investment treaty regime on climate action while safeguarding momentum for other much-needed reforms.\u00a0<\/span><\/p>\n

Developing an efficient carveout within its limited scope would notably require ensuring that it is<\/span><\/p>\n