THE AUTHORS:
Michael Greenop, Senior Associate at Wilmer Cutler Pickering Hale and Dorr LLP
Caroline Lauk, Intern at Wilmer Cutler Pickering Hale and Dorr LLP
Introduction
In November 2017, the Energy Charter Conference established and mandated the Modernisation Group to start negotiations on the modernisation of the Energy Charter Treaty (ECT). The negotiations led to an agreement in principle, reached on 24 June 2022 (“Agreement in Principle”). The Agreement in Principle is without prejudice to its final assessment by the Contracting Parties. Although the draft text is not yet publicly available, the Agreement in Principle explains that the key outcomes of the discussions build on three “pillars”, which are designed to further the clean energy transition and combat climate change:
- an updated list of energy materials and products falling within the scope of the investment protection provisions;
- a “flexibility mechanism” allowing Contracting Parties to carve out investment protection for fossil fuels in their territories; and
- a “review mechanism” every five years to react to technological and political developments.
In addition to the Agreement in Principle and the aforementioned discussions, the European Union (EU) has published a text proposal for the modernisation of the ECT. Together, these sources provide valuable insight into the anticipated reforms.
This article explores some of the main proposed changes to substantive investment protection provisions and the investor-State dispute settlement (“ISDS”) mechanism in the modernised ECT.
Background
The Energy Charter Secretariat proposed a modernisation of the ECT in response to public criticisms. The ECT has received criticism that it impedes the clean energy transition. The threat of legal proceedings by investors under the ECT’s ISDS mechanism has also been denounced on the basis that it disincentivises governments from regulatory action aimed at enhancing environmental protection. As the ECT Secretary-General stated, “The stakes are high. If the modernisation process fails, I don’t see a future for the Treaty.”
The EU Commission indicated that the EU may withdraw from the ECT should its core objectives not be achieved.
Substantive Investment Protections
In order to preserve States’ “right to regulate”, an Agreement in Principle has been reached on a number of changes to the substantive investment protections afforded to investments.
Definitions of “Investor” and “Investment”
Currently, in order to qualify as an investor under the ECT framework, natural persons must have residency, citizenship, or nationality of a Contracting Party. Companies are required to be organized in accordance with the laws of a Contracting Party.
Tightening the definition of a qualifying “Investor”, the new definition:
- excludes dual nationals who hold the nationality, or are permanent residents, of the host State; and
- requires that corporate investors have substantial business activities in the home State (demonstrated through circumstances such as physical presence or payment of taxes). This is intended to exclude special purpose vehicle companies from the definition of “Investor” under the ECT.
Similarly, a qualifying “Investment” under the modernised ECT must be made in accordance with the laws of the host State and fulfil certain characteristics, including the commitment of capital, the expectation of gain or profit, or the assumption of risk. This approach resembles the factors established in Salini v. Morocco, referred to by some arbitral tribunals when assessing qualifying investments under Article 25(1) of the ICSID Convention.
Whilst it remains to be seen whether the EU’s text proposal is implemented into the modernised ECT, it provides that the following will no longer constitute an investment:
- orders in judicial or administrative actions or arbitral awards;
- claims to money arising “solely from commercial transactions for the sale of goods or services by a natural person, a company or other organisation in the territory of a Party” to another in the territory of another Party, or the “extension of credit in relation to such transactions”; and
- short-term loans or a “short-term financial contribution”.
Exhaustive List of Fair and Equitable Treatment Measures
Article 10(1) of the ECT currently contains an open-ended definition of what constitutes fair and equitable treatment (“FET”), allowing investors to bring a broad variety of claims of alleged violations of FET. As a consequence of the success of these claims, Article 10(1) ECT has been described as imposing a “super standard” on States, as it limits States’ ability to regulate without breaching the ECT.
The Agreement in Principle indicates that the revised FET provision adopts the EU’s proposal to designate an exhaustive list of measures constituting violations of the FET standard. If the EU’s public proposal is adopted, measures will be limited to:
- denial of justice in criminal, civil, or administrative proceedings;
- fundamental breach of due process, including a fundamental breach of transparency in judicial administrative proceedings;
- manifest arbitrariness;
- targeted discrimination on manifestly wrongful grounds; or
- abusive treatment.
In theory, providing an exhaustive list of measures should narrow the scope of investors’ FET protection under the ECT. However, given the mixed support during the negotiation rounds (and the opposition from Switzerland and Japan), a compromise position in the final text may not necessarily result in a drastic change to the status quo.
Flexibility Mechanism Allowing for Carve-outs of Fossil Fuel Investments
At the time the ECT was first drafted, fossil fuels were the primary source of energy in most markets. It is for this reason that the implementation of “pillar 2” to the modernised ECT is significant; it incorporates a “flexibility mechanism” which permits Contracting Parties to exclude investment protection for fossil fuel investments in their territories. Contracting Parties can exercise this carve-out right from ten years after the amendment of the ECT takes effect, as well as for any new investments made after 15 August 2023.
The ability of host States to opt out of investment protections for fossil fuels is consistent with the objectives of the Paris Agreement (2015) and the clean energy transition. However, it could also limit the investment protections for existing long-term investments.
It will be interesting to observe the interplay that this will have with the Taxonomy Delegated Act the European Parliament approved on 6 July 2022 to label gas and nuclear energy as green in the EU’s Taxonomy rulebook from 2023. This will allow gas (a fossil fuel) to classify as a sustainable investment, provided certain targets are met. On the one hand, these incentives provided to green investments are designed to attract investors, to raise capital to meet climate change targets. On the other hand, the reform to the ECT may deprive these same investments of protection under the ECT.
Reform of the ISDS Mechanism
UNCITRAL Rules on Transparency (2013)
In line with the movement towards greater transparency in investment arbitration, the Agreement in Principle incorporates the UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration along with “further additions”. Subject to safeguards to protect confidential information, published cases will include written statements and submissions, a table listing exhibits to those documents, expert reports and witness statements. Hearings will be open to the public. Unless the modernised ECT contains a provision permitting disputing parties not to apply the Rules on Transparency, signatories will not be able to derogate from the Rules.
This is a significant development considering that the majority of ECT Contracting Parties have not signed the Mauritius Convention on Transparency (2014), which also requires States to apply the Transparency Rules to Investor-State Arbitrations.
Exclusion of Intra-EU Disputes
The modernised ECT will introduce a new article which excludes the application of Article 26 (ISDS) in relation to Contracting Parties that are members of the same Regional Economic Integration Organisation (REIO). Effectively, this provision excludes intra-EU investment disputes from the scope of the modernised ECT (given that the EU is the only REIO contracting party).
This aligns the ECT with the CJEU’s approach in Moldova v. Komstroy, which ruled on the incompatibility of intra-EU investor-State arbitration under the ECT and EU law. Whilst this decision has been rejected by some arbitral tribunals, it has notably been affirmed recently by a Stockholm Chamber of Commerce (SCC) tribunal in Green Power v. Spain, which held that EU law has primacy over the ECT.
The proposed reform of the ECT offers different investment protections to EU and to non-EU investors in the EU. Specifically, investors from non-EU States will enjoy an added layer of protection of investments in EU Member States as compared to EU investors investing in the same territory. This may incentivise European investors to reconsider how best to structure prospective and restructure existing intra-EU investments so that they can continue benefitting from ISDS protection.
Outlook
It is too early to draw firm conclusions regarding the success of the ECT modernisation without having seen the draft text in full. The modernised ECT is set for review by its Contracting Parties, and subsequent implementation on 22 November 2022. However, it will only enter into force following ratification by at least three-quarters of the Contracting Parties, which could take years.
Disclaimer: The views and opinions expressed in this article represent those of the authors, and not the views and opinions of Wilmer Cutler Pickering Hale and Dorr LLP.
ABOUT THE AUTHORS
Michael Greenop is a Senior Associate in Gary Born’s International Arbitration Practice Group at the London office of Wilmer Cutler Pickering Hale and Dorr LLP, specializing in commercial and investment treaty arbitration cases. He is a Fellow of the Chartered Institute of Arbitrators (UK), Rules Committee Coordinator of the Hague Court of Arbitration for Aviation, as well as a co-founder of the pre-eminent group for young arbitration practitioners in New Zealand, Young AMINZ. Michael has spoken at conferences and his work on arbitration and public international law has been published in leading legal publications.
Caroline Lauk is an Intern in the International Arbitration Practice Group of Wilmer Cutler Pickering Hale and Dorr LLP, and a final-year LLB and BBA student at IE University. She is part of the team of IE Law School’s Jean Monnet Chair of Civil Procedure as well as a student member of CIArb. She is the attaché of the Abrahamic Business Circle, based in Dubai. She has assisted on commercial and investment arbitration cases under ICSID, DIS, ICC, and ICDR Rules.
