ESG-focussed Reform for International Investment Agreements: A Potential Solution

Late last year, the UN Special Rapporteur on Human Rights and the Environment presented a scathing report to the UN General Assembly on investor-state dispute resolution (‘ISDS’) and its consequences for climate change and human rights. The report termed ISDS an ‘unjust, undemocratic and dysfunctional process’, which ‘perpetuates colonial extractivism and exacerbates inequality’.

While the report has met with some criticism (see here), the prevalent skepticism about ISDS, or for that matter towards international investment agreements (‘IIAs’) in general, is well-documented. This hostility has been fuelled in major part by the increasing ESG obligations of States. As States introduce more regulations to address key ESG issues, particularly climate change, labour and the environment, the conflict between such regulation and investor rights has become increasingly likely.

While efforts for reform of the IIA regime are ongoing, progress has been slow. This post considers how ESG obligations have been considered in treaty language and interpreted by arbitral tribunals, and offers a proposal for quicker reform of the IIA regime to permit States to effectively respond to ESG issues.

A. ESG and the IIA Regime

The IIA regime comprises approximately 3300 IIAs signed between 1959 and 2009, and 500 odd IIAs signed after 2010 (see here). The first set, commonly termed as older generation IIAs, contained broad investor protection standards, with no corresponding responsibilities on investors. They seldom contained any ESG-related provisions safeguarding States’ ability to regulate to achieve their ESG objectives, for example, in areas of public health, environment, energy and human rights. Investor claims challenging domestic policy measures in these areas, brought mostly under older generation IIAs, arguably created a regulatory chill, restricting or weakening measures taken by States.

In comparison, new generation treaties, ie IIAs signed mostly post-2010, have sought to balance investor rights with retaining flexibility for States’ regulatory powers. ESG obligations for States and investors have found their way into these IIAs through a variety of provisions, such as preambles, non-relaxation/non-lowering of standards clauses, non-precluded measures clauses and ESG-related carve-outs from treaty protection standards.

But, in the near term, most investor claims will continue to be raised under older generation IIAs. The question to ask then is whether and to what extent arbitral tribunals must take into account ESG considerations when assessing the merits of an investment treaty arbitration.

B. ESG Obligations and Investment Treaty Arbitration

ESG obligations are directly relevant to the State’s defence, both on admissibility and on merits. In the last decade or so, arbitral tribunals have shown increasing awareness of the relevance of ESG obligations.

Arbitral tribunals have considered the host-State’s obligations under international law with respect to ESG issues in assessing the reasonableness of its conduct, in particular, whether the State acted in accordance with the ‘police powers’ doctrine.

In  Philip Morris Brands Sarl and Ors. v Oriental Republic of Uruguay, the investor challenged certain anti-smoking measures adopted by Uruguay, which sought to implement the WHO Framework Convention on Tobacco Control and Guidelines thereunder (‘Convention’). The arbitral tribunal considered the Convention as a point of reference, alongside the relevant provisions of the Switzerland-Uruguay BIT, for assessing the reasonableness of Uruguay’s anti-smoking measures. The arbitral tribunal held that so far as regulations adopted for public health are concerned, there cannot be any legitimate expectation, except that there would be more stringent regulations. The arbitral tribunal also held in favour of a wide margin of appreciation for the State’s right to regulate in matters of public health and affirmed the applicability of the police powers doctrine.

One also sees arbitral tribunals interpreting substantive treaty provisions in accordance with Article 31(3)(c) of the Vienna Convention on the Law of Treaties ie in accordance with relevant rules of international law, thereby giving room for ESG obligations under various international legal instruments to be considered. In Philip Morris, even though the expropriation provision in the Switzerland–Uruguay BIT did not refer to the States’ police power, the tribunal referred to customary international law to include the police power of states. Arbitral tribunals have also found ESG obligations, based on domestic law, to be relevant, either to temper the legitimate expectations of investors in the context of treaty violations or as a valid and proper justification for the exercise of police powers.

In Spyridon Roussalis v Romania, the arbitral tribunal rejected the investor’s argument that Romania’s conduct in carrying out ‘too many inspections’ and imposing ‘too severe penalties’ as part of certain food safety related measures amounted to a failure to protect the investor’s legitimate expectations. The arbitral tribunal held that the inspections were carried out in accordance with Romania’s National Strategic Plan and were based on an obligation to implement food and safety regulations which ‘reflect a clear and legitimate public purpose’. Likewise, in Urbaser S.A. v The Argentine Republic, the arbitral tribunal observed that Argentina’s obligations under international law and the Federal Constitution to guarantee access to basic water supply were ‘expected to be part of the investment’s legal framework’.

ESG obligations have also been applied to defeat investor claims at the jurisdictional stage itself. For instance, in Metal-Tech Ltd v The Republic of Uzbekistan, the State disputed the jurisdiction of the arbitral tribunal on the basis that the investor had engaged in corrupt acts in violation of municipal law while establishing its investment and, therefore, such investment could not be protected under the investment treaty. A similar outcome was seen in World Duty Free Company v The Republic of Kenya and more recently in Churchill Mining PLC and Planet Mining Pty Ltd v Indonesia.

Any non-compliance with ESG obligations could also be relevant in assessing the compensation payable to the investor. For example, in Yukos Universal Limited (Isle of Man) v The Russian Federation, the arbitral tribunal reduced the damages payable to the investor by 25% on the basis that through their tax avoidance, they contributed to the extent of 25% to the prejudice they suffered.

That said, other arbitral tribunals have not shown any special concern towards ESG concerns. For example, in cases under the Energy Charter Treaty relating to renewable energy incentives, several arbitral tribunals have followed a largely traditional analysis based on legitimate expectations regarding total and unreasonable regulatory changes without any special consideration of the viability of renewable energy incentives and their impact on public finances. Similarly, in Eco Oro Minerals Corp. v The Republic of Colombia, despite there being an environmental carve-out in the Canada-Colombia FTA, the arbitral tribunal held that Colombia was liable to pay compensation.

C. The Road Ahead

While arbitral tribunals have become increasingly sensitive to the ESG obligations of States, there is far too much uncertainty about whether a specific arbitral tribunal will be considerate towards ESG concerns—and if so, then in what manner. This problem arises from a lack of guidance in treaty language and the substantial flexibility afforded to arbitral tribunals in terms of identifying and following prior decisions.

The ideal solution is to adopt modern balanced investment treaties. However, the negotiation of hundreds of new investment treaties or the modification of hundreds of existing investment treaties is likely to be a slow and difficult process. One could perhaps consider joint interpretive statements, but even those require a large degree of consensus. Further, arbitral tribunals could be tempted to ignore joint interpretive statements as ‘backdoor revisions’ to treaty protections. Lastly, even unilateral termination of older investment treaties would also not address this issue fully since the sunset clauses in such investment treaties will continue to protect existing investments for several years, and thereby restrict States from effectively pursuing ESG goals.

In my view, one feasible solution could be to adopt a multilateral instrument, designed on the lines of the Mauritius Convention (United Nations Convention on Transparency in Treaty-based Investor-State Arbitration), which contains detailed guidance on the relevance and scope of application of ESG obligations under municipal law and under international law.  The Mauritius Convention supplements existing investment treaties by applying the UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration to investor-state disputes. The unique mechanism of the Mauritius Convention provides that if a State accedes to the Mauritius Convention, then all of its investment treaties with the other parties to the Mauritius Convention automatically stand modified.

The UNCITRAL had in 2015 conducted a study on the Mauritius Convention as a model to be adopted to reform the ISDS mechanism, but that proposal did not consider reform of substantive treaty standards. The proposed mechanism is efficient and convenient. It can be used in a multilateral instrument which can supplement existing investment treaties by including an annex/protocol on ESG containing provisions that:

• recognise, define and safeguard States’ right to regulate with a specific reference to ESG goals and sustainable development;
• impose a positive duty on States to promote sustainable investment and not to lower labour, health and environment standards to facilitate investment;
• provide well-defined carve-outs related to ESG goals from substantive treaty protection;
• provide safeguards to ensure that regulatory measures taken by States are fair, reasonable and non-discriminatory while providing for a margin of appreciation for States; and
• impose obligations on investors to abide by local and international ESG norms while establishing investments and at all times thereafter, and permit States to raise counter-claims for breach of such obligations.

Anjali Anchayil is a Partner at JSA, Advocates & Solicitors.