ISDS in the Era of Mandatory ESG Guidelines: Reforming Existing BITs to Address Climate Change Concerns

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Author: Ayush Kumar*




The Growing Energy Demand and Implications for Climate Change

Global energy demand is projected to increase by 1.3% annually by 2040 unless efficiency improvements and climate policy changes intervene. While well below the remarkable 2.3% growth seen in 2018, the trend still represents a relentless upward march in energy-related emissions, and it is likely to exacerbate strains on almost all aspects of energy security.

Dangerous, irreversible climate change can occur if global warming exceeds two degrees Celsius. To have a more than 50% chance of staying under the two-degree threshold, the concentration of greenhouse gases in the atmosphere should stabilize around 450 parts per million by 2100. These alarming environmental figures have mobilized governments worldwide to develop new policies regulating foreign investments.


The Impact of COVID-19 on ESG Popularity

The COVID-19 pandemic pushed emission-producing corporations to the center of scrutiny, intensifying the debate around their roles and responsibilities in environmental, social, and governmental (“ESG”) matters. The purpose of ESG is to encompass all of the non-financial risks and opportunities in a company’s day-to-day operations.

ESG involves assessing businesses by their environmental, social, and governance performance alongside financial returns. It is becoming increasingly popular among investors who seek to profit from their investments responsibly. The ESG criteria also gauge a company’s alignment with the Sustainable Development Goals (“SDGs”) so that it can be held accountable for actions or inactions.


Incorporating ESG Clauses in Commercial Contracts: Challenges and Disputes

As ESG takes the central stage, many countries will likely implement new regulatory packages following the European Union’s (“EU”) footsteps in the coming years. For instance, the UK government has announced plans to introduce a new ESG framework for financial institutions. These developments are compelling corporations to reconfigure their internal policies and act in accordance with the new regulations. This also means corporations might become more cautious in building business relationships with other companies.

Accordingly, clauses regarding ESG are becoming more and more commonly incorporated in commercial contracts around the world. This trend is relatively recent, and disputes pertaining to the application and interpretation of ESG clauses are bound to arise in commercial and investment arbitration. These conflicts will likely arise because of new ESG regulations by governments aimed at addressing climate change concerns.

However, introducing these new ESG guidelines will be an uphill battle, given the number of Bilateral Investment Treaties (“BITs”) in force. Mandating investors to follow ESG guidelines could potentially give rise to Investor-State Dispute Settlement (“ISDS”) claims arising from BITs.

Such claims could arise if a country introduces mandatory ESG guidelines that significantly impact the operations or profitability of foreign investors. It may be seen as a regulatory change that triggers investor protection provisions in BITs. These provisions often include protections against arbitrary or discriminatory measures that could harm investors’ investments.


The Eco Oro Case: Environmental Bans and Investor Protection

In Eco Oro Minerals Corp. v. Republic of Colombia (2021), a Canadian mining company, Eco Oro, had the concession to extract gold and silver deposits in the Colombian mountains. However, the Colombian government imposed a series of environmental bans that eroded the company’s concession and caused it to lose over 50% of its mining rights. Eco Oro filed for arbitration against Colombia under the Colombia-Canada Free Trade Agreement (2008) (“FTA”). [1]

The tribunal found that Colombia’s bans violated the treaty’s minimum standard of treatment, requiring foreign investors to be treated fairly and equitably.[2] The tribunal also held that the FTA’s general environmental exception did not preclude payment of compensation.

This decision has implications for the ability of governments to regulate in the public interest. It suggests that even measures taken to protect the environment can be challenged and deemed a violation of international investment agreements (“IIAs”). This could make it more difficult for governments to enact climate change regulations, as these regulations could be seen as harming the interests of foreign investors.

According to UNCTAD, the Eco Oro decision “signals that measures taken for the protection of the environment can be challenged and deemed a violation of IIAs” and “sheds doubt on” the effectiveness of “explicit safeguards and exceptions” included to protect a state’s climate regulation.

More claims may come up wherein investors may argue that the mandatory ESG guidelines violate their rights under the BIT, such as fair and equitable treatment, protection against expropriation without compensation, or the right to a stable regulatory framework. The introduction of these guidelines may amount to a breach of investors’ “legitimate expectations” or create an indirect expropriation of their investments.

Additionally, investors might assert that the mandatory ESG guidelines impose additional costs, restrictions, or obligations that adversely affect their financial position or ability to operate profitably. They may argue that such measures disproportionately burden foreign investors compared to domestic companies, violating the principle of equitable treatment.

It is important to consider that if investors believe their rights under BITs have been violated due to the mandatory ESG guidelines, they may initiate ISDS proceedings. This involves bringing a claim against the host state before an international arbitral tribunal, seeking compensation for alleged damages caused by the measures, or seeking to invalidate the guidelines.

It’s important to note that the likelihood of ISDS claims arising from mandatory ESG guidelines depends on various factors, including the specific language of the BIT, the scope and impact of the guidelines, the evidence presented by the investor, and the interpretation of international investment law by the arbitral tribunal. Each case would be evaluated on its own merits and within the framework of the relevant legal instruments and principles.


Evaluating the Problematic Nature of Bilateral Investment Treaties

It is too early to assess how much these regulatory packages will help nations in limiting their carbon emissions, but implementing these regulatory packages in the first place is a challenging task. The states’ most significant stumbling block is the threat of excessive arbitral claims from foreign corporations who have invested in the country. Corporations use the non-reciprocal nature of BITs, which do not allow states to file claims against investors; only investors have the right to do so. This way, corporations indirectly maneuver a nation’s internal policy-making process.


Union Fenosa Gas Case and the Problematic ISDS Regime

In Union Fenosa Gas v. Arab Republic of Egypt (2014), Union Fenosa Gas (“UFG”), a Spanish company, filed an international arbitration case against the Government of Egypt at the World Bank’s International Centre for Settlement of Investment Disputes (“ICSID”). After four years of rigorous arbitration, the government was asked to pay USD 2 billion to the company, including interest and associated legal costs. It is worth noting that the BIT entered into by Egypt and Spain in 1992 enabled UFG to seek compensation from Egypt for changing its policies to mitigate any substantial environmental damage. Moreover, while the states cannot file claims against the corporations, they cannot ignore claims filed against them or refuse to ignore rulings of arbitral tribunals. If such an event occurs, the investor may obtain a ruling from an arbitral tribunal that grants them the authority to confiscate the commercial assets of the state in nearly any jurisdiction. BITs make the investor’s interest weigh heavier than the concerned country’s interests and the looming environmental crisis.


Threat of Regulatory Chill in a Warming World

ISDS mechanisms influence climate change initiatives, as highlighted in a recent study by the International Institute for Environment and Development (“IIED”). The study indicates that if measures to limit global warming are implemented, approximately US$5 trillion of oil and gas reserves may become stranded assets. Due to climate change policies, these assets would no longer be financially viable to exploit. The report suggests that implementing such measures could expose states to ISDS claims. The rise of claims against climate change measures has caused considerable outrage.

In the area of public health, the risk of claims against COVID-19 measures has led to calls for an ISDS moratorium during the pandemic, including by a former chair of the World Trade Organization (“WTO”) Appellate Body and by a former World Bank chief economist.


Reforming the ISDS Regime and Dealing with BITs:

The primary focus of reform should be on existing investment treaties rather than future ones. Even if newly negotiated treaties are enhanced or governments cease negotiating agreements with ISDS provisions, the current inventory of 2,827 investment treaties would still grant access to ISDS under the same conditions.

While attention is often drawn to improving future treaties, it is essential to recognize that modifying or terminating existing agreements is crucial for achieving meaningful reform. Existing treaties, with their ISDS provisions intact, enable investors to initiate claims against states, potentially resulting in substantial financial liability for governments. Most new ISDS cases derive from treaties signed at least 15 to 20 years ago rather than those ratified recently.

To bring about effective change, policymakers, international organizations, and legal experts must engage in discussions and undertake concerted actions to reform and update the existing stock of investment treaties. This may involve renegotiating outdated agreements, introducing provisions to enhance the balance between investor protection and states’ regulatory rights, and exploring mechanisms to resolve disputes more transparently and accountable.

By reforming existing investment treaties, it is possible to address the challenges posed by ISDS provisions and ensure a more balanced and equitable framework for investor-state dispute resolution.

States can cancel out the authoritarian nature of the existing BITs in two ways. First, they can terminate the existing stock of treaties. Several jurisdictions have chosen to terminate certain treaties, while within the EU, almost 300 intra-EU BITs have been terminated due to concerns specific to intra-EU relationships. However, the majority of countries lack substantial political backing for treaty terminations. Furthermore, unilateral denunciation of treaties is hindered by “survival clauses” or “sunset clauses,” which ensure the continuity of protections for a considerable period, even after termination. Consequently, this approach offers limited immediate efficacy in safeguarding states against contentious claims.


Renegotiating Existing Treaties

The second way is to renegotiate the terms of the existing treaties. Renegotiation of existing treaties can be a way for states to avoid new claims under survival clauses. Still, it can be challenging to do so when numerous BITs exist, requiring significant diplomatic effort and resources. The Netherlands has attempted to renegotiate some of its bilateral investment treaties with the authorization of the European Commission, but this process is time-consuming and can take many years. The EU’s focus on reforming the Energy Charter Treaty leaves other treaties lower on its priority list. Although some European states have terminated intra-EU BITs, they remain party to over 1,400 BITs with non-EU countries.


Use of Interpretative Statements by the Governments

Governments’ use of interpretative statements can also be a third option, which seems to be a cheaper and quicker alternative. International law grants states the right to do so, even after ratifying the treaties. Tribunals are required by the Vienna Convention on the Law of Treaties to take these statements into account,[3] and domestic courts have also recognized their status in recent years.[4]

The effectiveness of such statements is most significant when made by all parties to the treaty. Interpretative statements by states can provide a practical alternative to terminating or renegotiating treaties. By making their concerns clear through interpretative statements, governments can bring their reservations about existing investment treaties, already expressed during the negotiation of new treaties, to the attention of the relevant stakeholders.[5]

States can issue unilateral interpretative statements on their treaty commitments, either as submissions to specific claims (as a disputing or non-disputing party – see, for instance, El Salvador’s non-disputing party submission in Spence International Investments v. Republic of Costa Rica and Switzerland’s letter to the International Centre for Settlement of Investment Disputes (“ICSID”) in response to SGS v. Pakistan) or simply through a government’s website. However, unilateral statements are less likely to be determinative on a tribunal if the other party to the treaty disagrees with the interpretation.

States can also issue joint interpretative statements through ad hoc exchanges of diplomatic notes. However, states have rarely used interpretative statements in practice. India has attempted to issue interpretative statements with limited success. At the same time, in the context of NAFTA, the parties only managed to proceed with one substantive note of interpretation despite having reached an agreement on various issues.


Concluding Remarks

There are several ways in which the ISDS regime could be reformed to address the concerns raised above. Firstly, creating a new investment dispute resolution system would involve establishing a new international tribunal or court responsible for resolving investment disputes. This would help to ensure that disputes are resolved fairly and impartially.

Secondly, excluding climate change measures from the scope of investment treaties would make it more difficult for investors to challenge government measures to reduce greenhouse gas emissions. This will exclude a wide array of regulations from the scope of BITs, which will have to be negotiated and looked after on a case-to-case basis.

Thirdly, reforming the rules of investor-state arbitration would involve changing the rules that govern investor-state arbitration. These changes could include making the process more transparent, accountable, and accessible to developing countries. These are just some reforms that could be made to the ISDS regime. Which reforms become adopted depends on governments’ political will and stakeholders’ input. However, reforms are necessary to ensure that the ISDS regime does not hinder governments from taking action on climate change.


* Ayush Kumar is a penultimate law student at Dr. Ram Manohar Lohiya National Law University, Lucknow in India with a keen focus on dispute resolution. His specific areas of expertise encompass international commercial arbitration and construction arbitration.


[1] Eco Oro Minerals Corp v. Republic of Colombia, ICSID Case No ARB/16/41 (2021) available here.

[2] Eco Oro at para 821.

[3] ADF Group Inc v. United States of America, ICSID Case No ARB (AF)/00/1, para 177.

[4] Sanum Investments v. Laos (I), Judgment of the Court of Appeal of Singapore, 29 September 2016, para 116.

[5] Sharpe, J. (2020), “From Delegation to Prescription: Interpretative Authority in International Investment Agreements.”