Bilateral Investment Treaties as a Tool for Global Climate Governance?

International Investment Law (IIL) has long been understood as counterproductive to adopting effective climate change policy. As IIL aims for predictable investment protection, International Climate Change Law (ICCL) requires flexibility to respond to the evolving climate crisis by implementing national climate laws. The German Federal Climate Change Act represents such a measure by setting C0₂ mitigation goals for each economic sector. It foresees the current emission gap of 257 Mt C0₂ for the energy sector to decrease to 108 Mt C0₂ by 2030. Such laws restrict or phase out harmful climate activities, leading to fossil-fuel-related investor disputes. The tension between a state’s right to regulate and fossil fuel investment protection has its roots in the post-World War II era, where Bilateral Investment Treaties (BITs) were designed to enable foreign fossil fuel investments. However, instead of seeing BITs as an instrument of obstruction, they can be transformed into a powerful tool for climate governance and help bridge the tension between IIL and ICCL by including provisions such as (1) a state’s right to regulate climate policy, (2) substantive environmental protection, and (3) establish a preferential treatment for renewable energy investors.

The Regulatory Chill Effect: A Major Obstacle

The tension between IIL and ICCL manifests itself in what is known as the “regulatory chill” effect. This phenomenon occurs when states hesitate to enact climate policies due to fears of compensation claims from foreign investors protected under BITs, as they allow investors to make fair and equitable treatment (FET) claims if new climate policies adversely impact their investments.

The energy sector emits the most CO₂ out of all economic sectors and is central to this tension, with the European Energy Charter Treaty (ECT) being a prominent example. Of the more than 162 arbitrated cases under the ECT, about 50% involved fossil fuel investment protection claims. A notable recent case is Uniper Benelux Holding B.V and Uniper Benelux N.V v The Netherlands. In this case, the investor claimed FET violations after the Dutch government enacted the Dutch Coal Ban Act, which mandates the shutdown of coal power plants by 2030 without financial compensation. Uniper later withdrew its claims after the German government nationalized the company after it struggled with the 2022 energy price crisis due to Russia’s war on Ukraine. Still, this case exemplifies how fossil fuel investors can arbitrate provisions under an investment treaty when a state wishes to adopt an ambitious climate change policy.

Another clear instance of the regulatory chill effect is evident in Denmark, where the climate minister admitted that the country set a 2050 target for ceasing oil and gas exploration rather than 2030 or 2040 to avoid the “incredibly expensive” compensation that would otherwise be owed to fossil fuel companies. These examples highlight the urgent need to redesign BITs to prevent the regulatory chill and encourage proactive climate policies.

Redesigning BITs: A Three-Pronged Approach

To reconcile the goals of IIL and ICCL, BITs must be redesigned with a focus on three key areas: (1) ensuring a government’s right to regulate climate change policy, (2) including substantive environmental protection clauses, and (3) establishing preferential treatment for renewable energy investors.

The Right to Regulate Climate Change Policy

A crucial step is to embed the state’s right to regulate climate change policies within all BITs. Currently, only 17 % of BITs include such provisions. A trade agreement setting such an example is the progressive Canada–EU Comprehensive Economic and Trade Agreement (2016).

Article 8 (9.1) of CETA states: “The Parties reaffirm their right to regulate within their territories to achieve legitimate policy objectives, such as the protection of the environment.” Further, Article 8 (9.2) clarifies that: “The mere fact that a Party regulates, including through modification of its laws, does not amount to a breach of an obligation.”

This provision applies to the FET clause in Article 8(10.1) and (10.2) and shows that the EU and Canada have recognized the need to reduce the risk of the regulatory chill effect. Similar provisions in more BITs would empower states to enact rigorous climate policies essential for meeting global climate goals. Complementing such provisions would also widen an arbitrator’s scope of interpretation of a state’s right to regulate vis-a-vis the invoked FET clause when dealing with climate-related disputes.

Substantive Environmental Protection Clauses

BITs should also include clauses that strengthen investor responsibility regarding the environmental impact of their investments. Adhering to national or international obligations can mitigate environmental harm and reduce FET claims by fossil fuel investors. However, to date, only 4% of all BITs include provisions respecting national environmental regulations, and 6% refer to implementing international environmental obligations.

The Morocco Nigerian BIT, which still needs to be ratified, is a progressive new-generation BIT that provides for such an obligation. Article 14(1) requires foreign investors to comply with the more rigorous home or host state’s environmental impact assessments prior to establishing the proposed investment.

An exemplary agreement referring to international environmental obligations is the Canada-United States-Mexico Agreement. Article 24.9(1) states that “each Party shall take measures to control the production, consumption of and trade in substances controlled by the Montreal Protocol.” Including such provisions in BITs would ensure diligent foreign direct investment (FDI) and mitigate the risk of climate-harmful investments. Ultimately, substantive environmental obligation provisions can help a state justify implementing a new climate change policy in the event of an arbitral claim and help bridge the gap between IIL and ICCL.

Establishing Preferential Treatment for Renewable Energy Investors

Further, preferential treatment for renewable energy investors should be established when designing BITs, allowing recourse to arbitral mechanisms. Renewable energy investors need to be incentivized to make FDI, as the International Energy Agency estimates that to realize the 1.5° C target, as called for in the Paris Agreement, a total of USD 150 trillion of investment is needed to transform the energy sector by 2050.

Feed-in tariffs (FITs) are an effective policy incentive to attract FDI. They guarantee renewable energy producers a set price for the energy they deliver to the grid. However, FITs are vulnerable to regulatory changes. There have been 91 known cases involving claims by investors in the renewable energy sector, with 81 brought under the ECT. In Eiser, Masdar, Renergy and Norvenergia, the tribunals asserted a breach of the FET clause because the Spanish government rolled back on its once-given FITs, highlighting the effectiveness of how a FET clause can protect renewable energy investments, potentially incentivizing further FDI in renewable energies. Hence, to boost the energy transition, solely renewable energy investors should be allowed to invoke the FET clause, while fossil fuel investors should be excluded from this possibility.

The OECD Directorate for Financial and Enterprise Affairs Investment Committee has drafted model designs to align BITs with climate change protection. Option 1 provides: “The provisions on Investor-State Dispute Settlement of a climate-updated investment treaty do not apply to an investment by an investor of another contracting party in fossil fuels.” Option 2 excludes fossil fuel investors from invoking Investor-State-Dispute-Settlements. These suggestions would exclude the risk of a regulatory effect and encourage states to enact rigorous climate policies.

Reforms are underway, as seen in the proposed modernized version of the (MECT), which includes a carve-out provision in Article 26(2)(d), allowing states to opt out of protecting fossil fuel investments while detailing protections for sustainable investors.

Annex NI, Section B (i) allows contracting parties to opt out of granting Energy Material and Products, such as coal, oil and gas, investment promotion and protection under Part III (MECT).

The EU member states could not agree on signing the MECT as most states criticized that the opt-out provision was voluntary, and the sunset clause, the 20-year period in which fossil-fuel investors could make FET claims, was not amended. The EU is now left with a shattered Investment Treaty landscape. Instead of pushing for further reform of the MECT by including the provisions mentioned above, the member states took the easy way out, leaving its prolonged implications unaddressed.

Outlook

Redesigning BITs is imperative to align investment protection with climate change objectives. By embedding the right to regulate climate policies, including substantive environmental protection clauses, and establishing preferential treatment for renewable energy investments, BITs can be transformed from instruments of obstruction to powerful tools for climate change governance. These reforms would prevent the regulatory chill effect and shift FDI towards climate-friendly investments. With the proposed changes, BITs can bridge the current tension between ICCL and IIL, supporting global efforts to combat climate change.

The future of our planet depends on our ability to adapt and evolve our legal frameworks to meet the urgent demands of the climate crisis. It is time to harness the potential of BITs for the betterment of our world, ensuring sustainable development and environmental protection for generations to come.