Investor-State Dispute Settlement: A Key Feature of the Trade Policy Response to Climate Challenges

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Introduction

Investor-state dispute settlement (ISDS) systems have come under increased scrutiny of late amid efforts to accelerate the clean energy transition. In a recent report, the Sierra Club argues that foreign investors’ ability to sue host governments under ISDS for discriminatory practices or unfair treatment hinders climate-friendly efforts by channeling funds away from “green” technologies and toward fossil fuel companies’ bottom lines. “The only sensible path forward,” Sierra claims, “is to end the era of ISDS” through removing the mechanism from existing bilateral investment treaties and free trade agreements as well as excluding it from all future ones. After decades of support for ISDS provisions as safeguards for investor rights and promoters of foreign investment, several European countries have embraced this climate-centric skepticism and withdrawn from the Energy Charter Treaty, a multilateral framework for cross-border cooperation in the energy industry. Likewise, President Biden, with the backing of many Democrats in Congress, has excluded an ISDS mechanism from his administration’s ongoing trade negotiations.

Such a stark policy shift among advanced democracies rests on shaky and short-sighted premises. Many of the arguments against ISDS overemphasize the small share of ISDS cases pertaining to fossil fuel investments and overlook the growing number of “low carbon” cases, which cover wind, solar, hydro, and nuclear power projects. Other arguments inflate the success of fossil fuel firms engaged in ISDS disputes and the apparently hostile public attitudes toward the mechanism’s continued use. In total, these claims rely on a dubious foundation to wholly scrap, forget reform, a generally successful component of international investment law—and one that is all but certain to play an increasingly important role in the future. As state-led investments, such as those within the Inflation Reduction Act and European Green Deal, emerge as incentives for private sector involvement in the clean energy transition and friendshoring efforts, the legal certainty and stability provided by ISDS mechanisms will prove critical in facilitating cross-border investment.

Examining Popular Narratives about ISDS and Its Role in Energy Investments


Fossil Fuel Cases Arbitration

Climate-focused criticisms of ISDS paint the dispute settlement mechanism as overly deferential to the interests of the private sector over the public and, more specifically, to those of polluters over the planet. Critics argue that the protections provided under ISDS facilitate pro-business rulings, thus disincentivizing governments from implementing climate-friendly policies for fear of defending a lengthy and expensive case, paying millions to a foreign investor, and, ultimately, weakening or rolling back policies. However, there is a critical flaw in this argument: the fossil fuel industry is not as successful in ISDS disputes as some would argue. While fossil fuel corporations are victorious in 72 percent of cases heard by tribunals on their merits (43/60), those 60 cases account for a small fraction—only 35.5 percent—of all fossil fuel disputes. When factoring in all 169 fossil fuel cases concluded via an ISDS mechanism, including those that are resolved via settlement (31 percent), dismissed (15 percent), or discontinued (10 percent), investors prevailed in 32 percent of disputes, while tribunals decided an additional 23 percent in favor of the host state, according to a Sierra Club–cited analysis of UN Trade and Development (UNCTAD) data. Critics of the mechanism are technically correct in claiming that fossil fuel firms win most ISDS cases subject to a complete arbitration process, but those cases represent only a small segment of an already magnified population. An outsized focus on them belies a much broader story and overlooks the value of ISDS as a functional dispute settlement system responsive to the views of business and government alike.

Figure 1: The Outcome of Concluded Fossil Fuel Arbitrations, Total Number, and Percentage

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Photo: CSIS

Source: Lea Di Salvatore, "Investor-State Disputes in the Fossil Fuel Industry" (Winnipeg: International Institute for Sustainable Development, December 2021), https://www.iisd.org/system/files/2022-01/investor%E2%80%93state-disput…. Licensed under CC-BY-NC-SA 4.0.

Figure 2: The Outcome of Disclosed Fossil Fuel Arbitrations Decided on the Merits

Image
Photo: CSIS

Source: Lea Di Salvatore, "Investor-State Disputes in the Fossil Fuel Industry" (Winnipeg: International Institute for Sustainable Development, December 2021), https://www.iisd.org/system/files/2022-01/investor%E2%80%93state-disput…. Licensed under CC-BY-NC-SA 4.0.

Percentage of Arbitrations

The Sierra Club report mentions that over 90 percent of fossil fuel arbitrations are related to the oil and gas industry—and the large majority of claims within fossil fuel arbitrations are related to investments in the upstream sector, which comprises some of the most environmentally damaging operations. On the one hand, the fact that investments backed up by ISDS contribute to some of the most concerning aspects of the fossil fuel industry invites further inquiry on potential reforms, such as narrowing the scope of eligible transactions or requiring that tribunals consider environmental impacts. It certainly supports the presence of environmental standards in trade agreements. However, the broader statistic—and Sierra’s use of it to justify the end of ISDS—ignores the fact that the mechanism can serve the energy industry writ large, including investments in green technologies and low-carbon ventures. Arguing that ISDS inherently prioritizes dirtier sources of energy by isolating fossil fuel arbitrations rather than examining all energy-related arbitrations is disingenuous. Less than one-third of ongoing and completed ISDS cases are energy-related (374/1,206). Of those 374 cases, 226 (60 percent) are fossil fuel arbitrations and 36 percent are part of projects classified as “low carbon energy.” A leading example of the latter is in Spain, where, under the Energy Charter Treaty, over 20 separate solar panel plant investor groups have collectively been awarded more than $1 billion after the Spanish government retroactively removed renewable energy subsidies to cut costs after the 2008 financial crisis. The proportion of ISDS arbitrations related to fossil fuels relative to clean energy is likely going to decrease given the latter market’s significant growth and the United States’ recent uptick in support for renewables, including through Inflation Reduction Act subsidies. As these investments become increasingly consequential to securing green technology supply chains and accelerating the transition to renewables, ISDS will emerge as a cornerstone of the global drive toward decarbonization.

Figure 3: Investment Arbitrations and Share of Fossil Fuel Arbitrations Per Year

Image
Photo: CSIS

Source: Lea Di Salvatore, "Investor-State Disputes in the Fossil Fuel Industry" (Winnipeg: International Institute for Sustainable Development, December 2021), https://www.iisd.org/system/files/2022-01/investor%E2%80%93state-disput…. Licensed under CC-BY-NC-SA 4.0.

Public Sentiment

Aside from debating the merits of the policy, experts at the Sierra Club have also argued that “public and policy-maker sentiment against ISDS [is] rising” and point to this increasing discontent as evidence that ISDS does not have a place in trade policymaking. There are two main issues with this line of thinking. First, it is difficult to determine whether the claim is factual: there is little polling data on the general public’s view of ISDS, nor has there been a poll among policymakers. The Biden administration’s skepticism of ISDS arrangements may not be as indicative of a growing consensus against the mechanism as its critics would hope. Rather, it may represent deference to an influential coalition of Democrat-aligned interest groups who oppose ISDS and found common cause with Trump administration officials on narrowing the mechanism’s use in the United States-Mexico-Canada Agreement, albeit for vastly different reasons. Nevertheless, if rising anti-ISDS sentiment is indeed observable, the issue should be addressed—not necessarily by removing ISDS altogether, but through outreach, education, less biased news coverage, and, perhaps, targeted adjustments. Investment treaties with an ISDS mechanism have brought about increased capital flows for developing countries and thus enabled their private sectors to flourish. In addition, as mentioned above, ISDS can be a strong component of the green transition efforts precisely advocated for by the Biden administration, which require scaling up investment and production capabilities in a variety of goods, enabling the shift away from hydrocarbons. As with trade writ large, there seems to be a significant disconnect between the perception of the historical U.S. policy’s benefits and the reality—where it is blamed for policy failures in other areas.

Size of Awards

The Sierra Club and other like-minded groups likewise identify the financing of ISDS awards by cash-strapped governments, and by extension their taxpayers, as another unjustifiable obstacle to the clean energy transition. By forcing countries “to foot the bill” of ISDS tribunal rulings, which average $600 million across all fossil fuel cases—nearly five times the amount awarded in non-fossil fuel disputes—ISDS is said to be filling polluters’ coffers on the public’s dime, rather than enabling the flow of capital toward “public interest policies including ones related to . . . green jobs policies.” However, these large figures should not be surprising nor indicative of a flaw with ISDS mechanisms. In fact, they suggest that ISDS tribunals are attentive to sector- and case-specific concerns. Fossil fuel and, to a lesser degree, “low-carbon” projects tend to be extremely complex and risk-laden endeavors that require larger capital expenditures over a longer time horizon than others commonly subject to ISDS disputes, such as in mining, finance, and real estate. As a result of the myriad challenges encountered, especially in foreign countries lacking quality infrastructure or rule of law protections, energy investments’ higher risk profiles translate to much higher potential profits. When a dispute arises and large awards are subsequently granted, the final value reflects these considerations. ISDS tribunals do not actively seek to grant more valuable awards for polluters; rather, they seek to fairly repay investors of expensive energy projects determined to be subject to unjust treatment and policies, as they would with any investor type, including those in clean energy.

Conclusion

The United States and many of its economic partners are currently pursuing two policy goals related to climate and trade: they are seeking to accelerate the transition to renewable energy, while diversifying away from China’s dominance in the green technology space. Given China’s position as a manufacturing superpower, these two goals are inherently at odds with each other. The combined objectives of the green transition and de-risking will require the use of every economic policy tool in these countries’ arsenals to be accomplished successfully. An ambitious trade agenda should play a vital role in serving the current policy direction, as it will require robust economic partnerships between nations with their own comparative advantages in producing different critical goods.

The private sector will require assurances of the viability of green technology projects to buy into governments’ climate and de-risking plans. As countries aim to drastically scale up production capabilities in critical goods, such as lithium-ion batteries or wind turbines, viable financing will become increasingly important. According to the Columbia Center on Sustainable Investment, the primary drivers for foreign investment in renewable energy include the essential elements of legal consistency, political steadiness, and stability within fiscal and energy markets, which most clean energy investors deem crucial or highly significant when making investment choices. Investor-state dispute settlement systems have contributed to the development of energy projects—chief among them hydrocarbons—on foreign shores by providing this sense of stability. They will now also support clean energy undertakings. ISDS should remain in existing trade agreements and continue to feature in U.S. trade negotiations.

David Korn is an intern with the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Thibault Denamiel is an associate fellow with the Scholl Chair in International Business at CSIS. William Reinsch holds the Scholl Chair in International Business at CSIS.

David Korn

Intern, Scholl Chair in International Business