THE MODERNISATION OF THE ENERGY CHARTER TREATY – SOMETHING OLD, SOMETHING BORROWED, SOMETHING NEW?

On 24 June 2022, the Energy Charter Conference (ECC) confirmed that the Contracting Parties to the Energy Charter Treaty (ECT) had reached an Agreement in Principle on the modernisation of the treaty. We look at the key commitments made below.

Background

The ECC launched discussions for the modernisation of the ECT in November 2017. In 2018 the Contracting Parties agreed to discuss a specific list of topics including the States' right to regulate, transparency in investment arbitration, addressing frivolous claims, and corporate social responsibility, among others. Some of the delegations suggested some policy options for each of the topics in 2019, and in July 2020 the negotiation rounds officially started. There were 15 rounds of negotiations in total.

The Agreement in Principle sets out the main outcome of the negotiations. However, it does not represent the final text, which will be subject to editorial and legal review and subsequent approval by the Contracting Parties. Afterwards, the modernised treaty will enter into force 90 days after ratification by three quarters of the Contracting Parties. While the text will be communicated to the Contracting Parties on 22 August 2022, its final adoption will take place on 22 November 2022.

Key Agreements

The Agreement in Principle reveals several key themes which will be included within the final text.  Of particular importance are those commitments focused on (i) substantive investment protection; (ii) renewable energy, climate change and sustainable development; and (iii) the dispute settlement mechanism.

Substantive Investment Protection

The Contracting Parties have emphasised the need to strengthen their right to regulate. Accordingly, they have proposed additional references to the States' right to regulate in the preamble, a stand-alone article reaffirming such right in the interest of legitimate public policy objectives, as well as an exception clause building upon the analogous provisions of the GATT and GATS.

The fair and equitable treatment standard (FET) will also be amended. In its current form, Article 10(1) of the ECT simply provides "to accord at all times to Investments of Investors of other Contracting Parties fair and equitable treatment". No definition or further information is provided. The Contracting Parties intend to list certain measures that constitute the violation of the standard and clarify the circumstances where legitimate expectations may be considered. We may expect that the final provision takes inspiration from the Comprehensive Economic and Trade Agreement (CETA), in which Article 8.10 follows the same approach.

The Contracting Parties have also agreed to narrow the scope of application of expropriation. The notion of direct expropriation will be clarified and a list of factors introduced for the determination of indirect expropriation. Additionally, and in connection with the right to regulate, they foresee an explicit provision stating that non-discriminatory measures adopted in pursuance of a legitimate policy do not constitute indirect expropriation.

Renewable Energy, Climate Change and Sustainable Development

The Contracting Parties have sought to commit to renewable energy and to combat climate change through the modernisation process. In particular, they have updated the list of energy materials and products including hydrogen, biomass, synthetic fuels among others. Furthermore, they have introduced a "flexibility mechanism" which would allow Contracting Parties to exclude investment protection for fossil fuels in their territories; in other words, a carve-out for investments in fossil fuels. The EU and the UK have already opted for such mechanism.

Finally, the Contracting Parties envisage a number of provisions referring to environmental and labour agreements such as the UNFCCC, the Paris Agreement and the ILO Conventions. Similarly, they foresee a prohibition of lowering environmental and labour protection standards as a means to encourage the inflow of trade and investment in the energy sector. They also express their commitment to clean energy transition, promotion of low-carbon technologies in energy trade and investment, and cooperation in implementing climate change-related policies.

Dispute Settlement Mechanism

The Contracting Parties have also agreed to certain modifications to the dispute settlement mechanism. This includes: first, the modification of definition of investor. If the investor is a natural person and held the nationality of the host state when making the investment, they would be excluded from investment protection under the modernised ECT. This aims at excluding claims of dual nationals. For corporations, a requirement of substantial business activities in the home state is included. This modification aims at curbing treaty shopping.

Second, the UNCITRAL Rules on Transparency in Treaty-based Investor-State arbitration will be applicable. While these rules were adopted in 2013, their application has not been widespread. Thus, their express inclusion in the modernised ECT is a step towards greater transparency in investment arbitration.

Third, the early dismissal of frivolous claims is envisaged. While no details about the process for such dismissal are provided, it is revealed that the standard for dismissal draws inspiration from Rule 41 of the ICSID Arbitration Rules by referring to "manifestly without legal merit".

Fourth, a disconnection clause for Regional Economic International Organisations (REIO) is included. This provision excludes the application of the investment dispute settlement mechanism among Contracting Parties that are members of the same REIO. In practice, this provision seeks to exclude intra-EU investment disputes from the scope of the modernised ECT. This has proved a controversial issue in past intra-EU investment disputes. The inclusion of the disconnection clause in the modernised ECT may indicate the importance of the EU in the negotiation process.

The Takeaways

After years of negotiations, the modernisation of the ECT seems to be taking shape. The Agreement in Principle reached by the Contracting Parties is a milestone in this regard and it already provides a glimpse of what the modifications of the ECT might look like. Many of the foreseen changes are not new in investment agreements e.g. provisions limiting treaty shopping, clarifying the FET standard or reaffirming the State's right to regulate. Other provisions appear a step further in the fight against climate change, for instance, the inclusion of a carve-out for investments in fossil fuels. Others are clearly specific to the context of this particular treaty such as the disconnection clause for intra-EU investment disputes. All in all, the Agreement in Principle shows that the Contracting Parties have opted to recycle some of the provisions of recent investment treaties, and to add some that fit the energy sector. Yet, the explicit commitment to clean energy transition and to combat climate change is important and note-worthy.

In any case, we must wait for the finalised text to assess the potential impact of the proposed modifications. Certainly, the entry into force of the modernised ECT might still take some years, particularly if the EU Member States are to stand by for a decision of the Court of Justice of the European Union on the compatibility of the modernised ECT with EU law. Since the EU currently comprises 27 Member States, it is unlikely that the threshold for entering into force (three-fourths of the ECT Contracting States) will be reached without the ratification of the EU Member States.

For more information, please contact Patricia Nacimiento, Partner, or your usual Herbert Smith Freehills contact.