Energy Charter Treaty, Latest news

Comment: How the EU disconnected itself from the Energy Charter Treaty

Last Friday Energy Charter Treaty diplomats endorsed changes to the agreement after more than two years of ’modernisation’ negotiations. Although the new text has not yet been published, a summary communication released by the ECT secretariat indicates that there will be significant changes. This effectively foreshadows a gradual ‘withdrawal’ of the European union and its members states from the ECT.

After several years of negotiations and more than a dozen negotiation rounds the contracting parties of the Energy Charter Treaty announced their agreement ‘in principle’ on an updated treaty text.

The EU and its member states seem to have achieved most of their objectives in reforming the ECT by aligning it with the Paris Agreement on climate change and the investment protection provisions offered in CETA, the Comprehensive Economic and Trade Agreement concluded with Canada.

In this sense, the ECT was made future-proof and will remain a crucial tool in attracting the desperately needed additional investments required to achieve the energy transition and the de-coupling from Russian gas.

Hence, this outcome must be considered as very satisfactory for the EU and its member states.

However it seems ironic, to say the least, that despite this success, the EU and its member states have simultaneously decided to gradually ‘withdraw’ from the ECT by making it largely inapplicable among themselves.

Since the large majority of ECT investor-state dispute settlement cases concern intra-EU disputes, the withdrawal of the EU and its member states will lead to a significant reduction of the total number of ECT-based disputes in future.

At the same time the ECT will remain available for EU investors who have invested outside the EU – for example in Turkey or Kazakhstan – while non-EU investors, such as for example Japanese investors, would still be able to use the ECT against other parties, including the EU and its member states.

Fossil fuel carve-out

The new ECT text introduces a new level of flexibility by allowing contracting parties to selectively exempt themselves from certain important provisions of the ECT.

The matter of how to deal with fossil fuels within the ECT has been one of the most contentious issues of the modernisation process. The EU and its member states had been pushing for a complete carve out of fossil fuels, while more recently, they had proposed a transitional phase out of LNG and nuclear power until 2040.

Apparently, this was not agreeable to the other ECT contracting parties. Accordingly, the compromise solution is to enable those parties who wish so to carve out fossil fuels to do so, while allowing the other parties to maintain them.

Thus the EU, its member states and – interestingly – also the United Kingdom have opted to carve-out fossil fuel-related investments from investment protection under the ECT. This applies to existing investments after 10 years from the entry into force of the relevant provisions and for new investments made after 15 August 2023.

As a result, at least for the time being, fossil fuels will remain applicable for non-EU contracting parties to the ECT unless they opt into the carve-out too.

ISDS disapplied to intra-EU cases

Moreover, and on top of that, another flexibility provision has been added which allows Regional Economic Integration Organisations such as the EU to disapply certain ECT provisions among their members. The EU being the only REIO, it decided decided to explicitly disapply Article 26 ECT, which is the investor-state dispute settlement, or ISDS -provision.

Consequently, investment arbitration disputes between European investors and EU member states will no longer be possible.

This effectively amounts to introducing “disconnection clause”, which had not been included in the original ECT text. Despite the absence of such a clause in the text, both the EU as well as its member states had been arguing before ECT-based arbitral tribunals that such a disconnection clause in fact existed implicitly.

Until very recently, this argument had always been rejected by arbitral tribunals. However, in a recent award, published just a week before the ECT deal, an arbitral tribunal for the first time accepted not only the implicit disconnection clause argument but fully endorsed the recent jurisprudence of the European Court of Justice which had ruled that intra-EU ISDS proceeding also based on the ECT are in breach of EU law and thus prohibited.

All this effectively heralds the withdrawal of the EU and its member states from the ECT because, by excluding fossil fuels and the ISDS provision, there is no need for them to continue to remain party to the ECT.

In fact, this would also meet the demand made by the European Parliament, which in a recently adopted report calls for a “coordinated exit from the ECT”.

It now seems very likely that the EU and its member states will draft an ECT termination agreement similar to the one which terminated the intra-EU BITs.

However, as the case regarding the intra-EU BITs illustrates, not all EU member states may be ready to sign such a termination agreement, thereby giving some EU investors potential advantages over others in an uneven investor protection ‘playing field”.

In such an event, the European Commission will most likely bring infringement proceedings against those EU member states in order to achieve uniformity across the board.

Sunset clause

However, one issue, which is not mentioned in the ECT secretariat summary concerns the question of whether the ECT’s “sunset clause” will also be declared inapplicable for intra-EU investor-state disputes.

The ECT contains a 20-year sunset clause, which protects investments made before the termination of the treaty for another 20 years. This means existing investors would still be able to bring intra-EU ECT disputes for another 20 years.

In the current anti-ISDS climate this seems to be unacceptable for the EU and its member states. So one can expect that the sunset clause will be terminated as well, something which is also demanded by the European Parliament.

Yet the elimination of the sunset clause would arguably affect the legitimate expectations and legal certainty of investors who have invested based on the current ECT text.

The fact that existing fossil fuel investments would still be protected for 10 years as to the terms of the agreed carve-out, comes in apparent recognition of this concern. This seems to suggest that the sunset clause is merely reduced by 10 years rather than completely abolished.

However, the question remains whether the sunset clause for renewable energy investments would be maintained.

The situation regarding the sunset clause becomes even more complicated if other contracting parties to the ECT, for example Japan, would maintain the 20-year period. This would lead to asymmetrical rights and obligations, depending on which option a certain country has selected.

Of note in this context is the fact that the text does not mention any reforms regarding the arbitration system as such, for example replacing the current arbitration system by a permanent two-tiered investment court as is the case in CETA and as the EU is proposing in UNCITRAL Working Group III.

Apparently, this was an issue on which no agreement could be found or which the EU and its member states did not consider important any longer after having succeeded in getting rid of the intra-EU ISDS cases.

‘CETA-rization’ of the ECT protection standards

Another key area where the EU and its member states succeeded is the modification of the most important investment protection standards of the ECT by effectively aligning them with the provisions contained in CETA.

This arguably enhances the uniformity of recently concluded investment treaties – at least from the perspective of the EU and its member states.

The currently broadly formulated Fair and Equitable Treatment standard will be replaced by a very narrow closed list of specific FET breaches. Thus, as in CETA and the other EU investment agreements with Singapore and Vietnam, only certain measures may be considered as possible violations of the FET standard. This  significantly narrows down the room of interpretation of arbitral tribunals.

Also, the new indirect expropriation standard, which had hitherto been interpreted rather broadly by arbitral tribunals, will be narrowed down by effectively carving out measures that are taken for the protection of public policy objectives such as the protection of the environment – including climate- and health.

This means that such measures can no longer be considered as indirect expropriation and thus cannot lead to the payment of compensation, except in rare circumstances.

A further important restriction concerns the removal of letter box companies from the scope of beneficiaries of the ECT.

In line with CETA, the ECT will require proof of the investor that he or she has “substantial business activities”, which will be further defined by an indicative list of requirements, such as having a headquarter in the country, a certain number of employees and a certain annual amount of turnover. This list will probably be similar to the one that has been included in the 2019 Dutch model BIT text.

Also in line with CETA, the Most Favoured Nation clause will be further limited by explicitly stating that it cannot be used any longer to import more favourable dispute settlement provisions from other investment treaties into ECT arbitration proceedings.

Finally, several procedural changes will be introduced which will align the ECT with CETA and the reform proposals currently negotiated in UNCITRAL Working Group III.

Accordingly, the UNCITRAL Transparency rules would be made applicable to all ECT proceedings, new early dismissal proceedings for throwing out frivolous claims will be introduced, the imposition of security for costs on claimants will be made easier and claimants will be required to disclose the use of any third party funder for their claims – more here. 

Non EU-ECT members accept Paris Agreement incorporation 

All this will be further strengthened by the fact that more explicit provisions are included that guarantee in broader terms the “right to regulate” of contracting parties. This essentially excludes public policy measures, such as those aiming at combating climate change, from the scope of investment protection provisions of the ECT.

Also of note in this context are the additional provisions which intend to strengthen the sustainable development provisions and corporate social responsibility – CSR – obligations imposed on investors. However it remains to be seen how strongly worded these provisions will actually be.

More generally, the ECT secretariat summary notes that provisions have been introduced which would reaffirm the respective rights and obligations of the contracting parties under the Paris Agreement and International Labour Organisation conventions.

Although this language appears to be vague, it is nonetheless the first time that the ECT obligations are explicitly linked with the Paris Agreement.

In this sense, the EU also succeeded in exporting its climate change ambitions into the ECT and imposing it to all ECT contracting parties.

In summary, all these modifications will drastically reduce the number of ECT disputes in future. It will become much more difficult for investors to initiate and ultimately win ECT arbitration claims. At the same time, the policy space for contracting parties is significantly broadened.

All in all the modernised ECT fits into the current trend in international investment law and is made fit for the future – albeit combined with the gradual withdrawal of the EU and its member states from the ECT’s reach.

 

Nikos Lavranos is Guest Professor at Free University Brussels. He regularly contributes to Borderlex.

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