Introduction
Among the more uncomfortable ironies of the international investment law system is that measures designed to protect the environment — among the most urgent collective imperatives of our time — are increasingly becoming the basis for billion-dollar arbitration claims by foreign investors against the very states that enacted them. The mechanism is investor-state dispute settlement (ISDS), embedded in thousands of bilateral investment treaties (BITs) and multilateral investment agreements, and it has become a flashpoint in the broader ESG debate.
The tension is structural rather than accidental. Investment treaties were designed to protect foreign investors against arbitrary or discriminatory state action. Environmental regulation, by its nature, restricts economic activity — it shuts down coal mines, cancels exploration licenses, imposes carbon costs, and phases out fossil fuel subsidies. When these restrictions apply to assets held by foreign investors, those investors have the option of reframing legitimate regulatory action as a breach of their treaty-protected rights: the fair and equitable treatment standard, the prohibition on indirect expropriation, and the full protection and security obligation. The financial exposure for states can be enormous.
Legal Framework
The substantive treaty protections most commonly invoked in environment-related investment claims are three.
The fair and equitable treatment (FET) standard, present in virtually every modern BIT, has been interpreted by numerous tribunals to protect investor expectations of a stable and predictable regulatory environment. When a state changes its renewable energy subsidy regime — as Spain, Czech Republic, and Italy famously did after the 2008 financial crisis — investors who had committed capital in reliance on those subsidies claimed that the regulatory reversal breached FET. Dozens of claims were filed under the Energy Charter Treaty (ECT), generating awards running into the hundreds of millions of euros.
Indirect expropriation, the second major standard, applies where a regulatory measure, without formal transfer of title, substantially deprives an investor of the economic value of its investment. Environmental regulations that effectively render a project unviable — a mining prohibition over an ecologically sensitive zone, for example, or a coastal construction ban applied retrospectively — can constitute indirect expropriation if they are sufficiently severe and targeted.
The general exceptions clause, modelled on GATT Article XX, appears in newer generation treaties and allows states to justify regulatory measures taken for environmental protection or sustainable development purposes. However, not all treaties contain such clauses, and their scope of application remains contested in arbitral jurisprudence.
India’s BIT regime has undergone significant revision. Following an adverse award in White Industries Australia Ltd v. Republic of India and the avalanche of renewable energy-related claims that followed India’s retrospective tax measures, India terminated most of its first-generation BITs and launched a new Model BIT in 2016. The 2016 Model BIT substantially curtails investor protections — removing FET as an independent standard, narrowing the expropriation definition, and excluding taxation measures from the treaty’s scope. India has since been negotiating new BITs on this model, though progress has been slow.
Judicial and Arbitral Developments
The most significant recent development in the environment-ISDS intersection is the ECT reform saga. The ECT, originally designed to integrate post-Soviet energy markets into the global investment system, became the primary vehicle for fossil fuel investor claims against European states phasing out coal, gas, and oil under their climate commitments. By 2023, over 150 claims had been filed under the ECT, many by fossil fuel companies challenging subsidy removals or extraction bans.
The negotiations for ECT modernisation, aimed at aligning the treaty with the Paris Agreement, collapsed in 2024 after the European Union and its member states announced coordinated withdrawal from the treaty, concluding that modernisation had not gone far enough to insulate climate regulation from ISDS claims. Germany, France, Spain, the Netherlands, Poland, and eventually the UK formally notified withdrawal. This represents an extraordinary repudiation of an investment treaty by a bloc of developed economies, driven substantially by concern that ISDS was becoming an obstacle to the clean energy transition.
In Lone Pine Resources Inc. v. Canada, the investor challenged Quebec’s moratorium on hydraulic fracturing under NAFTA’s Chapter 11. The tribunal ultimately dismissed the claim after Canada withdrew its NAFTA participation and renegotiated under CUSMA (which eliminated ISDS for Canadian investors), but the underlying tension — between legitimate environmental regulation and investor protection claims — was starkly illustrated.
In RWE AG and RWE Eemshaven Holding II BV v. Kingdom of the Netherlands (ECT), a German energy company challenged the Netherlands’ legislative decision to phase out coal-fired power generation by 2030, claiming damages for the premature closure of its coal plant. The arbitration was still pending resolution as of early 2026, with the jurisdictional question of whether post-Brexit and post-withdrawal issues affected the claim creating additional complexity.
Contemporary Issues and Analysis
The core jurisprudential problem is the concept of regulatory chill — the risk that the prospect of ISDS claims causes governments to refrain from enacting necessary environmental regulation, or to water down such regulation, for fear of financial liability. Empirical evidence of regulatory chill is difficult to produce, since it operates through internal government decision-making that is rarely documented publicly. However, the internal Brazilian government documents leaked during the ECT withdrawal debate, showing civil servants recommending avoidance of certain environmental measures because of BIT exposure, provide a glimpse of the phenomenon in action.
The police powers doctrine is the counterargument deployed by states and academic critics of ISDS. Under this doctrine, bona fide, non-discriminatory regulatory measures enacted in the public interest — including environmental regulation — do not give rise to compensation obligations under international investment law. Some arbitral tribunals have embraced this doctrine robustly; others have applied it narrowly, finding indirect expropriation even in measures of clear environmental purpose where the investor had specific prior assurances about regulatory stability.
A second dimension concerns the democratic legitimacy argument. When an arbitral tribunal — composed of three private lawyers with no public accountability — overrides a democratically enacted environmental regulation and orders a sovereign state to pay hundreds of millions to a foreign corporation, it generates profound questions about the relationship between private investment adjudication and public regulatory sovereignty.
Comparative and International Perspective
The European Court of Justice’s decision in Slovak Republic v. Achmea BV (2018) held that intra-EU BIT arbitration clauses were incompatible with EU law, triggering a cascade of jurisdictional challenges to ECT and BIT claims brought by EU investors against EU member states. The impact on the architecture of investment arbitration in Europe has been enormous, with a large number of intra-EU claims being dismissed on jurisdictional grounds.
Brazil, notably, has never ratified investment agreements with ISDS clauses, relying instead on its domestic legal system and state-to-state dispute resolution mechanisms. Brazil’s approach has attracted renewed attention as an alternative model, particularly for developing economies that prioritise regulatory sovereignty.
Practical and Policy Implications
For India, the intersection of ESG and ISDS is particularly consequential. India’s climate transition plans involve substantial regulatory interventions — coal phase-down, renewable energy mandates, restrictions on single-use plastics, coastal development regulation. Foreign investors with existing coal or fossil fuel assets in India may have treaty-based claims if these regulatory changes affect their investments, depending on the BIT applicable to their investment.
India’s 2016 Model BIT provides significant insulation, but legacy BITs with more investor-protective provisions may still apply to older investments. A careful mapping of India’s treaty exposure to climate-related ISDS risk — conducted as an official government exercise — is urgently needed.
Suggestions and Reforms
States should systematically audit their BIT portfolios for climate-regulatory risk. New investment agreements should include robust carve-outs for environmental and climate measures, modelled on the provisions in the EU-Canada Comprehensive Economic and Trade Agreement (CETA), which explicitly exclude from the FET standard changes in law and regulation even if they disadvantage investor expectations.
The UNCITRAL Working Group III, which has been engaged in ISDS reform discussions since 2017, should accelerate work on a multilateral instrument that creates a standing investment court with an appellate mechanism, replacing ad hoc arbitration for investment disputes. A standing court would be better positioned to develop a coherent and predictable jurisprudence on the relationship between investment protection and environmental regulation — reducing the arbitrage potential that the current fragmented system enables.
Conclusion
The collision between ISDS and environmental regulation is not a problem that treaty text alone can resolve — it is a reflection of a deeper tension between the architecture of international investment law, designed in an era when regulatory stability was the paramount concern, and the demands of a climate emergency that requires regulatory dynamism. India has positioned itself ahead of the curve through its 2016 Model BIT reform. The global community is catching up, albeit with the urgency that the scale of the problem demands. Until a coherent multilateral framework emerges, states navigating the ESG-ISDS intersection will be doing so with imprecise tools, significant financial exposure, and the knowledge that the most consequential environmental decisions of this generation may be reviewed by private arbitrators with no mandate beyond the treaty text.
