Abstract
The global implementation of climate measures has generated complex legal challenges at the intersection of climate change mitigation and international investment law. While governments increasingly adopt regulatory measures to address their climate concerns, these policies have caused a rise in investor-state disputes. This article examines the legal challenges emerging from investor-state arbitration mechanism when states implement climate-related regulatory policies. It investigates the tension between state sovereignty in climate policy and international investment protection obligations. The analysis identifies systemic obstacles in the current arbitration practice and proposes approaches to reconcile the competing imperatives of climate action and investor protection. By analysing the legal implications of climate change regulatory measures, this article advances the scholarly discourse on climate governance and international investment law.
Keywords
Introduction
The global landscape of foreign investment is characterised by an intricate interplay between economic development strategies and emerging environmental imperatives. Traditionally, countries compete to create attractive investment environments by adopting liberal foreign investment regulations and establishing international investment agreements (IIAs). These agreements predominantly focus on protecting foreign investors’ economic interests through substantive and procedural mechanisms, including expropriation clauses, fair and equitable treatment (FET) clauses, and investor-state dispute settlement (ISDS) mechanisms, 1 designed to ensure investors can seek compensation if their investments are threatened.
However, a critical tension has emerged: these investment protection rules increasingly clash with global efforts to combat climate change. While international climate conventions, such as the Paris Agreement and the United Nations Framework Convention on Climate Change (UNFCCC), emphasise collective action to limit global temperature rise, IIAs have historically prioritised investor economic interests, often marginalising environmental considerations and social responsibilities. The fundamental conflict lies in the divergent regulatory approaches: climate conventions advocate for differential regulatory treatment based on carbon intensity, whereas IIAs traditionally provide uniform investment protections across industries regardless of environmental impact. This structural misalignment creates significant legal and regulatory challenges. When states exercise their right to implement climate measures, they risk triggering investor-state disputes that challenge the legitimacy of climate action. 2 Recent examples highlight this challenge. In response to their climate protection obligations under the international climate conventions, many countries have adopted more stringent environmental and climate measures. This proactive approach has promoted a spike in climate-related ISDS cases, particularly in sectors such as mining and renewable energy. For instance, the Netherlands and Germany have mandated coal-fired power plant phase-outs by 2030 3 and 2038 4 respectively, while countries like Spain have reduced photovoltaic power plant subsidies. 5 These actions, while crucial for fighting climate change, have triggered legal challenges from foreign investors, as evidenced in cases such as RWE v the Netherlands 6 and Cube Infrastructure v Spain. 7
The proliferation of climate-related ISDS cases underscores a critical gap in the international investment protection system. 8 While foreign investment is transitioning from purely economic-driven to climate-friendly investment patterns, most IIAs were drafted without sufficient consideration of climate change factors, lacking appropriate grounds in supporting host states’ climate initiatives. As climate protection considerations become increasingly integrated into IIAs, the inherent conflicts between climate action and investor protection become increasingly prominent. This article examines the practice and challenges of utilising ISDS mechanisms to contest state-led climate action. Part II reviews the trends in climate-related ISDS claims from a global perspective. Part III explores the problematic aspects of challenging climate action through ISDS mechanisms. Part IV proposes strategic recommendations for managing potential climate-related investor-state disputes and reconciling investment protection with climate governance imperatives. Part V concludes with implication for future developments. By exploring these complex issues, the article seeks to contribute to the evolving scholarly discourse on reconciling international investment law with urgent global climate mitigation strategies.
Trends in Climate-Related ISDS Claims
IIAs provide a critical legal pathway for foreign investors to challenge host state actions through ISDS. This mechanism permits investors to file claims against regulatory measures of the host states, even when those measures are adopted for legitimate public welfare objectives. Such claims are settled by way of arbitration, independently of the host state's judicial system. Access to an impartial and qualified arbitration tribunal is intended to ensure the adjudicative neutrality needed for foreign investment, particularly when investors have reservations about the legal processes of the host state. ISDS initially gained acceptance because it offered a solution to these concerns. While ISDS was designed to promote cross-border investment and incentivise host state to maintain predictable regulatory environments, it has also been criticised for constraining host states’ regulatory right. Consequently, the costs and benefits of the ISDS mechanism have long been the subject of scholarly and policy debate.
In recent years, ISDS has become the primary method for resolving investment disputes related to climate change. The urgent global challenge of mitigating climate change demands rapid development of renewable energy and systematic reduction of fossil fuel dependency. In response, many countries have developed strategic policies to attract foreign investment in renewable energy and facilitate the gradual phase-out of fossil fuels. The exit from fossil fuel industry and the introduction of renewable energy industries have sparked a significant increase in ISDS cases. This article collectively conceptualises investment disputes arising from climate change policy implementation as ‘climate-related ISDS claims’, focusing primarily on arbitration proceedings initiated by investors experiencing economic detriment from host states’ climate mitigation interventions. This section explores the landscape of the climate-related ISDS claims, examining cases where regulatory actions potentially contravene established investment protection obligations under IIAs.
The landscape of climate-related ISDS claims has emerged as a critical transnational legal phenomenon, with arbitration mechanisms increasingly deployed to challenge governmental climate strategies. Recent research reveals a proliferation of ISDS claims specifically targeting climate-related policies, with particular focus in fossil fuel and renewable energy sectors. 9 The Energy Charter Treaty (ECT) is the most frequently invoked IIA in ISDS cases, responsible for more than 90% of recent renewable energy ISDS cases. 10 Its ambiguous investment protection provisions, especially the FET clauses, have become a pivotal legal instrument enabling expansive interpretations that empower investors to contest climate governance policies. 11 The structural characteristics of ISDS fundamentally challenge regulatory sovereignty, creating significant impediments to comprehensive climate action.
Climate-related ISDS claims can be categorised into two types based on the host state's implementation of climate change policies: disputes arising from active implementation of climate-friendly policies and disputes arising from modification or suspension of climate-friendly policies. Prohibiting coal production represents one type of actively implementing climate-friendly policies. Fossil fuel industry investors have emerged as predominant actors in climate-related ISDS cases, initiating at least 219 claims challenging diverse forms of state regulatory interventions. 12 Notable cases illuminate the complex tensions between climate governance and investment protection. One of the most significant is RWE v Netherlands, which exemplifies the systemic risks confronting states implementing decarbonisation strategies. German investor RWE invoked the ECT in response to Netherlands’ coal phase-out policy aimed at fulfilling its Paris Agreement commitments, claiming €1.4 billion in damages. 13 Such large sum of claims underscores the potential financial liabilities associated with climate mitigation policies. This case demonstrates how ISDS can potentially impede progressive environmental regulation. It also reveals a critical conflict between international investment law and climate governance frameworks, highlighting the substantive challenges states face in taking climate action. 14
Suspending the implementation of climate-friendly policies primarily involves the host state modifying or suspending the regulatory system upon which investors based their investments. A notable example is the significant surge in ISDS cases in the renewable energy sector. Such cases predominantly emerged from legislative measures affecting renewable energy production incentives, with a particular concentration of claims against Spain, the Czech Republic, and Italy under the ECT. 15 The contextual backdrop of these cases reveals a complex regulatory landscape where European nations initially implemented feed-in tariff policies in 2000s to stimulate renewable energy investments. 16 However, the 2008 financial crisis precipitated substantial economic challenges, rendering these support mechanisms financially unsustainable. For example, Spain's budget deficit escalated to $31 billion by 2011, compelling the government to halt renewable energy subsidies. 17 Investors subsequently challenged these regulatory modifications, arguing violations of the FET standard, particularly concerning the protection of legitimate expectations. Currently, 58 related arbitration cases have been filed against Spain, with 32 out of 48 decided cases supporting the investors. 18 These cases exemplify the fundamental tension between the ISDS and evolving climate policy imperatives, highlighting the profound challenges in reconciling economic interests and climate obligations.
ISDS Limitations in Addressing Climate-Related Claims
The ISDS mechanism presents significant challenges in the context of contemporary climate governance. A fundamental structural tension arises from the misalignment between IIAs and evolving climate imperatives: most IIAs, conceived before the emergence of comprehensive climate action frameworks, incorporate ISDS provisions without explicit consideration of climate-related objectives. This omission has created substantial impediments to environmental protection and climate policy implementation. As a result, states pursuing ambitious climate policies face potential challenges from investors invoking existing IIA frameworks. Such challenges range from expropriate claims arising out of the nationalisation of carbon-intensive assets to disputes over regulations that reduce the profitability of high-emission activities during the transition to renewable energy. This tension often gives rise to the so called “regulatory chill”, whereby states hesitate or refrain from implementing robust climate measures for fear of potential ISDS claims. 19 Notable examples include Denmark and New Zealand's moderation of climate initiatives in response to possible ISDS cases, 20 and France's dilution of its proposed 2040 fossil fuel phase-out legislation following investor threats. 21 Regulatory chill arises from multiple factors, particularly legal and financial. Broad investment protection standards, vague treaty language, arbitral precedents favouring investors and the heavy burden of defending the ISDS claims are key drivers. 22 These factors create uncertainty and cast doubt on the resilience of climate regulations when challenged by investors. This uncertainty, coupled with the substantial financial implications associated with ISDS claims, discourages states from advancing strong climate policies. It also helps explain the persistence of regulatory chill. According to the United Nations, ISDS tribunals have already awarded over $100 billion to fossil fuel and mining industries, with potential future awards estimated at $340 billion. 23 Such liability exposure becomes a major disincentive for meaningful climate action by host states.
Furthermore, critics argue that the structure asymmetry of ISDS particularly disadvantages developing nations and small island states, which often lack adequate legal and financial resources to mount effective defences against ISDS claims. 24 The Dominican Republic's ongoing defence of its environmental legislation exemplifies this vulnerability. 25 Critics contend that this imbalance between investor protection and state regulatory autonomy undermines climate policy implementation, characterising ISDS as a “daunting obstacle” to environmental protection 26 that threatens to “choke climate action in emerging economies”. 27 Recent advocacy for the complete elimination of ISDS from existing and future IIAs 28 reflects growing concern, as evidenced by the withdrawal of several European nations from the ECT. 29
Proponents of ISDS, however, argue that it is unclear whether ISDS-linked regulatory chill poses a significant threat and ISDS could actually help enforce and strengthen climate commitments. 30 Abolishing ISDS could deter climate-friendly investments, increase regulatory uncertainty, and make it harder to hold governments accountable for policy reversals. Instead of eliminating ISDS, they advocate reforming it to incorporate stronger environmental and social safeguards. They primarily emphasise the role of ISDS in establishing legal stability and maintaining independence from states politics, and generating strong cross-border capital flows. 31 ISDS supporters argue that climate change is a systemic legal issue that touches on politics, economics, environmental aspects, and many other areas. The controversy over climate change continues to fuel a strong demand for ISDS, particularly in renewable energy and other climate-friendly sectors. 32 ISDS can provide legal protection to investors in such sectors against arbitrary or discriminatory government actions. This is particularly important given that climate investments often involve substantial upfront capital with returns spread over decades. Without ISDS, foreign investors may be hesitant to finance large-scale climate projects due to the risk of expropriation, regulatory changes, or discriminatory treatment by host states. The availability of ISDS encourages capital flows into green sectors that are crucial for climate mitigation.
ISDS proponents also emphasise the regulatory stability and predictability it provides. Climate investments often require long-term commitments. ISDS provides some assurance that the regulatory framework that attracted the initial investment will not be arbitrarily changed, encouraging investors to commit to climate solutions. The predictability is particularly crucial for certain sectors, such as renewable energy, where regulatory consistency significantly influences investment decisions. Research from the Columbia Centre on Sustainable Investment indicates that ISDS serves as a critical risk mitigation tool for renewable energy investors, with legal and political stability ranking as primary considerations for international investment. 33 They strongly support the ISDS to stay to provide this sense of stability and predictability. 34 Furthermore, ISDS advocates claim that as countries accelerate their transitions toward net-zero economies, existing investments in carbon-intensive sectors face increasing regulatory risks. ISDS can provide a forum where legitimate expectations are balanced against necessary climate action. This creates space for regulatory evolution while providing a structured approach to determining when and how affected investors should be compensated. Rather than preventing climate regulation, well-functioning ISDS can help manage the inevitable economic costs of transition by allocating them in a predictable manner.
The following paragraphs examine some of the major systemic limitations of the current ISDS framework in accommodating state-initiated climate action, analysing the tension between investment protection and environmental regulation in the context of climate change mitigation efforts.
Insufficient Grounds for Relief
Unlike the UNFCCC, which affirms state’ regulatory autonomy in in implementing climate protection measures, 35 the current IIA framework shows significant structural limitations in supporting states’ climate initiatives, creating tension between investment protection and climate action. Within the existing framework of 3,323 IIAs, 36 a predominant proportion (over 85%) consists of “old-generation” agreements (signed from the 1980s to early 2010s), which were negotiated and concluded without substantive consideration of states’ regulatory discretion in environmental protection and climate action. 37 These earlier agreements feature broadly formulated treatment standards and minimal safeguard provisions, making them poorly suited for addressing environmental challenges. This limitation is particularly evident in environmental and climate-related disputes, where most cases are decided under these old-generation agreements, 38 potentially hampering states’ efforts to safeguard the environment or address climate change effectively. For example, among all the ISDS cases initiated in 2023, about 70% were brought under IIAs signed in the 1990s or earlier. 39 All of the 175 ISDS cases brought against environmental protection related measures from 1987–2021 were initiated on the basis of IIAs signed before 2010, highlighting the need for addressing the large body of outdated old-generation IIAs. 40 The ECT stands out as the most frequently invoked IIA in ISDS claims, reflected in the high volume of cases brought under it. According to UNCTAD, more than 20% of the 1,332 known ISDS cases between 1987 and 2023 have been brought under the ECT provisions. 41 This disproportionate utilisation stems directly from the ECT's problematic design: its ISDS clauses contain ambiguous language that favours investor interests over state regulatory authority. Particularly concerning are the ECT's FET and expropriation clauses, which were drafted with vague terminology that enables expansive interpretations by arbitration tribunals. EU member states have disproportionately borne the impact of these flawed provisions, facing a significant number of claims challenging their regulatory measures on renewable energy production, as seen in Spain's case discussed above. 42 Driven by concerns that the ECT was incompatible with modern climate goals, some members have withdrawn from it, including Spain, Netherlands, Denmark, France, and Germany. 43 Another example of “old-generation” IIAs is the North American Free Trade Agreement (NAFTA), which faced criticism of lacking robust environmental protection, leading to several environmental measures being challenged under its ISDS provisions for alleged violations of the FET and expropriation clauses. For example, in Metalclad v Mexico, the tribunal ruled against Mexico for denying a permit for a hazardous waste facility based on environmental concerns, awarding the American investor $16.7 million. 44
In contrast, more recent IIAs, signed since 2010, show some progress in protecting states’ regulatory authority and incorporating environmental provisions. 45 For example, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) includes a general exception for environmental measures and affirms parties’ right to regulate. 46 The Canada-EU Comprehensive Economic and Trade Agreement (CETA) contains similar provisions. 47 However, the inclusion of robust safeguards for state regulatory autonomy remains limited. Empirical evidence from UNCTAD's analysis of 284 IIAs concluded between 2012 and 2022 reveals significant gaps: only 17 agreements (16%) explicitly recognise states’ regulatory authority, 4 (1.4%) acknowledge environmental regulations, 6 (2.1%) address compliance with international environmental obligations, and 41 (14.4%) incorporate environmental exceptions in expropriation provisions. 48 This statistical evidence demonstrates that even recent IIAs often fail to adequately protect climate policy space.
The numerical disparity between old-generation and new-generation IIAs presents substantial challenges for climate governance. A key issue lies in the lack of explicit provisions affirming states’ regulatory authority to pursue climate objectives. This gap creates a normative vacuum. As a result, tribunals have no clear guidance on how to assess the legitimacy and reasonableness of climate-related measures. This increases the risk of inconsistent interpretations of investment protection clauses. Consequently, investor interests may be prioritised at the expense of states’ climate commitments. The FET claims brought under the original ECT against Spain regarding its renewable energy subsidy reduction are good examples. 49
Inconsistent Interpretation
The interpretation and application of IIA clauses in ISDS claims has been inconsistent, leading to uncertainty and unpredictability in the arbitral process. This inconsistency arises from a broad range of factors, such as the ambiguous drafting of key clauses, the absence of a binding precedent system, and the broad discretion given to tribunals. As a result, tribunals adopt different approaches based on the specific facts of each case, leading to unpredictability in the outcomes of ISDS proceedings. This inconsistency underscores the need for precise treaty drafting and the development of coherent interpretative frameworks to provide greater legal certainty for both investors and states. To illustrate these issues, this section examines two core clauses - Expropriation and FET - which have been most frequently invoked and subject to especially varied interpretations in past climate-related ISDS decisions.
Expropriation Clauses
Expropriation clauses within IIAs fundamentally serve to circumscribe or prohibit expropriatory actions by host states. A significant proportion of ISDS cases involving expropriation claims originate from carbon-intensive sectors, particularly energy and mining. These disputes frequently focus on whether regulatory measures that severely reduce an investment's value without direct seizure of assets qualify as expropriation requiring compensation. The interpretation of expropriation clauses falls within the jurisdiction of arbitral tribunals, which must interpretate their meaning within the specific context of the relevant IIA. However, a critical issue emerges from the absence of a consistent approach to determining when government actions cross the line into expropriation. This inconsistency is particularly evident in cases of indirect expropriation, where substantial state interference effectively deprives investors of fundamental ownership rights.
In adjudicating whether states’ regulatory actions undertaken for purported public purposes constitute expropriation, tribunals have used several tests, but the boundary is often unclear. One of the main tests is the “effects-based test” where a tribunal only considers the effect of the host state's measures when determining indirect expropriation, regardless of the host state's intent or the public purpose behind the measures. 50 In contrast, the “proportionality test” assesses whether the impact on the investor is proportionate to the public purpose being pursued. It weighs the balance between protecting investments and allowing host states to regulate in the public interest. 51 These different approaches can lead to remarkably different outcomes. For example, in South American Silver Company V Bolivia, the tribunal used the effects-based test to rule that Bolivia's cancellation of a mining concession constituted expropriation, even though it was done for public health reasons. 52 In Metalclad v Mexico, the tribunal found that Mexico's new law of Ecological Decree ‘had the effect of barring forever the operation of the landfill” and therefore constituted indirect expropriation. 53 The tribunal “need not decide or consider the motivation or intent of the adoption of the Ecological Decree”. 54 Similarly, expropriation was also held in Unglaube v Costa Rica where the tribunal refused to consider the environmental protection purpose of the host state's measure. 55 However, in Telenor v Hungary, the tribunal applied the proportionality test and dismissed the investor's expropriation claim. 56 Likewise, in Philip Morris v Uruguay, the tribunal found Uruguay's tobacco control measures, motivated by public health concerns, were legitimate and did not amount to expropriation. 57 This case recognises legitimate regulatory space for states to enact public health measures, reflecting the willingness of the tribunal to “pay great deference to the sovereign choices of the State”. 58 This recognition aligns with the approach taken in Tecmed v Mexico, where the tribunal held that measures for public purpose can be justified if they are proportional to achieve such a purpose. 59 However, Mexico ultimately lost the case due to the lack of proportionality between the public interest pursued and the permanent loss of the economical value of the investment. 60
A further complication arises from the ambiguous scope of expropriation clauses in most IIAs, which fail to clearly specify whether expropriation must affect an entire investment or if it can apply to just part of it. This ambiguity has led to divergent interpretations. Some tribunals, as in CMS Gas v Argentina, have adopted a stringent approach, requiring the entire investment to be significantly affected before finding expropriation. 61 The tribunal ruled that Argentina's emergency measures did not constitute expropriation because CMS retained full ownership and control of its investment, despite significant economic impact on its operations. 62 This case established an important precedent regarding the threshold for indirect expropriation claims, suggesting that substantial interference with the economic benefit of an investment, without more, may be insufficient to establish expropriation. Conversely, other tribunals focus on whether specific investor rights were violated, despite the overall investment remaining partially viable. In Eureko v Poland, the tribunal found that Poland's reversal of a privatization agreement constituted expropriation of specific contractual rights, even though Eureko maintained its shareholding in Poland's largest insurance company. 63
Unlike CMS Gas v Argentina, the tribunal found expropriation had occurred, ruling that Poland's actions had deprived Eureko of specific contractual rights that were central to its investment decision. 64 The tribunal's decision was significant because it recognised that expropriation could occur even when an investor retains its shares and the company continues to operate profitably.
Fair and Equitable Treatment (FET)
Like the expropriation clause, the interpretation of the FET clause by tribunals in ISDS claims has been a subject of considerable debate, primarily due to the vague nature and the broad discretion it provides arbitrators. 65 Arbitral tribunals are frequently called upon to interpret this standard, yet its inherent flexibility and lack of precise definition often lead to inconsistent and unpredictable outcomes. The interpretation of the FET clause presents numerous challenges, including textual ambiguity, the tension between competing policy objectives, and inconsistent jurisprudence. These issues are compounded by the absence of binding precedent and the fragmented nature of international investment law.
The lack of a precise and universally accepted definition of the FET standard in international investment treaties creates significant difficulties for tribunals. Terms such as “fair”, “equitable” and “treatment” are inherently subjective, providing little guidance on their intended scope. Often, the FET standard is drafted in broad and open-ended terms, with minimal guidance provided. Many IIAs simply require the host state to “accord FET” to investors, without further elaboration. 66 If a particular IIA does not define what constitutes FET, in practice it will usually be interpreted broadly by arbitral tribunals, expanding its connotation to cover reasonable expectations, non-discrimination, and due process etc. This lack of clarity creates uncertainty for both investors and host states, as neither party can predict with confidence how the FET clause will be applied in any given dispute. In cases where FET provides no explicit guidance, tribunals have tended to rely on general principles of fairness and adopt a broader and more flexible interpretation, as demonstrated in Saluka v Czech Republic. 67 The high level of uncertainty in the interpretation process has led to the FET clause being referred to as a “black box full of surprises”, 68 positioning the host state at great risk of lost in ISDS disputes. These cases demonstrate the wide-ranging interpretations of the FET clause due to its inherent ambiguity. This variability underscores the importance of clearer treaty drafting and interpretative guidelines to reduce inconsistencies and enhance predictability in ISDS proceedings.
One of the most challenging aspects of interpreting the FET clause is balancing the legitimate rights of investors with the host state's sovereign right to regulate in the public interest. States often adopt regulatory measures to address pressing societal issues, such as public health, environmental protection, or economic stability. While such measures may inadvertently affect foreign investments, they are generally undertaken in good faith and for legitimate public policy purposes. Tribunals must assess whether such measures constitute a breach of FET. This balancing act is particularly evident in cases involving emergency measures. In Philip Morris v Uruguay, for example, the tribunal upheld Uruguay's tobacco control measures, emphasising that the state has a legitimate right to regulate for public health, even if such measures adversely impact foreign investors. 69 Conversely, in Enron v Argentina, the tribunal found that Argentina's emergency economic measures breached the FET standard, highlighting the investor's legitimate expectations and the stability of the legal framework. 70 These divergent outcomes reflect the inherent tension between state sovereignty and investor protection. They underscore the need for a coherent framework to evaluate such ISDS claims.
In practice, FET claims are particularly common in environmental protection and renewable energy cases. The concept of legitimate expectation is central to such claims. The meaning of legitimate expectations has become central to the interpretation of the FET clause. Tribunals often examine whether the host state's actions frustrated the investor's legitimate expectations, which are typically based on the legal and regulatory framework at the time of the investment or specific assurances made by the state. However, determining the legitimacy and reasonableness of such expectations is inherently subjective and context dependent. For instance, in Tecmed v Mexico, the tribunal held that the investor's legitimate expectations were frustrated due to Mexico's denial of renewing the landfill operation permit. 71 The tribunal held the FET clause requires the host state to act in a manner that does not “affect the basic expectations that were taken into account by the foreign investor to make the investment”. 72 This case has been frequently cited in subsequent ISDS cases for its broad interpretation of FET and its emphasis on protecting investors’ legitimate expectations. By contrast, in Glamis Gold v United States, the tribunal adopted a more a restrictive interpretation of FET, equating FET with the “minimum standard of treatment” under customary international law, which requires “a gross denial of justice or manifest arbitrariness falling below international standards” to find a violation. 73 The tribunal stated that “merely not living up to expectations” is insufficient to breach the minimum standard of treatment. 74 Specific commitment or assurance to induce the investment is required for legitimate expectation to arise, which was not established in this case. 75 Similarly, in Parkerings v Lithuania, the tribunal emphasised that investors must anticipate regulatory changes and explicit assurances from the host state is required to form the basis of legitimate expectations. 76 The tribunal rejected the investor's FET claim and set a higher threshold for establishing legitimate expectations. These varying approaches illustrate the lack of uniform criteria for assessing legitimate expectations, further contributing to the unpredictability of FET jurisprudence.
Malfunctioning Exceptions
IIAs often incorporate exceptions and safeguards aimed at addressing critical policy objectives, such as environmental protection and climate change. These exceptions are intended to function as a safety valve, enabling host states to avoid liability for compensation under specific circumstances, even when they fail to comply with their obligations under the IIA. However, in practice, these exceptions often malfunction or are interpreted inconsistently, resulting in significant challenges in their application. The interpretation of such exceptions can vary considerably across cases, influenced by the specific terms of the IIA at hand and the composition of the arbitral tribunal. This ambiguity leads to inconsistent interpretations, making it difficult for both investors and host states to predict how a particular measure might be treated in an arbitration. For example, in Suez v Argentina, the tribunal found that Argentina's actions were not justified under the treaty's general exceptions, although the measures were taken for public policy reasons. 77 In contrast, in Biwater Gauff v Tanzania, the tribunal upheld Tanzania's action related to water regulation, even though they had a detrimental effect on the investor, thus applying a more lenient approach towards the state's regulatory rights. 78 This lack of uniformity in interpretation is a central cause of inconsistency in arbitral awards, which undermines predictability and creates uncertainty regarding the rights and obligations of both investors and host states. Overly expansive interpretations of these exceptions may extend beyond the intended scope of IIAs, potentially undermining the regulatory autonomy of host states.
One of the most contested exceptions in IIAs concerns environmental protection. The application of environmental carve-outs has been scrutinised in several arbitral decisions. A critical structural weakness in many environmental carve-outs is their failure to expressly include core investment protection standards such as FET and indirect expropriation. Consequently, even when states implement legitimate environmental measures, they remain vulnerable to investor claims predicated on these substantive protections. For example, in Eco Oro v Colombia, the tribunal held that Colombia's environmental measures could not be justified under the environmental carve-out in the Canada-Colombia Free Trade Agreement (FTA), ruling in favour of the investor. 79 In Infinito Gold v Costa Rica, the tribunal determined that Costa Rica could not invoke the environmental carve-out as a defence for its denial of an environmental permit to the investor. 80 Similarly, in Bilcon v Canada, Canada rejected the investor's application for a quarry project due to environmental concerns but the tribunal again ruled in favour of the investor. 81
These rulings demonstrate a significant limitation in the efficacy of environmental carve-out clauses. When these clauses lack explicit application to alleged violations of IIAs, they fail to function as effective defensive mechanisms for host states implementing environmental regulations. This deficiency is particularly evident in cases where tribunals have adopted inconsistent interpretative approaches regarding the scope and applicability of environmental carve-outs. Some tribunals have adopted a teleological approach that acknowledges the intended regulatory space preserved by environmental carve-outs, while others have adhered to strict textual interpretations that significantly constrain their protective scope. 82 This interpretative divergence renders the utility of such clauses highly unpredictable. It creates a regulatory dilemma for host states, which must navigate between fulfilling their environmental obligations and avoiding potential liability under investment treaties. Without comprehensive coverage extending to all substantive investment protections, environmental carve-outs constitute merely nominal safeguards rather than effective instruments for reconciling the competing imperatives of investment protection and environmental regulation. This limitation undermines the capacity host states to implement necessary environmental measures without incurring significant liability risks, impeding the objective to strike a balance between investors’ legitimate expectations and states’ regulatory autonomy in the international investment regime.
The Future: Road Ahead
The intersection of climate protection obligations and investment protection commitments presents an increasingly complex challenge in international investment law. Cases discussed in Part III demonstrate that the existing IIA framework can significantly constrain states’ regulatory autonomy in implementing environmental protection measures and climate change mitigation strategies. This raises fundamental questions about the ISDS's compatibility with urgent climate action imperatives. The evolving demands of climate change necessitate urgent reforms to ensure that the ISDS mechanism does not hinder states from implementing environmental protection and climate change measures. This section examines some of the possible ways to reconcile the competing imperatives of investment protection and climate action, focusing on ISDS reform options that would preserve states’ ability to implement effective climate policies.
The tension between environment protection and investment protection has driven several reform initiatives within the international investment law regime. At the forefront of these efforts is the United Nations Commission on International Trade Law's (UNCITRAL) Working Group III, which has been specifically tasked with addressing systematic reforms to the ISDS. 83 Recent developments within Working Group III have led to some procedural improvements aimed at enhancing the transparency, consistency, and fairness of the ISDS process. 84 However, the protection of host states’ regulatory space - particularly in relation to climate action - remains a politically sensitive issue. To date, no consensus has been reached on concrete reforms in this area, reflecting deeper divisions among states over the appropriate balance between investor rights and state sovereignty.
Another significant development is the modernisation of the ECT, a paramount instrument governing foreign investments in the European energy sector and the most frequently invoked treaty in ISDS claims. The modernised version, adopted in December 2024, introduced substantial modifications to facilitate low-carbon transition while reforming its ISDS mechanisms to better accommodate environmental concerns. 85 More importantly, it affirms the sovereign right of members to regulate matters concerning the energy transition and climate change, while reiterating their commitments under the UNFCCC and the Paris Agreement. 86 With provisional application scheduled for September 2025, its potential impact on shaping the ISDS practice in reconciling investment protection with climate imperatives remains to be seen. 87
Other reform discussions have expanded beyond traditional frameworks to critically examine the damages calculation methodologies in ISDS claims. 88 More ambitious proposals advocate for structural reforms, including the establishment of specialised national courts, exemplified by the European Union's Investment Court System, 89 and the potential creation of a permanent Multilateral Investment Court. 90 Some even proposed a more targeted approach through a specific carve-out from ISDS for greenhouse gas reduction measures. 91 Such proposals aim to create a more equitable framework that reconciles the competing interests of investors and host states, while ensuring that regulatory space for environmental and public welfare measures is preserved. However, these propositions, while potentially expedient, address only a subset of the broader challenges of the existing ISDS framework.
The fundamental tension underlying ISDS reform lies in the international community's ongoing struggle to achieve an optimal balance between investor rights and state regulatory authority. This article argues that wholesale abandonment of the ISDS would be both imprudent and counterproductive, particularly given the current volatile global investment landscape where ISDS continues to serve as a crucial mechanism for protecting cross-border investments. Rather than advocating for the elimination of ISDS from the international investment framework, a holistic reform is necessary. Reform efforts should focus on comprehensive recalibration of ISDS within the broader international investment system. Particular emphasis should be placed on circumscribing arbitral tribunals’ discretionary powers through more precise and environmentally conscious treaty language and interpretative guidance. The ultimate objective is twofold: ensuring that ISDS mechanism does not obstruct states’ legitimate environmental and climate action while simultaneously minimising states’ exposure to ISDS claims arising from bona fide climate change mitigation measures. The following paragraphs propose some approaches to achieve these complementary goals.
Legitimising States’ Right to Regulate by Incorporating Regulatory Authority Clauses
The insufficient grounds for relief in IIAs discussed in Section 3 (A) necessitate a fundamental reconceptualisation of state regulatory authority within the international investment framework. IIAs could incorporate explicit provisions that ensures host states’ right to address climate change and take climate-related actions. This is especially important in environmentally sensitive sectors like energy and mining, where regulations must keep evolving to meet emerging climate challenges. Contracting parties could explicitly recognise that climate change mitigation and adaptation measures operate in a rapidly evolving policymaking environment that requires flexibility and adaptation. This recognition could be expressed through specific IIA clauses that explicitly protect regulatory flexibility, including the authority to modify existing rules and incentive programs or create new ones as circumstances change. Such clauses would simultaneously legitimise necessary state regulatory climate action while aligning investment protection with international climate obligations.
Recent treaty practice offers compelling models for effectively incorporating such regulatory authority without undermining legitimate investor expectations. For example, Article 3 of Canada's 2021 Foreign Investment Promotion and Protection Agreement Model reaffirms the parties’ right to “regulate within its territory to achieve legitimate policy objectives, such as with respect to the protection of the environment and addressing climate change; social or consumer protection; or the promotion and protection of health, safety, rights of Indigenous peoples, gender equality, and cultural diversity”. Similarly, the EU-UK Trade and Cooperation Agreement recognises the Parties’ respective rights to regulate in order to achieve legitimate public policy objectives such as the protection and promotion of e.g., public health and the environment including climate change. 92 The UK-New Zealand FTA further advances this approach through Article 14.18, incorporating provisions recognising states’ regulatory rights in pursuing legitimate policy objectives, including environment, health and climate change mitigation and adaptation. Furthermore, the CPTTP dedicates an entire chapter on the environment, affirming each Party's authority to establish, adopt or modify its environmental laws and policies in line with its own priorities. 93 In addition, article 9.16 explicitly preserves the right of states to adopt measures they consider appropriate to ensure that investment activity in their territory is conducted in a manner sensitive to environmental, health or other regulatory objectives. These clauses provide a concrete legal basis for host states to implement climate-related measures. By explicitly codifying regulatory authority through carefully crafted clauses, future IIAs can create a more balanced and sustainable framework that respects both investment protection and environmental imperatives.
There has been much discussion on procedural reforms in ISDS, such as transparency, predictability and arbitrator independence. 94 However, it is crucial to recognise that substantive provisions regarding state regulatory authority are a core part of investment treaty design. These cannot be adequately addressed through procedural reforms alone. While procedural innovations may contribute to improved stakeholder engagement, they do not address the fundamental need to balance investor protection and the regulatory authority of host state. Therefore, the incorporation of substantive provisions on state regulatory authority in relation to climate action is essential for creating a coherent legal framework. The key is to craft these provisions carefully, providing clear guidance to arbitral tribunals while maintaining enough flexibility to address evolving climate challenges.
Prevention of Arbitrary Interpretations
In response to Section 3 (B), preventing arbitrary interpretations of investment treatment clauses requires a combination of precise drafting, clear interpretative mechanisms, and procedural safeguards. As international investment law continues to evolve, developing a coherent and predictable framework for interpreting the key IIA provisions is essential to enhancing the legitimacy and effectiveness of ISDS. The cornerstone of preventing arbitrary interpretations lies in establishing precise and well-defined frameworks within IIAs. Treaty drafting techniques should be used to enhance predictability and consistency in treaty interpretation. Contemporary treaty practice has increasing evolved to offer more precise articulations of fundamental concepts, serving as a safeguard against interpretative inconsistency. For instance, the concept of indirect expropriation, historically subject to divergent interpretations, now frequently incorporates cumulative criteria requiring tribunals to examine various aspects. Annex 8-A of CETA establishes a comprehensive framework requiring tribunals to conduct a fact-based inquiry examining: (i) the economic impact of governmental measures, (ii) the duration of such measures, and (iii) the character of governmental action, particularly its object, context, and intent. 95 Similarly, the Netherlands Model BIT provides granular clarity regarding “fair and equitable treatment” by exhaustively enumerating conduct that constitutes a breach, including (a) denial of justice, (b) fundamental breach of due process, (c) manifest arbitrariness, (d) discrimination on wrongful grounds, and (e) abusive treatment of investors. 96 This approach significantly constrains tribunals’ interpretative latitude while preserving legitimate investor protections.
Moreover, IIA can also incorporate comprehensive interpretative annexes and explanatory notes providing detailed guidance on provision application. Such interpretative annexes and explanatory notes provide guidelines for arbitration on how key clauses should be interpreted. Some even provide specific examples illustrating the boundary between legitimate regulation and compensable interference. For example, Annex 9-B of CPTPP specifies that “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, except in rare circumstances”. 97 This provision creates a clear presumption that bona fide regulatory measures fall outside the scope of compensable expropriation, thereby reducing interpretative ambiguity for tribunals.
To ensure the IIAs clauses are correctly interpreted, arbitral tribunals must adopt interpretative methodologies grounded in the customary rules of public international law, as codified in the Vienna Convention on the Law of Treaties (VCLT). The VCLT provides a structured framework for treaty interpretation that requires examining the ordinary meaning of terms, the context of the clause, as well as the treaty's object and purpose. 98 It also permits consideration of subsequent agreements, subsequent practice, and relevant rules of international law applicable between the parties. 99 Adherence to these principles promotes interpretative consistency across tribunals and reinforces the legitimacy of the interpretative process. Importantly, IIA clauses do not operate in isolation. They must be interpreted in harmony with other relevant international legal norms, particularly in areas such as human rights, environmental law, and sustainable development. Proper interpretation requires systemic integration - an approach that interprets treaty provisions in harmony with the full body of international law. Article 31(3)(c) of the VCLT serves as the normative basis for this approach. 100
The case of Urbaser v Argentina illustrates the significance of proper interpretative methodology. The tribunal emphasised that investment treaty provisions must be interpreted within their broader legal context, including relevant human rights and environmental obligations. The tribunal explicitly invoked VCLT Article 31(3)(c) to integrate human rights norms into the interpretation of the Argentina-Spain BIT and confirmed the “right to water” was a human right under international law. 101 It held that Argentina's water service regulations, designed to protect the human right to water, did not violate FET standards. 102 This systematic approach prevented an isolated reading of investment protections that would have ignored Argentina's human rights commitments. Similarly, in Philip Morris v Uruguay, the tribunal applied VCLT principles to interpret Uruguay's regulatory measures on tobacco packaging within the context of the country's public health obligations. 103 The tribunal explicitly acknowledged that Uruguay's sovereign right to regulate in matters of public health was preserved under the Switzerland-Uruguay BIT when interpreted in light of broader international legal obligations, including the obligations under the WHO Framework Convention on Tobacco Control. 104 These rulings highlight how broader legal contexts, including multilateral environmental and public health commitments, can shape the meaning of investment protections.
Article 31(3)(c) of the VCLT also underpins the interpretation of environmental carve-outs, ensuring they are read in line with states’ broader international environmental obligations. Where environmental carve-outs are included, the broader objectives of sustainable development, environmental protection, and regulatory autonomy must inform the interpretative process. Exemplary exception frameworks preserve state regulatory autonomy while providing clear parameters for its exercise. The CETA specifically excluding environmental measures from indirect expropriation claims when non-discriminatory. 105 Environmental carve-outs are also included in the Canada-Colombia Free Trade Agreement (FTA). 106 Despite these advancements, scholars have raised concerns that tribunals often continue to apply traditional interpretative frameworks, even to modern IIAs that include detailed environmental provisions. The fundamental concern is that if arbitral tribunals interpret new generation IIAs through the same lens applied to older treaties lacking explicit environmental exceptions, then the additional complexity and detail become merely superficial additions. 107 This critique highlights a crucial disconnect between treaty drafting and arbitral interpretation that must be addressed. To resolve this disconnect, reform must go beyond drafting to the development of new interpretative approaches that give proper legal effect to environmental and climate-related provisions. Tribunals need to shift from rigid, investment-centric reasoning towards a holistic interpretative model that genuinely values states’ environmental commitments. This reinforces the importance of the interpretative methodologies based on the VCLT rules discussed above. This evolution is not merely desirable but essential to ensure that enhanced treaty language translates into effective protection for legitimate public interest regulation, particularly in the face of the climate crisis.
Procedural framework is also crucial in ensuring consistent interpretation. Joint interpretation mechanisms, with the establishment of specialised committees for interpretation, enable contracting parties to issue binding interpretative statements clarifying provision meaning and application. CETA's Joint Committee demonstrates this approach through its comprehensive mandate to adopt binding interpretations of treaty provisions. 108 Similarly, the Netherlands Model BIT establishes a structured framework for joint interpretative declarations by outlining a formal mechanism through which both treaty parties can collaboratively clarify the meaning of specific provisions. 109 This framework not only promotes transparency and legal certainty but also ensures that interpretations reflect the mutual intent of the contracting states. Consequently, it limits the scope for inconsistent or overly expansive interpretations by arbitral tribunals.
Furthermore, mandate transparency requirements are critical in preventing arbitrary interpretations while maintaining effective investor protection. It is a fundamental element of legitimate dispute resolution in international investment law. This has often been done by e.g., ensuring public access to documents, hearings and reasoned decisions. CETA is one of the IIAs that includes strong ISDS transparency rule. It incorporates UNCITRAL Rules on Transparency and requires the request for consultations, the agreement to mediate and relevant documents etc to be made publicly available. 110 Hearing “shall be open to the public” unless determines by the tribunal. 111 Another example is the United States-Mexico-Canada Agreement (USMCA) which builds on the transparency rules of NAFTA but made them stronger. Documents such as notice of intent, notice of arbitration, minutes or transcripts of hearings, as well as orders, awards and decisions of the tribunal must be made publicly available. 112 It also mandates public disclosure of pleadings, memorials and briefs submitted to the tribunal. 113 Such procedural safeguards provide a framework for predictable and consistent treaty interpretation, thereby enhancing legal certainty in international investment law.
Expressly Incorporating Climate-Focused Carve-Outs
The problems discussed in Section 3 (C) demonstrate the pressing need for a robust regulatory framework within IIAs that explicitly addresses climate action. Although modern IIAs commonly include environmental exceptions, evidence suggests that these general exceptions may be interpreted narrowly by arbitral tribunals. 114 This highlights the need for explicit climate-focused carve-outs that directly reference international climate commitments and provide clearer parameters for distinguishing legitimate climate action from compensable regulatory changes. Consequently, there remains a compelling case for specific climate-focused carve-outs in IIAs. Such specificity would not only prevent potential misinterpretation by arbitral tribunals that might construe general environmental exceptions restrictively, but also establish clear regulatory parameters for both states and investors. 115
Incorporating climate-focused carve-outs into IIAs requires a comprehensive approach that balances investment protection with climate action objectives. Such provisions need to specifically exempt climate action measures from ISDS proceedings, thus preserving regulatory sovereignty while preventing investors from challenging climate-related measures through arbitration. They could include explicit language detailing which actions are not compensable, with well-crafted treaty language that articulates the parties’ intent to align investment policy with global climate commitments and specifies that legitimate climate regulations do not breach IIAs. To ensure effective enforceability, climate-focused carve-outs could specifically exclude the application of ISDS in cases where the climate measures are taken by the host states in fulfillment of their obligations under the Paris Agreement and UNFCCC. Effective carve-outs could contain precise formulations such as “Non-discriminatory climate-related measures designed primarily to achieve emissions reduction targets under internationally recognised climate agreements, such as Paris Agreement and UNFCCC, do not constitute indirect expropriation or breaches of fair and equitable treatment clause.” Such carefully crafted climate-focused carve-outs ensure that states maintain the necessary policy space to implement climate measures while providing investors with clear guidance on the scope and limits of investment protections in the context of climate action.
Recent developments in treaty practice have seen various approaches to protecting climate action through specific carve-out provisions, ranging from general references to environmental protection to explicit climate-focused language. The CETA includes direct references to climate change, requiring parties to cooperate on environmental issues of mutual interest, specifically listing “climate change” as a priority area. 116 Similarly, USMCA Article 24.11 specifically addresses climate protection, stating that “the Parties recognise that air pollution is a serious threat to public health, ecosystem integrity, and sustainable development”. It also specifically requires parties to cooperate to improve air quality. 117 While the CPTPP does not contain a specific provision labelled “climate change”, it includes several provisions that relate to climate change mitigation and environmental protection. For example, parties affirm their commitments to preventing marine pollution from ships and to controlling emissions certain substances to protect the ozone layer. 118 In addition, Article 20.15 explicitly recognises emissions reduction and clean and renewable energy sources as cooperative areas, strengthening the legal basis for climate measures. These examples demonstrate the evolution of treaty practice towards more robust climate-focused provisions. They reflect a growing recognition that the investment protection regime must accommodate urgent climate needs. While approaches vary in their specificity and enforceability, the trend clearly points toward more specific and comprehensive climate provisions that safeguard regulatory space for implementing climate policies. This evolution represents a significant shift from earlier investment agreements that focused primarily on investor protection with minimal environmental safeguards.
Conclusion
The tension between investment protection and climate action imperatives represents one of the most pressing challenges in international investment law. The ISDS mechanism, originally designed to protect foreign investors from arbitrary state action, has increasingly become a contested forum for adjudicating climate policy interventions. The surge in climate-related ISDS claims, both those challenging the implementation of climate-related policies and those contesting their modification or suspension, reveals fundamental structural incompatibilities within the current international investment regime. The systemic limitations that undermine the ISDS mechanism's capacity to accommodate legitimate climate action necessitate an urgent reform. Effective reform must address both substantive and procedural dimensions of the ISDS regime, adopting a balanced approach that safeguards investors’ right while preserving adequate policy space for states to fulfill their climate obligations. In essence, this requires legitimising host states’ regulatory authority through explicit treaty provisions, preventing arbitrary interpretations through precise treaty drafting and interpretative mechanisms, and also explicitly safeguarding climate action through specific carve-outs. The fundamental purpose of investment protection is not merely to shield investor interests, but to promote sustainable development that harmonises economic growth with environmental and social considerations. As climate change accelerates and states ramp up their transition efforts, the frequency and complexity of climate-related ISDS case is likely to increase. It is therefore imperative to take proactive actions to address these systemic limitations to ensure that ISDS does not become an impediment to legitimate climate action.
Footnotes
Funding
The authors received no financial support for the research, authorship, and/or publication of this article.
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.