Given the substantive protection provided to investors by the Energy Charter Treaty (ECT), the treaty has long been considered by many as a barrier to effective climate action.
In June 2022, the contracting states to the ECT released a public communication summarising a range of 'modernisations' to the treaty. This latest modernisation effort has been undertaken with a view to preserve states' rights to pursue public policy objectives, specifically in a climate context. The changes seek to address the stagnation or 'regulatory chill', caused by the threat of investor-state dispute settlement (ISDS) arbitration being brought against a contracting state, which many countries face when it comes to climate-related issues where positive action is now accepted as a pressing public need.
However, there is a fine line to walk between taking positive, rapid climate action and ensuring investors' legitimate rights and expectations are not stripped away without warning. The economic fallout of doing so could be irreversibly damaging to communities and businesses alike.
So how far does the ECT modernisation really go?
What is changing?
The following notable changes are being made (along with many more as set out in the public communication):
- The definition of 'economic activity in the energy sector' has been extended to cover the capture, utilisation and storage of carbon dioxide in order to decarbonise the energy systems, meaning that investments in alternative energy sources will be protected under the ECT. The list of energy material and products provided protection by the ECT will be revised every five years.
- The definitions of 'investor' and 'investment' have been amended to extend only to those with 'substantive economic interests' in the particular jurisdiction. Meaning that the practice of 'treaty shopping' (re-structuring to gain access to ISDS in anticipation of climate-related measures) may become increasingly difficult.
- A new flexibility mechanism has been introduced which allows contracting parties to exclude, or carve out, investment protection for fossil fuels based in their territories.
- There will be greater transparency of the ISDS process, meaning that procedural documents will be publicly available, and hearings may be publicly accessible. The higher level of public scrutiny seeks to ensure that due process is followed, and higher levels of public participation are encouraged.
- A number of provisions have been introduced that reaffirm the respective rights and obligations of the contracting parties under multilateral environmental and labour agreements, such as the UNFCCC, the Paris Agreement and ILO fundamental conventions.
- Contracting parties have also reaffirmed their commitment to clean energy transition, promotion of low-carbon technologies in energy trade and investment, and co-operation in implementing climate change-related policies where appropriate.
What does it mean in practice?
For many commentators, one of the largest problems with the proposed changes is that they do not sufficiently address the urgency of the climate crisis, and several contracting states have already indicated a willingness to withdraw from the ECT, Spain being the most recent.
The problem highlighted by many is that, while the flexibility mechanism sounds progressive, any carve-out introduced by a contracting state can only apply to existing investments 10 years after the date of entry into force of the relevant provisions. In terms of new investments, such carve-outs will only apply to new investments made after 15 August 2023 (ie still one year away). The possibility of ISDS arbitration against states' climate policies therefore continues to loom big in the short to medium term.
Many also consider the ECT sunset clause (Article 47) as an ongoing obstacle to substantive change. Article 47 provides investors with 20 years' continued protection following a state's withdrawal from the treaty (and even then, the state must provide one year's notice of its proposed withdrawal). No amendments to this provision appear to be on the cards. The continued risk of ISDS arbitration, even after withdrawing, means that contracting states will have little incentive to withdraw and 'go it alone'.
Article 16 also looks set to remain, which provides that where conflicting provisions in other treaties exist, for example the Paris Agreement, the provisions which provide investors with the most protection shall prevail.
This does not mean that investors and their investments remain unaffected. The modernisation efforts will ensure that the ECT is applicable to fewer investors and investments, and in a more limited range of circumstances. In addition, the revised ECT will narrow the scope of some of the key investment protections available to investors. For example, the revised 'Fair and Equitable Treatment' (FET) provision will include a detailed list of events that constitute a violation. This more proscriptive approach will reduce the ability of investors to apply a broad interpretation of the FET provision, reducing the scope of the protections available to them.
While the proposed changes indicate a clear intention to provide states with more backing when making climate-related policy changes, an element of certainty and continuity for investors has necessarily remained – not just to assist current investors in the face of the global green transition, but also to encourage more activity in green investments. It remains to be seen how it will play out in practice once the text is formally adopted, but it's clear that the presence of investment treaty arbitration under the ECT will not be disappearing any time soon.
If you'd like to know more about what this might mean for you or your business, reach out to a member of our Disputes & Investigations team.
