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When free trade takes on democracy

WORLDWIDE: Two years ago Swedish utility Vattenfall filed a claim against the German government for a reported €4.7 billion in compensation for the loss of potential profits from its two nuclear facilities in the country.

The move come after Germany decided in the wake of 2011's Fukushima disaster that it would phase out all of its nuclear power plants by 2022 in favour of renewables.

Although the case is expected to take several years to resolve, the fact that it was brought at all is feeding the flames of concern about the power of multinational corporations to undermine the ability of governments to regulate their own energy futures.

Vattenfall made the claim under a clause in the Energy Charter Treaty - created in 1994 to promote openness in global energy markets and signed by 52 countries and the European Union (EU) - that gives foreign firms a special right to sue governments over changes in local law that affect their investments.

The mechanism it is using to press its case, known as investor-state dispute settlement (ISDS), has become a standard feature in thousands of trade and investment treaties since it first appeared in a bilateral agreement between Germany and Pakistan in 1959. But it wasn't until the EU and US sat down in 2013 to start hammering out a sweeping new free trade deal, known as the Transatlantic Trade and Investment Partnership (TTIP), that public outcry over the concept erupted.

It has become so controversial that the EU stopped negotiations with the US on the ISDS mechanism in early 2014 and launched an online consultation that swamped the European Commission with nearly 150,000 responses, the majority of which were against including ISDS in the treaty.

Discipline needed

"There's a growing concern about the ability of corporations to invoke ISDS to challenge legitimate public policy measures by government," says Lawrence Herman, a Canada-based international trade lawyer. "At first I was sceptical that there was a real problem. But we need to look at (the ISDS process) collectively to try and bring some discipline to it."

Opponents point to the fact that ISDS cases are heard behind closed doors by international arbitration panels composed of highly paid corporate lawyers, who are not accountable to any electorate or system of legal precedent. Little information is made available to the public, third parties are not allowed to intervene, and decisions are not subject to judicial review. The threat of expensive judgments, they say, could lead policymakers to lower regulatory standards and stop or weaken new legislation. And that, opponents fear, is tantamount to allowing multinational corporations to dictate the policies of democratically elected governments.

Proponents argue that there needs to be a way for investors to protect themselves when government changes the rules of the game. Vattenfall's claim, says the utility's general counsel Anne Gynnerstedt, is not about being for nuclear and against renewables. Nor is it an attempt to influence government policy. "This is no way prevents democratic decisions. Germany can naturally decide to reorient its energy policy, but foreign investors should not have to pay the price for such a decision and lose money. That in itself would be in conflict with democratic principles," Gynnerstedt argues in a statement on the utility's website. "If there is no way to receive compensation, then no one could be expected to make major long-term investments over national borders, which would be counter productive."

Good intentions

ISDS mechanisms were originally designed to stimulate investment flows from rich to poor countries by giving companies some comfort that they would be protected from discrimination or expropriation. "They were intended to provide stability in international investments by ensuring that egregious action by countries that didn't follow the rule of law and acted arbitrarily would be disciplined," says Herman.

But the number of ISDS claims has been escalating in recent years. Oft cited cases include tobacco giant Philip Morris which is suing the Australian government, via an ISDS clause in its free trade agreement with Hong Kong, over a law that strips company logos from cigarette packaging and replaces them with health warnings, and a C$250 million claim under the North American Free Trade Agreement (NAFTA) challenging Quebec's decision to place a moratorium on fracking while the province undertakes an environmental assessment of the controversial natural gas extraction process.

In the three decades following the introduction of the ISDS concept, just 50 known cases were launched worldwide. But between 2011 and 2013, investors brought in at least 50 claims a year. The United Nations Conference on Trade and Development (UNCTAD) recorded 42 ISDS cases last year, with 40% of them initiated against developed countries.

What this shows, says Herman, is that if an avenue exists to protect their commercial interests, companies will take it. "Why would you expect otherwise?" he says. "But did the world community think in these terms when these models were developed? I don't think so."

The renewable energy industry has also made use of the ISDS process. UNCTAD counted 11 claims against Spain in 2013 and 2014 arising from the country's drastic retroactive cuts to its support schemes, and investors in Europe's largest solar plant stepped forward earlier this year to add their names to the list. "Claimants maintain that the 7% tax on the revenues of power generators and a reduction of subsidies for renewable energy producers - introduced by Spain in 2012 to counter the budget deficit - wipe out expected profits from their investments in photovoltaic, solar thermal and wind plants," UNCTAD said in a recent report.

Italy, the Czech Republic, Romania and Bulgaria are all facing claims after their governments rolled back feed-in-tariff (FIT) programmes and, in some cases, moved to claw back some cash by imposing new taxes on producers. Italy, which potentially faces cases from dozens more investors affected by cuts to incentives for solar power projects, has served notice it plans to withdraw from the Energy Charter Treaty early next year. It won't prevent those claims from going forward, because the ECT's dispute settlement provisions remain in force for 20 years, but it could affect how future investors approach the market. In Canada, offshore developer Windstream Energy, owned by US investors, filed for arbitration of a C$475 million claim under NAFTA after the Ontario government offered a FIT contract for a 300MW project in Lake Ontario, and then slapped a moratorium on offshore wind.

Access to the ISDS process is the best path investors have for holding governments to account for policy changes that affect the value of deals made in good faith, says Aris Karcanias, a managing director in FTI's energy practice. "It is the most neutral, efficient and advanced mechanism available in today's market," he says. "But it is also the last port of call, which can be challenging for newcomers to navigate. We shouldn't have to rely on it."

It is only fair to expect regulations in place to give a stable investment environment, he adds, but developers and manufacturers also need to take time to understand local market conditions: "While investors should be able to rely on the rule of law, a wise investor will also look at the returns and the market and make pragmatic decisions based on the uptake of technology, forming a realistic view as to whether or not the system is politically sustainable," says Karcanias.

Equally, governments need to be more transparent so investors have the information they need to make the informed decisions. "Then I would say that these investment treaties can be looked at in the way they were meant to be, with everyone going into investments in a fair and transparent environment," he adds.

The pushback against ISDS is prompting reforms to inject more openness into the process, including new UN rules on transparency that countries can include in their trade agreements. Recent treaties, including a free trade deal between Canada and the EU, have tried to narrow the kind of disputes that can be taken to arbitration. "There are attempts by government to whittle this thing down to avoid egregious claims and to safeguard government decision-making," Herman says.

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