Symposium on International Investment Law & Contemporary Crises: Energy Finance Market Design & IIA Claims

[Frederic G. Sourgens is the James McCulloch Chair in Energy Law at Tulane Law School and Director of the Tulane Center for Energy Law, and a practicing arbitration lawyer. He has acted as counsel and expert in complex cross‑border disputes]

The recent study on International Investment Law Protections in Global Banking and Finance by Arif H. Ali, David L. Attanasio, Yarik Kryvoi, and Kai-Chieh Chan (the ‘Study’) provides much-needed food for thought for energy market, and energy finance market, design. Both will be critical to deliver critical global energy and decarbonization outcomes. Importantly, the manner in which States might intervene in energy and energy finance markets will have a significant impact on the ability of third States to deliver core energy policy outcomes. As the Study shows, investment treaty arbitration is likely to serve as an under-estimated guardrail with regard to such policy designs. In this post, I will briefly highlight three examples for which the Study is particularly pertinent. 

Climate-Related Lending Regulations

The International Court of Justice recently released its Advisory Opinion on Obligations of States in Respect of Climate Change. One of the Court’s critical conclusions in the attribution context is that the ultimate climate consequences of State regulation are attributable to the relevant State. The Court noted particularly that the:

“[f]ailure of a State to take appropriate action to protect the climate system from GHG emissions—including through fossil fuel production, fossil fuel consumption, the granting of fossil fuel exploration licenses or the provision of fossil fuel subsidies—may constitute an internationally wrongful act which is attributable to that State”.

(para 427)

While the Advisory Opinion did not mention lending to traditional thermal power and oil and gas projects, limiting such sources of finance has become a policy focus. It cannot be excluded that a State with a strong reputation for climate litigation like the Netherlands will implement such a policy, for instance, by setting global portfolio-wide scope through emission limitations for lenders within its jurisdiction to respond to the ICJ Advisory Opinion. Such a regime could also draw in foreign lenders who transact in or through the Netherlands. This raises the question whether such a regime would amount to a violation of the investment treaty protections for qualifying lenders impacted by the regime. The policy implementation of the Urgenda climate decision by the Dutch Hoge Raad has already led to investment arbitrations. It is likely that a decision limiting finance access, too, would draw investment treaty scrutiny by foreign investors holding qualifying and protected investments.

The Study discusses two critical concepts to assess the merits of such claims. The first is the discussion of emergency interventions, premised particularly in the exercise of policy powers found on pages 34 and 53 and following. It is likely that any energy finance restrictions would rely on an asserted exercise of police powers rationale to respond to a declared climate emergency. Here, the Study’s authors’ analysis of police powers defenses in the context of financial emergencies is likely to prove prescient:

“tribunals have felt the need to strike a delicate balance between finance and banking investors’ expectations of a fair and stable business environment, on the one hand, and the State’s sovereign right to regulate, on the other hand”. 

(p. 36)

The second is the discussion of sectoral reform outlined on page 38 of the Study. It is again worthwhile to quote the Study. It notes that the State’s:

“regulatory power does not affect the investors’ right to receive compensation in cases of direct expropriation or due process violations during the implementation of the reform”.

(p. 38)

Here, it is interesting to note that if the reform were indeed the result of climate litigation, it may well be the case that lenders would have been deprived of a meaningful opportunity to be heard as the likely respondent in the action would be the government (and its failure to meet its stringent due diligence obligations) and not the finance institution or lender. Were a State to introduce such measures, they would be deeply disruptive to the energy sector. They would also affect the ability of Global South jurisdictions to receive a fair participation in energy projects on their territories, as I and Leonardo Sempertegui have argued (pp. 66-67). The extent to which such measures could lead to successful investment treaty claims very much remains an open question. It will require a detailed appraisal of the facts and the regulatory regime in question. The Study will be invaluable in addressing these concerns.

Climate Finance and Regulatory Changes in Energy Markets

One of the most important tools to increase energy access in furtherance of Sustainable Development Goal 7 and to mitigate climate change consistent with the Paris Agreement, Glasgow Climate Pact and the First Global Stocktake under the Paris Agreement is finance. One of the critical pieces of finance to be made available under international climate agreements is climate finance. Private lenders are likely to participate in climate finance facilities.

Climate finance by its nature will impose limitations on qualifying projects, and will in principle also make fundamental assumptions about the context in which qualifying projects will operate in order to ascertain that the financed project structure will in fact achieve the desired climate mitigation or adaptation outcomes. Consequently, climate finance will make reasonably far-reaching assumptions about how financed projects will operate and integrate into their respective energy systems. 

This leads to a potential conflict between climate finance requirements on the one hand and the energy policies of the receiving state on the other. The receiving State may find itself in a position of wishing to change its energy policy trajectory. This change in trajectory, in turn, may undercut the underlying assumptions of lenders providing climate finance under international or national climate finance programs. In principle, it is conceivable that a particular project may no longer qualify for the lender and would thus create issues in the lender-home state relationship.

Here, the underlying problem would be the interaction between international climate documents, national energy policy, and the finance instruments and underlying national policies to which the lender would be subjected. One interesting question would be whether the lender—and through the lender international policy actors—could resort to international investment arbitration against the host State for interfering with the underlying finance structure. 

The Study is again instructive in understanding how such claims might be handled. In this context, the underlying climate finance transaction would likely fall between two types of finance, both of which are discussed in the Study. Climate finance made available directly to a private project sponsor by a private lender would look like a private financial instrument. It would be a loan transaction between a foreign lender, drawing on climate facilities, and a host state project company. The change in energy policy could either constitute a reason to halt disbursement of the loan or otherwise constitute an event of default under the finance instruments. This would obviously harm the project company, as it would now lack access to funds. The project company therefore may have a claim for a change in policy that deprived it of available financing. Importantly, however, this is not the only potential party with such a claim. The lender, too, may well have a claim of its own against the host state to the extent that it is not able to collect its anticipated return on the finance transaction. 

With regard to measures affecting private finance instruments, the Study very helpfully provides a rubric for how a tribunal would approach such a claim. It begins that:

“[a]lthough tribunals have sometimes found that the State’s interference with an investor’s private financial instrument (e.g., State measures to invalidate contracts) was legitimate, they have insisted that the State must follow due process and act proportionally and in good faith while doing so”.

(p. 40)

It nevertheless cautions that:

“[t]ribunals confirm that investors have legitimate expectations that States will not interfere with their private financial instruments except in good faith and for legitimate public purposes”.

(id.)

Alternatively, the underlying finance transaction may provide funds to a state entity, or otherwise involve a state entity as a party to the finance instruments. In this case, the underlying finance instrument may be treated as analogous to sovereign debt. The Study suggests that this would be a helpful structure for investors as “[s]o far, investors have prevailed in all cases with decisions on the merits related to sovereign debt” (p. 6). The Study therefore suggests that a particular form of climate finance structuring may provide additional leverage to financing institutions concerned about the longevity of energy policy initiatives at the heart of the assumptions supporting climate finance commitments. 

I would note that in this context, States may well again rely on their national energy sovereignty in defense to any treaty claim. Energy access is critical for almost any other governmental initiative. Should the state find that energy policies must deviate from climate commitments to deliver energy to core population areas, they are likely to insist they acted under their police powers. Such police power claims—as the Study helpfully notes—are not endlessly exculpatory but would provide an additional avenue of defense for the affected State.

Sanctions

Finally, one important unknown in energy lending decisions is whether a project will become the target of future sanctions. In principle, States can impose sanctions that limit the ability of investors within their jurisdiction to transact with identified targets of the sanctions. Most frequently, such sanctions hope to deprive the target of funds in order to exercise leverage over the target to alter their behavior. Financial institutions frequently are prevented from disbursing funds to targets or third parties if that disbursement would benefit the target. Consequently, energy finance transactions can find themselves at the heart of sanctions regimes. This is particularly the case when energy producers such as the Russian Federation are the targets of sanctions.

This raises the question whether lenders can advance a claim against the sanctioning State, assuming that there is a qualifying foreign investment and a protected treaty investor. Part of this question will depend on how one characterizes sanctions. One might consider sanctions as a kind of countermeasure against the foreign state to bring about the cessation of an internationally wrongful act. Were one to think of sanctions in this way, this would perhaps have surprising consequences as investment jurisprudence suggests that in some contexts at least, a countermeasure defense is unavailable against an investor that is not the wrongful actor.

One would assume that, as the Study makes clear throughout, any claims challenging sanctions would be subject to a case-by-case analysis. It is interesting in this context that paying compensation to a lender (as opposed to the sanctioned borrower) is not inconsistent with the underlying policy goal to sanction the borrower. The borrower still does not have access to funds even if the lender were successful in its claim against the sanctioning State. Rather, what the claim at heart alleges is that the sanctioning State may not use the assets of its own nationals to achieve foreign policy outcomes without paying for them just compensation. Thus, while a State may of course requisition materiel, say for a war effort, it must pay for it. When the State does so to prevent a third party from accessing the material in question, the same logic could well apply. Providing compensation for the lender, in other words, would not frustrate the underlying policy purpose. All that remains to establish is whether police powers, again, come to the rescue of the State and obviate the need to pay compensation, a subject eloquently dealt with in the Study.

Conclusion

The Study will prove an invaluable resource as we hope to understand the complexity of energy finance at this particular moment of energy transition and geopolitical confrontation. Its care and nuance will be helpful in diffusing the emotive impact of the values at stake in those disputes. Its call to contextual analysis is something we are well to heed, whether as counsel, arbitrator, or indeed policymakers acting in the energy finance space.