Is Investment Law a Restraint on States in Pursuing International Environmental Regulations for Climate Change?

By Vivian Rocha Gabriel*

Environmental provisions are legitimate manifestations of the State sovereignty, in particular, those signed through international treaties to avoid the effects of climate change. However, investment agreements provisions concerning indirect expropriation, despite legal, have come to challenge the concretion of this purpose through the regulatory chill effect.

This phenomena has already been happening in some investor-State arbitration cases and the main concern lies in if the international community will achieve the purposes of the new Paris Agreement even though the likely clash of interests that it will be triggered with investors. The solution for this dead-lock is normative and could be done narrowing international treaties to get more commitment and predictability between the States and investors, and reinforcing the respect of environmental provisions signed yet.

Environmental concerns are already part of the worldwide news. They encompass oil spills, air pollution, fires, and toxic waste dump. In response of these events, the international community has been developing positive efforts to foster the cooperation in mitigating environmental problems. Nation States “are urged by international environmental law to progressively develop sound systems to manage natural resources, protect biodiversity, and secure healthy environments for people[i]”. To meet this goal, several protective mechanisms were developed through multilateral environmental agreements. In the climate change field, it is important to highlight the effect of the 1992 United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol. These international agreements require Parties to implement a course of actions that lead to an unspecified amount of GHG emission reduction, recognizing the need to hold “the increase in global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels[ii].” According to the Kyoto Protocol, the purpose was to reduce 5.2% over 1990 levels in the period between 2008 and 2012, also called the first commitment period. As the reduction targets are not homogenous for all countries, there were different conflicts for the 38 countries that emit the most gases. Developing countries (such as Brazil, Mexico, Argentina, and India) did not have reduction targets.

 The most recent agreement on the field is the Paris Agreement, which entered in force on November 4th, 2016. As an extension of the Kyoto Protocol,[iii], it requires that both developed and developing countries have shared obligations to reduce greenhouse gas (GHG) emission and binds Parties “to institute a continuous planning process to mitigate and adapt to climate change impacts, documented in a “nationally determined contribution every five years”[iv]. According to Charles E. Di Leva, the Chief Counsel of the Environmental and International Law Practice Group in the World Bank Legal Vice-Presidency, and, Xiaoxin Shi, Legal Analyst of the Environmental and International Law Practice Group in the World Bank Legal Vice-Presidency, the “national emission reduction targets and the proposed policy instruments to achieve them are documented in the intended nationally determined contributions (INDCs) or, once a country has ratified the Paris Agreement, their nationally determined contributions (NDCs)”[v]. All the States which have committed with the Agreement must make efforts to materialize this purpose.

At the same time, environment protection is also a topic dealt in other fields, in particular, in those related to the economic outlook. One of this areas is the International Investment Law. In accordance with the understanding of Freya Baetens, Professor of Public International Law at the PluriCourts Centre in Faculty of Law at the Oslo University, it is important to highlight that “the expansion of international investment law in particular is occurring at such speed and in such a manner that overlap with other areas of law, such as international rules relating to sustainable development, seems unavoidable”[vi]. It can arise when States enact certain domestic environmental policies or even obligations imposed by international environmental treaties to protect the environment.

However, this new embrace of environmental regulation is controversial because it involves additional costs to investors.[vii]. For example, regulatory measures enacted by the host States may affect investor property, depriving the owner of substantial benefits of the investment, and forcing the investor to abandon their business or close down its operations[viii].

The State must show that the act was neither arbitrary nor discriminatory[ix], but necessary to pursue environmental protection. This phenomena calls indirect expropriation[x] and, differently from the direct expropriation, which affects the direct domain of the property, in this case regulatory measures imply in a decrease in the value of the investment, “although a transfer of property title from the investor to the host State never actually takes place”[xi]. In International Investment Law, International Investment Agreements (IIAs)[xii]provide protection to investors against indirect expropriation willing security and predictability for investors in the host states[xiii].

However, it is important to highlight that expropriation is a legitimate manifestation of the sovereign power of the State and it is lawful.  It must be done according to some basic requirements, such as: (i) it must be justified by the public interest, (ii) cannot be discriminatory or arbitrary, and (iii) it must be followed by adequate, fair and effective compensation. In other words, if it does not follow these requirements, it will unlawful[xiv] and the States can argue a compensation before international dispute settlement mechanisms.

The main concern lies in the fact that, the investment arbitration claims and the text of the newest IIAs have been imposing restrictions that may lead to a State regulatory chill “from promoting the objectives of other institutions (climate changes objectives, for example)” [xv]. For instance, in the Vattenfal v Germany case[xvi], the Swedish state-owned enterprise, Vattenfal, installed in Hamburg, challenged the German environmental regulations imposed on its coal-fired power plant. It had imposed more burdensome measures on the plant compared to those originally guaranteed, a clear manifestation of an indirect expropriation. These measures were enacted after de 2008 elections and the Green Power succeeded to power in Hamburg and were justified because the coal-fired plants affected the climate change. The investor argued that a violation of the Energy Charter Treaty and sought 1,4 billion euros in damages. Furthermore, Germany agreed to settle and allowed Vattenfal´s operation, releasing the enterprise from commitments to reduce environmental damages. Thus, “it can be assumed that the prospect of paying 1,4 billion euros in compensation has `chilled` the government´s desire to stop the construction and the operation of this power plant”[xvii]. This dispute is an important precedent involving Investment Law and climate-related disputes, mainly because represents a concrete example of the “regulatory chill” phenomena, where “States refrain from enacting stricter environmental standards in response to fears of losing a competitive edge against other countries in obtaining FDI”[xviii] and it is an attempt to frustrate objectives of climate change treaties as well[xix].

The international community has seen evidences of regulatory chill relating to the enactment of carbon tax regulation in the past years, such as in the US, EU[xx] and Australia. The list of evidences encompasses, for instance, all the broad-based energy tax-regulation proposed by the American President Bill Clinton in 1993, which encompass “a broad-based energy tax of 25.5 cents per million BTUs to be phased in over three years starting in 1993. However, energy-intensive industries complaint about the competitiveness impacts of the tax, sought exemptions from the fees and ultimately caused the collapse of the proposal”[xxi]; the 1992 proposal by the European Commission that combined carbon and British Thermal Unit Tax (BTU) “was to be levied on carbon dioxide emissions and energy content of products, such as natural gas, mineral oil and certain kinds of electricity. It was to be set at a level of US$3 per barrel and be increased up to US$10. But the proposal was conditioned on the EU´s major trade partners acting in tandem”[xxii],  and the proposal of the 1994 Australian carbon tax as well fell down, because of the competitiveness concerns of the industrial sector[xxiii].

Currently, the main concern may be that the effects of regulatory chill on environmental law, in general, can logically be applied to the implementation of the Paris Agreement.  There are a couple of reasons for these concerns. Firstly, because the goals are more ambitious than the Kyoto Protocol. Secondly, because it involves not only developed countries, the but also developing countries. It is unavoidable the expectation of a regulatory chill in the domestic environmental regulation of both categories of countries. However, considering the economic vulnerability of the developing countries and its dependence of FDIs, the concern lies on if they will really fulfill with its international environmental obligations or will abstain from the necessary regulation. If the developing countries allowed their policy-making to be influenced by this sort of rationale, “it would utterly trump the purpose of the Agreement”[xxiv].

It is still necessary to find a solution to try to combine both interests, even if the Police Powers doctrine states that “a State may not be found liable for a measure with an expropriatory effect so long as it was enacted in accordance with due process, for a public purpose such as sustainable development, and on a non-discriminatory basis”[xxv].. For instance, if a permit of pollution control is unlimited, how the authorities can imply new restrictions? The answer would be that it is feasible “if there is new knowledge about the impacts of the activity, or if the preferences of environmental protection change”[xxvi].

For this reason, the belief is that the solution may come with more predictability. The states should “develop their IIA models by adding specific language regarding environmental protection clarifying the non-conflicting intent with national environmental regulation”[xxvii].

In addition, another the solution comes also with a clear arrangement. It allows the change of regulation that will affect investor´s activities if new knowledge arises concerning its damaging effects. For example, it has already applied in Denmark, where “operating permits are ‘safeguarded’ for a period of eight years, after which the supervisory body may issue new orders on safeguarding measures. However, before eight years have passed, the Danish authorities may issue new orders concerning the activity if new knowledge arises concerning its harmful effects” [xxviii]. This arrangement should be based on accurate scientific evidence and will try to predict “how the state may introduce new environmental standards to an ongoing industrial activity while honouring the needs of the investor to plan for the operations” [xxix].

In conclusion, it is well-known that regulatory changes may, clearly, impact business actors and their profitability. However, “the unpredictability of regulatory change is somewhat inherent in environmental law”[xxx]. On the one hand, the States have the role to acknowledge these uncertainties and try to provide foreseeability to investors as much as possible. On the other hand, the investors have to adapt to changes imposed by environmental regulations if he wants to continue his activities in the Host State, respecting the rule of law.  For this reason, to try to achieve a balance of interests, taking the regulatory chill phenomena away, keeping the regulatory space of the countries save for pursue environmental purposes and combining the investment protection, the best choice is still through the norm. On narrowing international investment treaties the international community will have more predictability and clearness. Thus, if is necessary to one of the parts give it away, it will be based on the law and not through economic pressure.

*Vivian Rocha Gabriel is a Junior Editor on MJEAL. She can be reached via email at viviandr@umich.edu.

The views and opinions expressed in this blog are those of the authors only and do not reflect the official policy or position of the Michigan Journal of Environmental and Administrative Law or the University of Michigan.


[i] See Åsa Romson. Environmental Policy Space and International Investment Law 23 (2012).

[ii] See Di Leva, Charles E. and Shi, Xiaoxin, The Paris Agreement and the International Trade Regime: Considerations for Harmonization, Sustainable Development Law & Policy. 17 1 20 (2017).

[iii] See Åsa Romson. Environmental Policy Space and International Investment Law 239 (2012).

[iv] See Di Leva, Charles E. and Shi, Xiaoxin, The Paris Agreement and the International Trade Regime: Considerations for Harmonization, Sustainable Development Law & Policy. 17 1 20 (2017).

[v] See Di Leva, Charles E. and Shi, Xiaoxin, The Paris Agreement and the International Trade Regime: Considerations for Harmonization, Sustainable Development Law & Policy. 17 1 20 (2017).

[vi] F. Baetens, Foreign Investment Law and Climate Change:  Legal Conflicts Arising from Implementing The Kyoto Protocol through Private Investment, in Sustainable Development in World Investment Law. (Cordonier Segger M.-C., Gehring M.W., Newcombe A. eds., 2011).

[vii] See Surya P Subedi, International Investment Law, 197 (3rd ed., 2016).

[viii] See Surya P Subedi, International Investment Law, 151 (3rd ed., 2016).

[ix]See Christina L. Beharry and Melinda E. Kuritzky, Going Green: Managing the Environment Through International Investment Arbitration, in 30 American University International Law Review 3 2 398 (2015).

[x] According to Åsa Romson: “the tribunal in the Telenor case in 2006 made this non-exhaustive list of acts of government or government-controlled agencies that have been held to amount to indirect expropriation:678 1. Repudiation of the concession agreement. 2. Forced amendment of a Memorandum of Association so as to require relinquishment of the exclusive right of use of a licence which had the effect of destroying the commercial value of the investment. 3. Displacement of the investor’s management. 4. The imposition of taxes which would substantially erode profits. 5. Denial of permits necessary to operate the concession, and associated measures. 6. Freezing of the investor’s bank account and harassment of its staff. 7. Detention and deportation of key personnel necessary to run the business comprising the investment. 8. Acquisition of a majority shareholding in the concession company where subsequent measures adopted by the majority which destroy the economic value of the investment go beyond the legitimate exercise of a majority shareholder’s right to manage the company. Among these acts, health and environmental policies are most involved in concession agreements, taxes, and permits. The other types of acts do not typically attach to the environmental policy area”. See Åsa Romson. Environmental Policy Space and International Investment Law 273 (2012).

[xi] F. Baetens, Foreign Investment Law and Climate Change:  Legal Conflicts Arising from Implementing The Kyoto Protocol through Private Investment, in Sustainable Development in World Investment Law 12-13 (Cordonier Segger M.-C., Gehring M.W., Newcombe A. eds., 2011).

[xii] For instance, the 2012 US Bilateral Investment Treaty Model states in the Annex B the indirect expropriation provision referring it as a “measure tantamount to expropriation”: “: “Annex B Expropriation The Parties confirm their shared understanding that: Article 6,  4. The second situation addressed by Article 6 [Expropriation and Compensation](1) is indirect expropriation, where an action or series of actions by a Party has an effect equivalent to direct expropriation without formal transfer of title or outright seizure. (a) The determination of whether an action or series of actions by a Party, in a specific fact situation, constitutes an indirect expropriation, requires a case-by case, fact-based inquiry that considers, among other factors: (i) the economic impact of the government action, although the fact that an action or series of actions by a Party has an adverse effect on the economic value of an investment, standing alone, does not establish that an indirect expropriation has occurred; (ii) the extent to which the government action interferes with distinct, reasonable investment-backed expectations; and (iii) the character of the government action. (b) Except in rare circumstances, non-discriminatory regulatory actions by a Party that are designed and applied to protect legitimate public welfare objectives, such as public health, safety, and the environment, do not constitute indirect expropriations”.

[xiii] See Valentina Vadi, Analogies in International Investment Law and Arbitration 209 (2016).

[xiv] See Anne K. Hoffmann, Indirect Expropriation, in Standards of investment protection 166 (August Reinisch ed., 2008).

[xv] Markus W.  Gehring and Avidan, International investment agreements and the emerging green economy: rising to the challenge in Investment Law within International Law: Integrationist Perspectives. Freya Baetens (ed) 215 (2013).

[xvi] Vattenfall AB and others v. Federal Republic of Germany, ICSID Case No. ARB/12/12.

[xvii] Markus W.  Gehring and Avidan, International investment agreements and the emerging green economy: rising to the challenge in Investment Law within International Law: Integrationist Perspectives. Freya Baetens (ed) 214 (2013).

[xviii] F. Baetens, Foreign Investment Law and Climate Change:  Legal Conflicts Arising from Implementing The Kyoto Protocol through Private Investment, in Sustainable Development in World Investment Law 14 (Cordonier Segger M.-C., Gehring M.W., Newcombe A. eds., 2011).

[xix] Markus W.  Gehring and Avidan, International investment agreements and the emerging green economy: rising to the challenge in Investment Law within International Law: Integrationist Perspectives. Freya Baetens (ed) 215 (2013).

[xx] Baetens, Foreign Investment Law and Climate Change:  Legal Conflicts Arising from Implementing The Kyoto Protocol through Private Investment, in Sustainable Development in World Investment Law 15 (Cordonier Segger M.-C., Gehring M.W., Newcombe A. eds., 2011).

[xxi] Daniel C. Esty & Damien Gerardin. Environmental Protection and International Competitiveness: A Conceptual Framework , 32 Journal of World Trade 20 (1998).

[xxii] Daniel C. Esty & Damien Gerardin. Environmental Protection and International Competitiveness: A Conceptual Framework , 32 Journal of World Trade 19 (1998).

[xxiii] Daniel C. Esty & Damien Gerardin. Environmental Protection and International Competitiveness: A Conceptual Framework , 32 Journal of World Trade 20 (1998).

[xxiv] Baetens, Foreign Investment Law and Climate Change:  Legal Conflicts Arising from Implementing The Kyoto Protocol through Private Investment, in Sustainable Development in World Investment Law 15 (Cordonier Segger M.-C., Gehring M.W., Newcombe A. eds., 2011).

[xxv] See Christina L. Beharry and Melinda E. Kuritzky, Going Green: Managing the Environment Through International Investment Arbitration, in 30 American University International Law Review 3 2 398 (2015).

[xxvi] See Åsa Romson. Environmental Policy Space and International Investment Law 135 (2012).

[xxvii] See Åsa Romson. Environmental Policy Space and International Investment Law 79 (2012).

[xxviii] See Åsa Romson. Environmental Policy Space and International Investment Law 79 (2012).

[xxix] See Åsa Romson. Environmental Policy Space and International Investment Law 79 (2012).

[xxx] See Åsa Romson. Environmental Policy Space and International Investment Law 137 (2012).

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