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Canada and the EU should divest from CETA’s dangerous investment court system

It’s time to treat the novel investor-state dispute settlement system like a stranded asset

October 20, 2023

8-minute read

In a report published this September, the International Energy Agency warned that fossil fuel demand must fall by 25 per cent from current levels by the end of this decade, on a pathway to net zero by 2050, if we hope to meet the goal of limiting average global temperature increases from climate change to 1.5 degrees Celsius.

The updated forecast from the agency ratchets up pressure on major fossil fuel producers and exporters like Canada to stop approving new oil, gas, and coal projects while scheduling the rapid phaseout of current operations. Investments in these sunsetting sectors are rightly considered stranded assets—that is, assets that suddenly become liabilities—since the social and ecological costs of continuing to extract and burn fossil fuels far outweigh the benefits.

The same label can be applied to the nascent Investment Court System (ICS) in Canada’s Comprehensive Economic and Trade Agreement (CETA) with the European Union. The ICS—a variation on investor-state dispute settlement (ISDS)—is a stranded asset in three consequential senses.

ISDS is incompatible with bold climate action

Many governments, experts, and civil society movements now acknowledge that treaty-based investment arbitration is a barrier to decarbonization—a key driver of recent ISDS reforms efforts. Even the threat of a costly lawsuit can scare countries off from introducing new environmental measures. For this and other reasons, a July 2023 UN report states that ISDS poses a “catastrophic” threat to climate mitigation and adaptation efforts and the achievement of human rights.

Canadian and EU officials claim the ICS responds to these concerns by striking a good balance between protecting investors, including fossil fuel companies, from wrongful expropriation or mistreatment by public bodies while safeguarding governments’ right to regulate. These are hollow promises from governments that have themselves employed much stronger and more effective options, including withdrawal of consent to ISDS, for safeguarding climate action.

The ICS does contain procedural innovations over traditional ISDS. It establishes a standing tribunal to hear cases, rather than ad hoc panels made up of investor- and state-appointed arbitrators, with the aim of fostering more consistency in arbitral decisions on similar points of law. A new appeals body is meant to ensure there is recourse for states—or investors—to challenge unfavourable decisions.

But while an appellate body might increase the consistency of rulings, it is naïve to expect a group of “judges,” largely recruited from inside the investment arbitration clique, to put an end to socially and environmentally harmful rulings. Not all bad arbitral rulings are legal errors. They are a predictable outcome of a system that empowers independent arbitrators to interpret highly protective investor rights in the absence of enforceable rights, or a meaningful voice, for other affected societal interests.

There is no compelling case for this elaborate and costly parallel legal system solely for foreign investors. As many observers have noted, the EU and Canada already provide high standards of investment protection though their respective domestic laws and court systems, without discrimination based on nationality.

Despite some adjustments, CETA’s substantive investor protection rights—which form the basis for claims that will be decided by the standing tribunal—are still problematic. Revised wording around vague provisions such as fair and equitable treatment (FET) tends simply to change arbitrators’ justification for their findings, without affecting outcomes.

The highly controversial Eco Oro v. Colombia decision against the state (related to restrictions on mining in environmentally sensitive wetland regions vital to Colombia’s freshwater) and the pending $20-billion Ruby River Capital v. Canada NAFTA case (contesting Quebec’s decision to reject a carbon-intensive LNG facility are good examples. In both cases, complainants and arbitrators have already adapted their way of speaking about alleged FET violations to reflect modernised provisions such as those in CETA, while still assailing lawful environmental protection measures.

The ICS is holding up CETA ratification

The Canada-EU investment “court” can be called a stranded asset for a second, perhaps more superficial reason: it may be institutionally unworkable in Europe. CETA has so far been ratified by 17 of the 27 EU member states (excluding the United Kingdom) present at the signing of the treaty in 2016. The remaining 10 holdout nations must follow suit before the ICS can be implemented.

Opposition to ISDS remains high across Europe—notably in France, where the government has yet to introduce CETA ratifying legislation in the senate. Removing CETA’s unneeded and unpopular ISDS system would be the progressive and more environmentally responsible thing to do. It might also help the European Commission put the awkwardness of provisional application behind it, although there is no legal reason preventing CETA from being “provisionally applied” indefinitely.

Unfortunately, Canada and the Commission seem intent on getting the ICS up and running as soon as possible, whatever the costs to climate policy or a united EU trade policy. Leaked EU documents show officials have just agreed to (inadequately) clarify some of CETA’s substantive investment protections as a condition of Germany ratifying the deal, which it did this summer.

On September 21, German groups Powershift and the Munich Environmental Institute released the classified consolidated text of a CETA Joint Committee decision meant to clarify how the agreement’s investment chapter provisions on fair and equitable treatment (Art. 8.10) and indirect expropriation (Art. 8.12 & Annex 8-A) should be interpreted by future Investment Court System tribunals.

The document, which is dated July 17, 2023, also includes short sections purporting to reaffirm the CETA parties’ right to regulate for environmental and public security reasons. The German NGOs describe the effort as “de facto worthless,” based on a new legal opinion that finds the revised final Joint Committee decision will have no legally binding effect on ICL “judges” and is less protective of climate policy than an earlier, also critiqued version.

“It has already been shown in arbitration proceedings in the field of investment protection, that even explicit treaty language does not offer sufficient protection in limiting the arbitrators' scope for interpretation,” says an English translation of the legal opinion obtained by the CCPA (a German summary of the opinion is here). “Moreover, a mere interpretation of the existing treaty text is not capable of reversing the fundamental regulatory concept of the agreement. The agreement fundamentally protects all investments, regardless of their impact on sustainable development.”

Two years ago, Germany’s coalition government decided it would ratify CETA as long as the Joint Committee had first issued a binding decision on FET and expropriation, as foreseen by Art. 26.1.5(e) of the agreement. The German Greens within the governing coalition were particularly concerned that nothing in CETA should allow ISDS cases to be brought against the EU, Germany or other European states for measures designed to meet environmental obligations such as the greenhouse gas reduction targets of the 2015 Paris Agreement.

In August 2022, the German Ministry of Economic Affairs and Climate Action announced it had negotiated a text with the European Commission that would “further specify” the investment protection rules. German and Canadian civil society groups, including the CCPA, issued a statement condemning the process and reiterating “that establishing a parallel justice system for corporations” in the ICS “is fundamentally against the public interest.” A non-paper containing the proposal was released in September.

When the Commission took up this German document as a basis for negotiations with Canada on a CETA Joint Committee decision, Germany’s cabinet tabled CETA ratifying legislation. Despite the continued opposition to CETA in Germany, the Bundestag (akin to Canada’s House of Commons) voted to ratify CETA in December 2022—even though Canada-EU negotiations on the interpretive statement had barely begun by that point. Germany notified the Council in August this year that its CETA ratification procedures were complete.

“The fact that MPs agreed to a free trade agreement on the basis of a document that they could not have been aware of and that subsequently turns out to be completely ineffective is a real scandal,” says Ludwig Essig, a trade expert at the Munich Environmental Institute (translated from the German press release). “An additional declaration cannot turn an outdated and climate-damaging agreement into a modern instrument of trade policy.”

The Council of the European Union is expected to discuss and approve the CETA Joint Committee decision at the end of November. The decision-making process in Canada is less clear but may entail federal consultations with provincial and territorial governments before a final sign-off from the federal trade minister. Once these internal checks by the CETA parties are complete, the Joint Committee is free to incorporate the decision into the trade agreement. This step could be announced at a planned committee meeting in early 2024.

The ICS is out of step with the times

The third and final reason we can call CETA’s investment “court” a stranded asset is that in the face of a rapidly escalating climate crisis the legitimacy of ISDS is even shakier than it already was when the former Conservative government launched CETA negotiations in 2009—and especially when the current Liberal government concluded an agreement in 2016.

In 2018, Canada agreed to U.S. demands to strip ISDS out of the renegotiated NAFTA (now the Canada-U.S.-Mexico Agreement, or CUSMA), at least between the two countries. The renegotiated agreement also significantly curtailed ISDS between the U.S. and Mexico. Incidentally, Canada proposed a version of the ICS during the CUSMA talks but both the U.S. and Mexico rejected it.

The Biden administration has so far spurned new bilateral investment treaties or free trade deals containing ISDS, while prominent Democrats are campaigning to terminate or renegotiate older treaties. This cements a bipartisan shift in U.S. trade and investment promotion policy away from ISDS.

The political backlash against ISDS in Europe that is holding up CETA ratification also resulted, in 2023, in the EU announcing its intent to withdraw from the Energy Charter Treaty—the world’s most litigated investment treaty—on the basis that it was incompatible with member states’ commitments under the Paris climate accords. Such political controversy will make it difficult for the EU to assume the former role of the U.S. as the lead global champion of a “reformed” ISDS regime.

Canada is a lonely believer in the EU’s vision to internationalize the ICS concept into a multinational investment court, or MIC. The recently released text of a modernized Canada-Ukraine Free Trade Agreement includes a section in the investment chapter (Art. 17.40) committing both countries to consider replacing the treaty’s ISDS system with “a First Instance Investment Tribunal or an Appellate Mechanism” (aka the MIC) if such a thing “is developed under other institutional arrangements and is open to the Parties for acceptance.”

This is unlikely to happen soon, if ever. Many developing countries are keenly aware of the policy and financial risks of ISDS as well as the hypocrisy of developed countries seeking to impose it (or some version of it such as the ICS) on them while turning away from treaty-based arbitration among themselves. The MIC concept is rejected by both international ENGOs and labour unions and a large section of the traditional ISDS industry, though for very different reasons.

Far from resolving the controversy around ISDS or persuading other trading partners of its value, the delayed application of CETA’s investment “court” simply kicked the political conflict over ISDS down the road.

Drop the ICS and move on

Without addressing the imbalances in CETA’s substantive investor rights, implementing a standing roster of arbitrators and creating an appellate mechanism would only further institutionalize a flawed ISDS system. It would legitimize and entrench investor-state arbitration when it is most embattled and vulnerable to more decisive reform and/or rejection.

Incredibly, Canada and the Commission are also considering a Belgian proposal that would expand the scope for ISDS cases under CETA by creating an expedited and even subsidized arbitration system for small and medium-sized enterprises (SMEs). From the documents we have seen, the discussions are based on a section of Canada’s 2021 model investment treaty on expedited arbitration (also already built into the Canada-Ukraine FTA) and recent additions to the ICSID Arbitration Rules. Additionally, Canada and the EU are discussing how SMEs might have a portion of their arbitrator’s fees covered when “small” claims (under $10 million) are successful.

The concern in Belgium is for procedural fairness, since it is easier for deep-pocketed multinationals to bring ISDS cases forward than smaller firms and investors. Helping SMEs get over this hurdle, however, will only increase the use of ISDS to settle disputes that should appropriately be handled by administrative or judicial bodies in Canada and the EU.

We should hope that these efforts falter and that clearer heads prevail in Ottawa, Brussels, and EU member state capitals. Canada and the EU never needed a special court to hear complaints from privileged foreign investors. Neither the original ICS nor subsequent reforms change this fact. The best course of action is for Canada and the EU to remove the ICS from CETA or let it sit in limbo in perpetuity.

Topics addressed in this article

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