If you’ve never heard of ISDS (investor-state dispute settlement) that’s not surprising. ISDS operates in the shadows. It’s a mechanism for solving disputes between parties in cases of foreign direct investment while offering legal protections for the investor. The investment is typically provided by a private company to a foreign ‘host state’.
How ISDS is linked to climate change
ISDS is not new but has long been contentious. It’s of particular concern for national governments because it’s being used by foreign companies, to claim, or threaten to claim, for damage to their investments caused when governments act to combat climate change. The Dutch government is facing an ISDS claim of €1.4bn (£1.24bn) from RWE, a German energy company. Dutch courts, following representations from Dutch voters, had ruled the government was breaching its own environmental commitments when it constructed a coal-fired power station. The Dutch government withdrew plans to build two further coal-fired power stations and were sued by RWE.
UK oil company Rockhopper succeeded in 2017 in suing the Italian government for €225mn (£199mn) after it banned oil drilling on the Adriatic Coast. The problem for host states is not only the cases claimants win but the actions governments don’t take to meet climate targets for fear of being sued.
Global Justice Now (GJN) campaigns to redress the economic and political power imbalances between the capital rich ‘western’ economies, and the relatively much poorer developing counties that often need to raise finance from the capital rich and risk averse countries. By making ISDS clauses a condition for their investments, wealthier countries maintain an economic imbalance over developing states.
On 13 April the York branch of GJN arranged a ‘study/ information tour’, attended by 30 people from all over Yorkshire, to the Leeds financial district which is also home to law practices that promote their ISDS services on their global, national or local websites: Reed Smith, DLA Piper, Clyde&Co, Squire Patton and Boggs, Eversheds Sutherland. Requests from Yorkshire Bylines about which of these Leeds offices provide ISDS services have received no replies to date.
The workings of ISDS – aspects of concern to opponents
ISDS takes place largely behind closed doors in ‘courts of arbitration’. These ‘courts’ are tribunals operating outside national legal systems in which each party appoints a team of commercial lawyers that make their cases to advocates who in turn will adjudicate on the case presented.
Each party in the dispute appoints one advocate. A third advocate is selected by joint agreement of the first two. The advocates and lawyers often rotate roles from dispute to dispute creating conflicts of interest.
Deliberations and outcomes of the tribunals are not disclosed without the express consent of the parties to the dispute. Claimed ‘losses’ include speculative losses geared to the investor’s expectations of returns.
Some investors bypass the legal systems of the host state altogether, opting to pursue their claims through the courts of arbitration. If ISDS finds against a government, its taxpayers effectively reimburse corporations. The sums involved in the claims and the associated legal costs are often in the millions, sometimes billions.
ISDS provisions appear in international agreements such as free trade agreements, bilateral investment treaties, multilateral investment agreements and others. They’ve produced a complex entanglement of agreements, some of them going back many years.
The financial and legal arguments for ISDS
From an investor’s viewpoint, ISDS reduces exposure to risk from unexpected actions, unpredictable political regimes and uncertain legal systems in host countries that might reduce investors’ hoped-for returns on investments. Assisted by commercial lawyers, many operating in the UK or the US, ISDS agreements are written to give the investor a route to legal redress over and above the legal provisions in place in the host country.
Lawyers argue there is a clear and legitimate role for ISDS in their clients’ contracts. In a marketing video Norton Rose Fulbright acknowledges that ISDS attracts critics but refutes the idea there is anything untoward about them since ‘investors aren’t always successful in their claims’ – 60% of claims involving fossil fuel investors favour claimants.
That criterion of balanced interests is undermined somewhat by the disparity in the outcome that arise for the two parties in any dispute. Investors can win massive amounts of money to offset speculative losses. Governments can only ‘not lose’, at best their costs recouped if the claim fails. They must balance the importance of defending their actions against further claims against their national priorities, environmental commitments for example, considering the potential drain on their country’s finances if ISDS awards go against them.
The energy charter treaty – a source of dispute itself
In 1994 the energy charter treaty (ECT) was signed by 55 countries. The treaty was inspired by the new opportunities for energy investments in the post-Soviet Russia. These countries were commercially attractive partners in energy supply but nevertheless inexperienced, unproven and unpredictable trading partners.
The expectation behind the ECT was that investors would be suing the emerging economies in any future disputes. Governments trying to tackle climate change are now losing disputes to fossil fuel emitters in other investor-states.
After attempting to ‘modernise’, and redraft the ECT, so that signatories were less vulnerable to ISDS claims and could pursue their commitments to fossil fuel reduction, the point is approaching where the EU countries are going to abandon the treaty. A stumbling block is the 20 year ‘sunset clause‘ which means the terms of the treaty persist for 20 years after treaty ends. A possible solution is for all signatories to formally agree not to exercise the sunset clause.
Evidence of how ISDS favours investors can be seen in the growing market of third-party funding. Globally, large investors are seeking higher returns than offered by established investments. A third-party funder pays an investor’s costs which it loses if the claim fails. If the claim succeeds, the claiming investor recoups its investment, less a pre-agreed fee for the dispute funder. Dispute funder fees are 30-50% of the award and average awards based on those known about were running at $500mn in 2018.
With returns of this size it is no surprise to see funding pouring into dispute resolution. It could turbo-charge investor claims and make potential host states even more cautious about taking action that might attract a claim.
There is nothing illegal about ISDS. But the effect of a system that favours investors and their claims while obstructing climate action calls into question their future use.