European Yearbook of International Economic Law 2022 303128531X, 9783031285318

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20022

European Yearbook of International Economic Law 123

European Yearbook of International Economic Law Volume 13 Series Editors Jelena Bäumler, Lüneburg, Germany Christina Binder, Neubiberg, Germany Marc Bungenberg, Saarbrücken, Germany Markus Krajewski, Erlangen, Germany Giesela Rühl, Berlin, Germany Christian J. Tams, Glasgow, UK Jörg Philipp Terhechte, Lüneburg, Germany Andreas R. Ziegler, Lausanne, Switzerland Assistant Editor Judith Crämer, Lüneburg, Germany Advisory Editors Armin von Bogdandy, Heidelberg, Germany Thomas Cottier, Bern, Switzerland Mary Footer, Nottingham, UK Stefan Griller, Salzburg, Austria Armin Hatje, Hamburg, Germany Christoph Herrmann, Passau, Germany Meinhard Hilf, Hamburg, Germany Locknie Hsu, Singapore, Singapore William E. Kovacic, Washington, USA Gabrielle Marceau, Geneva, Switzerland Ernst-Ulrich Petersmann, Florence, Italy Hélène Ruiz Fabri, Luxembourg, Luxembourg Bruno Simma, München, Germany Rudolf Streinz, München, Germany Tania Voon, Melbourne, Australia

The European Yearbook of International Economic Law (EYIEL) is a Springerpublication in the field of International Economic Law (IEL), a field increasingly emancipating itself from Public International Law scholarship and evolving into a fully-fledged academic discipline in its own right. With the yearbook, editors and publisher make a significant contribution to the development of this “new” discipline and provide an international source of reference of the highest possible quality. The EYIEL covers all areas of IEL, in particular WTO Law, External Trade Law of major trading countries, important Regional Economic Integration agreements, International Competition Law, International Investment Regulation, International Monetary Law, International Intellectual Property Protection and International Tax Law. EYIEL publishes articles following a substantive review by the editors and external experts as appropriate. The editors have published extensively in the field of IEL and European Law alike. They are supported by an international Advisory Board consisting of established scholars of the highest reputation.

Jelena Bäumler • Christina Binder • Marc Bungenberg • Markus Krajewski • Giesela Rühl • Christian J. Tams • Jörg Philipp Terhechte • Andreas R. Ziegler Editors

European Yearbook of International Economic Law 2022

Editors Jelena Bäumler Leuphana University Lüneburg, Germany

Christina Binder Bundeswehr University Munich Neubiberg, Germany

Marc Bungenberg Saarland University Saarbrücken, Germany

Markus Krajewski University of Erlangen-Nuremberg Erlangen, Germany

Giesela Rühl Humboldt University Berlin, Germany

Christian J. Tams University of Glasgow Glasgow, UK

Jörg Philipp Terhechte Leuphana University Lüneburg, Germany

Andreas R. Ziegler Université de Lausanne Lausanne, Switzerland

ISSN 2364-8392 ISSN 2364-8406 (electronic) European Yearbook of International Economic Law ISBN 978-3-031-28531-8 ISBN 978-3-031-28532-5 (eBook) https://doi.org/10.1007/978-3-031-28532-5 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Editorial

When the editors of the European Yearbook for International Economic Law (EYIEL) published the open call for contributions for Volume 13 in December 2021, the world looked very different than it does today. The aggressive war launched by Russia against Ukraine on 24 February 2022 not only brought death and destruction to the citizens of Ukraine, but also fundamentally changed the political architecture in Europe and had profound ramifications on global commerce and investment. Assessing the impact of this war on international economic law and relations will be the subject of future editions of the EYIEL. Instead, the EYIEL 2022 focuses on a global crisis, which already existed before 2022 and will continue to shape lives across the globe even long after the war between Russia and Ukraine has ended: The climate change crisis. As shown in the latest report of the Intergovernmental Panel on Climate Change (IPCC) entitled “Climate Change 2022: Impacts, Adaptation, Vulnerability”1 human-induced climate change causes significant disruptions in nature affecting the lives of billions of people around the world. People and ecosystems least able to cope will face the most severe consequences. Heatwaves, droughts, and floods are increasing and occur simultaneously. They have exposed millions of people to acute food and water insecurity. The IPCC therefore calls for urgent, ambitious, and accelerated action to adapt to climate change and for rapid progress with regard to cutting greenhouse gas emissions. In light of these facts, Part I of the present EYIEL volume specifically assesses the impact of climate change on international economic law and vice versa. The contributions look at the role of international trade, finance and investment law as well as constitutional and civil law and other subfields of domestic and international law. All chapters approach their topic in light of the fundamental question how the law can contribute to climate change mitigation and adaptation, but also which

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Charter of the United Nations, 24 October 1945, 1 U.N.T.S. XVI (1945). v

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elements of the law actually stand in the way of effective actions against climate change. Traditionally, the EYIEL begins with a distinguished essay on a topic of general interest. This year’s focus reaches beyond the traditional realm of international economic law addressing climate change and constitutional law. Martin Eifert and Michael von Landenberg-Roberg contextualise the 2021 German Federal Constitutional Court’s climate change judgement within climate constitutionalism. They argue that climate change requires constitutional responses based on fundamental rights or environmental protection clauses contained in many domestic constitutions. In the opinion of the authors, climate change challenges to constitutional law arise due to climate protection’s dependence on scientific knowledge and international efforts as well as the need to take the time dimension into account. The two subsequent contributions analyse legal issues in the context of international climate change law, in particular the United Nations Framework Convention on Climate Change (UNFCCC). Nciko wa Nciko Arnold critically discusses the specific instrument of Nationally Determined Contributions (NDCs) and argues that expecting countries of the Global South to account for greenhouse gas emissions of transnational corporations in the same way as in the Global North contradicts the principle of common but differentiated responsibilities. Arnold suggests that TransNationally Determined Contributions (TNDCs) can provide an adequate solution to this challenge. Rainer Maria Baratti analyses the Green Climate Fund established by the Conference of Parties of the UNFCCC in 2010 and investigates the transformative role of this Fund in involving companies in the fight against climate change. In addition to addressing the institutional aspects, he assesses the Green Climate Fund with particular attention to the criticisms of indigenous peoples. One of the most controversial instruments to support the fight against climate change are trade barriers aiming at conditioning market access, in particular carbon border adjustment mechanisms (CBAM). Ilaria Espa and Kateryna Holzer assess the EU Commission’s CBAM proposal and explain how imports can be partially or fully excluded from the scope of application of this instrument. Based on this, they ask if the exclusion features could be overcome by opting for a carbon club approach. The authors also discuss which model of clubbing could be more appropriate with a view to foster mutual supportiveness between the multilateral trade and climate regimes. Still focusing on CBAM, Christian Riffel assesses the EU CBAM proposal on the basis of WTO law, in particular the GATT. He argues that although the proposed instrument would infringe Articles I:1 and II:1(b) of the GATT, it could be justified in principle. Riffel compares CBAM with alternative measures to prevent carbon leakage and proposes to revisit the interpretation of the chapeau of Article XX GATT and to reduce it to an arbitrariness test, because otherwise WTO Members may be forced to rely on the security exception of Article XXI GATT. Continuing with the discussion of trade law issues, Xinyan Zhao analyses the WTO Panel Report on US-Safeguard Measure on PV Products which seems to have clarified that WTO members should use safeguard measures to protect their environmental industries against unfair competition. After explaining the positive and negative impact of the Panel’s ruling on WTO members’ national strategies for

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promoting the use of clean energy, Zhao suggests a more comprehensive analytical framework balancing various sustainability elements to combat climate change. Moving from the multilateral trading system to bilateral agreements, Patrick Abel discusses the trade and climate action linkage in the EU-UK Trade and Co-operation Agreement (TCA). In the TCA, the parties agreed on innovative provisions on climate action unprecedented in the EU’s practice of free trade agreements. Abel compares the TCA to the designs of earlier EU free trade agreements (FTAs) and situates it within international climate change law. Based on this analysis, he suggests that the TCA may serve as a template for trade and climate action linkages in future EU FTAs. After climate change and trade law, the next two chapters address international investment law. Emily Webster and Myriam Gicquello focus on the Energy Charter Treaty (ECT) and discuss the impact of investor-state dispute settlement (ISDS) under the ECT on EU Member States in response to fossil fuel phase-outs and policies promoting investment in renewable energies. The authors argue that ISDS created significant barriers to the introduction of laws, regulations, and policies facilitating energy transition, but they also draw attention to the possibilities of investment treaty protection supporting policies attempting to scale up renewable energies. The ECT is also the topic of Mattia Colli Vignarelli’s contribution on making this treaty climate friendly. The author analyses the text of the “modernised” ECT with particular attention to the “flexibility mechanism” for the optional progressive carve out of fossil-fuel investments. Vignarelli argues that this mechanism would continue to ensure fossil-fuel investments protection at the crucial stage of energy transition. Therefore, the author also assesses a withdrawal of the EU and its Member States from the ECT. After the more “traditional” fields of trade and investment law and their impact on climate change policies, the next chapters turn to regulations applicable to private economic actors. Gudrun Zagel and Dieter Huber discuss how finance flows can be made consistent with the aims of the Paris Agreement and focus specifically on the EU banking sector and its regulatory framework. The authors discuss how activities, tasks, and mandates of the private banking sector, banking supervisory authorities, and central banks in the EU and the related regulatory framework may affect the achievement of the objectives of the Paris Agreement. Finally, Zagel and Huber propose measures the EU banking sector can undertake and identify necessary changes in EU legislation. In his contribution, Philip Förster assesses a very specific issue in the context of corporate sustainability reporting. He asks if the proposed so-called double materiality principle in the draft EU Corporate Sustainability Reporting Directive effectively tackles green washing. The materiality principle aims at streamlining company reports, focusing on the most relevant factors, and reducing information overload. The author concludes that the proposed new Article 19a of the EU Non-Financial Reporting Directive addresses the main challenges of non-financial reporting, i.e. information overload and greenwashing, but he also suggests that there is still a need for clarification of the details of the materiality principle.

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The next two chapters deal with the emerging trend of climate change litigation. Nikita Pattajoshi takes a critical look at shareholder-based climate change litigation in the Global South. She shows that the landscape of shareholder climate change litigation is very Global North centric, both quantitatively and qualitatively. There are hardly any climate change litigation cases against corporations brought by shareholders in a country of the Global South. Pattajoshi suggests that there is an opportunity of shareholder climate lawsuits in the Global South and she predicts that they will increase and positively influence the climate change litigation landscape, even if they are unsuccessful in terms of the judicial outcome. Turning to different actors, Astrid Iversen focuses on the potentials of climate change litigation against central banks and analyses how the protection of central banks under the laws of immunity can be overcome. Drawing on the example of a 2021 judgement of the Swedish Supreme Court, Iversen argues that far-reaching immunity is not only unreasonable when taking into consideration the original justification for central banks’ immunity but may also prompt a backlash against the immunity related to the core functions of central banks, namely monetary policy mandates. The last four chapters of EYIEL 13 are devoted to EU law instruments and their impact on climate change. Bernadette Zelger begins with a look at environmental and sustainability aspects in EU competition law. In particular, she asks if the approach under Article 101 Treaty on the Functioning of the European Union (TFEU) can be expanded and developed into a “more economic & ecological approach”. Zelger analyses the TFEU competition provisions and shows to what extent and on which basis environmental considerations and sustainability aspects can be taken account of within the current EU competition law framework. Julia Wallner and Emil Nigmatullin assess climate-related individual rights under EU secondary law following a climate change lawsuit in Austria in which the claimants tried to derive a right to require the issuing of an ordinance on fossil fuel sales bans from the EU Effort Sharing Regulation, which stipulates greenhouse gas emission reduction targets for EU Member States. The authors examine the existence of climate-related individual rights in EU secondary law and also discuss their limitations based on primary EU and international law. The EU Emission Trading System (ETS) has been praised as an efficient instrument to reduce GHG emissions and mitigate the consequences of global heating. Ina Frieling discusses the expansion and adjustment of this regime by EU Member States’ civil courts in climate litigation proceedings. She compares the 2021 Shell decision by The Hague District Court and the 2017 RWE decision of the Higher Regional Court of Hamm. The author asks how the EU ETS shapes the duty of care of companies with regard to climate change measures and how it can serve as a justification of an interference with the rights of others. Concluding the focus section on climate change, Concetta Maria Pontecorvo attempts a first assessment of the proposed EU Regulation on Trade in Forest-Risk Commodities (FRCs) aimed at reducing the EU’s global deforestation “footprint”. Notwithstanding some important limits and shortcomings in the Commission’s proposal, in particular relating to land tenure rights’ protection, Pontecorvo argues that the EU has a moral duty to avoid contributing to the global destruction and

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degradation of forests. However, the proposed regulation needs to be better aligned with WTO law. Part II of EYIEL 13 on “Current Challenges, Development and Events in European and International Economic Law” only contains one contribution. Frank Hoffmeister assesses the practice of the European Commission in the area of trade defence since 2014. Based on his experience and knowledge as an “insider”, Hoffmeister analyses how the Commission exercised its political discretion in the field of anti-dumping measures, countervailing duties and safeguards. He concludes that there was a progressive development of Commission practice, in particular in the field of anti-dumping measures and a dynamic interpretation of the law in the last 7 years. Most contributions to Part I of EYIEL 13 followed an open call for papers which not only ensured the high quality of the chapters but also led to more diversity in the group of authors. We are happy that authors from different regions of the world and at various stages of their academic or professional careers contributed to this volume and we hope that readers will appreciate the innovative and original approaches taken by the authors. Lüneburg, Germany Neubiberg, Germany Saarbrücken, Germany Erlangen, Germany Berlin, Germany Glasgow, UK Lüneburg, Germany Lausanne, Switzerland December 2022

Jelena Bäumler Christina Binder Marc Bungenberg Markus Krajewski Giesela Rühl Christian J. Tams Jörg Philipp Terhechte Andreas R. Ziegler

Reference IPCC (2022) Climate Change 2022: Impacts, adaptation and vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change [Pörtner H-O, Roberts DC, Tignor M, Poloczanska ES, Mintenbeck K, Alegría A, Craig M, Langsdorf S, Löschke S, Möller V, Okem A, Rama B (eds)]. Cambridge University Press, Cambridge. https://doi.org/10.1017/9781009325844

Contents

Part I

Climate Change & Liability

Climate Change Challenges Constitutional Law: Contextualising the German Federal Constitutional Courts Climate Jurisprudence Within Climate Constitutionalism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Martin Eifert and Michael von Landenberg-Roberg Trans-Nationally Determined Contributions for Climate Justice: Resolving a Paris Agreement’s Contradiction That Is Working Against Developing States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nciko wa Nciko The Green Climate Fund, Climate Change and Corporate Due Diligence: What Role for the Private Facility Sector? . . . . . . . . . . . . . . . Rainer Maria Baratti Market Access Conditionality and Border Carbon Adjustments . . . . . . Christian Riffel

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Removing Barriers to Climate Change Litigation: The Progressive Erosion of Central Banks’ Immunity . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 Astrid Iversen The WTO Panel Report on US-Safeguard Measure on PV Products: A Decisive Victory for the Fight Against Climate Change? . . . . . . . . . . . 175 Xinyan Zhao The Innovative Trade and Climate Action-Linkage in the EU-UK Trade and Cooperation Agreement: A Template for the EU’s New Approach to Green Trade Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Patrick Abel

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The Investment Treaty Regime and the Clean Energy Transition . . . . . 235 Myriam Gicquello and Emily Webster Making the Energy Charter Treaty Climate-Friendly: An (Almost) Impossible Leap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 Mattia Colli Vignarelli Making Finance Flows Consistent with the Aims of the Paris Agreement: Roles, Obligations, and Limitations of the EU Banking Sector and Its Regulatory and Supervisory Institutions . . . . . . . . . . . . . 295 Gudrun Zagel and Dieter Huber The Double Materiality Principle (Article 19a NFRD) as Proposed by the Corporate Sustainability Reporting Directive: An Effective Concept to Tackle Green Washing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345 Philip Förster Assessing the Climate of ‘Shareholder Based Climate Change Litigation’ in the Global South . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 365 Nikita Pattajoshi From Unilateral Border Carbon Adjustments to Cooperation in Climate Clubs: Rethinking Exclusion in Light of Trade and Climate Law Constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389 Ilaria Espa and Kateryna Holzer Environmental and Sustainability Aspects in EU Competition Law: Towards a “More Economic & Ecological Approach” Under Article 101 TFEU? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411 Bernadette Zelger Climate-Related Individual Rights Under EU Secondary Law and Limitations to Their Material Scope . . . . . . . . . . . . . . . . . . . . . . . . 443 Julia Wallner and Emil Nigmatullin Reducing GHG Emissions in a Constitutional Democracy: When EU Civil Courts Adjust the EU Emission Trading System . . . . . . 477 Ina Frieling The Proposed EU Regulation on Trade in Forest-Risk Commodities (FRCs): A First Assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507 Concetta Maria Pontecorvo Part II

Current Challenges, Development and Events in European and International Economic Law

Seven Years Inside the Trade Defence Machinery Room: How Political Is the European Commission? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543 Frank Hoffmeister

Part I

Climate Change & Liability

Climate Change Challenges Constitutional Law: Contextualising the German Federal Constitutional Courts Climate Jurisprudence Within Climate Constitutionalism Martin Eifert and Michael von Landenberg-Roberg Contents 1 Climate Change as a Challenge for Constitutional Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Types of Constitutional Provisions Relevant to Climate Protection . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Specific Climate Protection Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 General Environmental Protection Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Fundamental Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Constitution Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Constitutional Standard-Setting Against the Background of Climate Protection’s Special Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Climate Protection as a Global Challenge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Climate Protection as a Knowledge-Dependent Challenge . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Climate Protection as a Temporal Challenge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Climate Protection as an Institutional Challenge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Obligations to Protect Against Climate Change: Determination and Application of the Constitutional Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Constitutional Climate Protection Obligations Arising from General Environmental Protection Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Fundamental Rights Guarantees of Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Preserving Freedom on the Path to Climate-Neutrality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.1 The Inextricable Connection Between Present and Future Freedom . . . . . . . . . . . . . . . . . 5.2 Necessity to Protect Future Freedom at Present . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3 The Intertemporal Preservation of Freedom and Its Difficulties . . . . . . . . . . . . . . . . . . . . . . 6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract Climate change requires constitutional responses. The fundamental rights or environmental protection clauses contained in most constitutions provide a basis for this endeavour. The particular difficulties of determining the constitutionally required level of climate protection, climate protection’s dependence on scientific M. Eifert (✉) and M. von Landenberg-Roberg Humboldt-Universität zu Berlin, Faculty of Law, Berlin, Germany e-mail: [email protected]; [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 3–34, https://doi.org/10.1007/8165_2022_100, Published online: 24 December 2022

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M. Eifert and M. von Landenberg-Roberg

knowledge and international efforts, and the need to take the time dimension into account are specific challenges for any constitutional order. This article addresses these basic questions on constitutional law and presents the answers given by the Federal Constitutional Court in its landmark climate decision regarding the German Constitution.

1 Climate Change as a Challenge for Constitutional Law The existential threat to humankind and the environment caused by anthropogenic climate change poses particular challenges to constitutional law. As the basic legal order of a polity, modern constitutions are intended to secure a fundamental level of freedom and protection for the individual irrespective of current political majorities.1 Climate change and its consequences not only endanger people’s lives and health but also their freedom.2 In an environment that is becoming more and more hostile to human life due to increased global warming, rights to freedom are drying up into empty forms—either because of the hostile environment or because of late and desperate attempts to address climate change. If constitutions should preserve their function of protecting the necessary preconditions of exercising individual and collective freedom, they cannot remain neutral with climate change being the biggest threat to humankind in the twentyfirst century. The protection of the earth’s climate through the transformation to greenhouse gas (GHG) neutrality in time, as well as protection against the impacts of the already inevitable level of global warming through adaptation, must also be a normative imperative of the constitution, if only for reasons of the self-preservation of a dignified life and freedom.3 Freedom, however, must not only be constitutionally protected by the requirement of a profound and timely transformation process towards climate neutrality; it must also be guaranteed with respect to the transformation process as such. Climate protection must be implemented in a way that preserves freedom and human rights to the greatest possible extent.4 Constitutional law needs to reflect the dangers to civil liberties that climate protection obligations might entail. From the perspective of the protection of freedom, climate change thus poses two central challenges for constitutional law and its interpretation: First, the level of 1

For constitutions rooted in the liberal-democratic tradition see Grimm (1991), pp. 116–119. See Reder (2012), S. 66 f.; Ekardt (2014), pp. 192–198. 3 On the impact of the right to human dignity e.g. The Lahore High Court, Leghari v. Federation of Pakistan, Judgement of 25.1.2018, W.P. No. 25501/2015, pp. 10 f. 4 Emphasising the necessity of safeguarding human rights in mitigation and adaptation activities UNEP (2015), p. 26. The Paris Agreement also expressly recognizes in its preamble, that “Parties should, when taking action to address climate change, respect, promote and consider their respective obligations on human rights”. 2

Climate Change Challenges Constitutional Law: Contextualising the. . .

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protection required under constitutional law must be determined with regard to the tolerated extent of climate change. Second, freedom must be preserved to the greatest possible extent within this transformation process, and the burdens associated with the transformation process must be distributed equitably within and between generations. Overall, constitutional law should define cornerstones for the inevitable path to climate neutrality. The global challenge of climate change has triggered an international debate on the role of law and the courts.5 In this debate, the general issues related to the characteristics of climate change and climate change politics encounter specific (national) legal systems.6 This broadens understanding and allows for a range of arguments to emerge, but the particular constitutional answer remains dependent on the constitutional law in question. This article focuses on the role of constitutional law regarding climate change.7 It aims to contribute to the debate in two ways. Firstly, it identifies the basic constitutional questions that arise in most jurisdictions in the face of the challenge of climate protection, and secondly, it presents the German Federal Constitutional Court’s response to each of these basic questions as developed in its climate decision.8,9

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From the extensive literature see Posner (2007), p. 1925; Preston (2011), p. 3; Markell and Ruhl (2012), p. 15; Okubo (2013), p. 741; Peel and Osofsky (2015); Burger and Grundlach (2017); Setzer and Bangalore (2017), p. 175; Bouwer (2018), p. 347; Saurer (2018), p. 679; Graser (2019), p. 271; Burgers (2020), p. 55; Mitkidis and Valkanou (2020), p. 11; Setzer and Higham (2021); Peel and Markey-Towler (2021), p. 1484; Wagner (2021), p. 2256; Franzius (2021a), p. 121; Payandeh (2021), p. 64; Rodi and Kalis (2022), p. 5; de Vilchez Moragues (2022); Lange and Lippold (2022), p. 685; Fellenberg (2022), p. 913; Wegener (2022), p. 425; and further contributions in Kahl and Weller (2021). For a special focus on the post-Paris situation Wegener (2020), p. 17; Beauregard et al. (2021), p. 652; Preston (2021), p. 1; Saiger (2022). An instructive review of the research on courts and litigants in climate governance is provided by Setzer and Vanhala (2019), pp. 1–19; Peel and Osofsky (2020), pp. 22–26. 6 In particular, see articles in Alogna et al. (2021); Sindico and Mbengue (2021); Lin and Kysar (2022); and furthermore Vanhala (2013) p. 447; Peel and Lin (2019), p. 679; Setzer and Benjamin (2019), p. 77; Zhao et al. (2019), p. 349; Saiger (2020), pp. 51 ff.; Chaturvedi (2021), p. 1459; Torre-Schaub (2021), p. 1445; Voigt (2021), p. 697; Cameron and Weyman (2022), p. 195; Kotzé and Du Plessis (2022), p. 615. 7 For a broader notion of “constitutionalism” see the contributions in Jaria-Manzano and Borrás (2019) and Ghaleigh (2021), p. 445. 8 Bundesverfassungsgericht (Federal Constitutional Court), Order of the First Senate of 24 March 2021—1 BvR 2656/18, paras. 1–270 (hereafter cited as: BVerfG, Climate Decision). The decision is officially published in BVerfGE 157, pp. 30–177. A translation in English is available at http:// www.bverfg.de/e/rs20210324_1bvr265618en.html (last accessed 3 October 2022). 9 This decision has triggered a controversial debate in German literature. For rather critical views Calliess (2021b), p. 355; Fassbender (2021), p. 2085; Hofmann (2021), p. 1587; Kloepfer and Wiedmann (2021), p. 1333; Möllers and Weinberg (2021) p. 1069; Polzin (2021) p. 1089; Ladeur (2022), p. 13; Lenz (2022), p. 73; von Weschpfennig (2022), paras. 19–24; more ambivalent Buser (2021), p. 1409; Krämer-Hoppe (2021), p. 1393; Ekardt and Heß (2021), p. 579; Berkemann (2021), p. 701; Stark (2021), p. 237; Minnerop (2022), p. 135; Kirchhoff (2022), pp. 9–31; Volkmann (2022), p. 5; Winter (2022a), p. 209; differentiating Kahl (2022a), p. 2; Franzius (2021b), p. 136; for a decidedly positive evaluation Eifert (2021a), p. 1085; Schlacke (2021),

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2 Types of Constitutional Provisions Relevant to Climate Protection The starting point of all consideration must be the constitution itself. If the state’s obligation to protect the Earth’s climate should not only be an ethical postulate but a juridical constitutional requirement, climate protection must be anchored in the text of the constitution. Climate protection can be explicitly required in the constitutional text itself or can be inferred from it by way of interpretation. A textual basis can be found in special environmental protection clauses as well as in fundamental rights provisions.

2.1

Specific Climate Protection Clauses

To date, only few constitutional texts explicitly mention climate protection. However, climate protection is expressly incorporated in the preamble or the main text of eleven constitutions worldwide, mostly more recent ones from Latin America, Africa and Asia.10 The form and content of the provisions differ considerably. Only rarely has the state been made so explicitly responsible as, for instance, in the Constitution of Ecuador, where the state is obliged to “adopt adequate and crosscutting measures for the mitigation of climate change, by limiting greenhouse gas emissions, deforestation, and air pollution” and “to protect the population at risk”.11 More commonly, general commitments to climate protection without a specific duty or the formulation of respective expectations with uncertain legal implications can be found.12

2.2

General Environmental Protection Clauses

Insofar as constitutional texts do not expressly contain a climate protection provision, as is particularly the case in Europe and North America, it can also be convincingly derived from general environmental protection clauses. These can be found as general constitutional provisions or right guarantees for a healthy

p. 912; Sinder (2021), p. 1078; Wahnschaffe and Lücke (2021), p. 1099; Aust (2022), p. 150; von Landenberg-Roberg (2022), pp. 269–276. Defending the decision against points of criticism that were regularly voiced Eifert (2022b), pp. 542–545. 10 According to Ghaleigh et al. (2022), p. 7, these include: Algeria, Bolivia, Côte d’Ivoire, Cuba, Dominican Republic, Ecuador, Thailand, Tunisia, Venezuela, Vietnam and Zambia. 11 Art. 414 of the Constitution of the Republic of Ecuador. 12 For a more detailed account, see Ghaleigh et al. (2022), p. 9; May and Daly (2019), pp. 235 ff.

Climate Change Challenges Constitutional Law: Contextualising the. . .

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environment in more than 150 constitutional documents worldwide.13 Here, too, the range in wording, normative content, density of regulation and enforceability in court is considerable.14 However, it is hard to imagine that the protection of the environment, regardless how the provision is formulated (for instance protection of a “healthy environment” or “natural basis of life”), does not include the global climate as part of its most basic conditions. These form a basis for the state’s obligation to protect the climate.

2.3

Fundamental Rights

Constitutional requirements for climate protection measures can also be derived from fundamental rights which are enshrined in most constitutions. Due to the extraordinary risks of unrestrained climate change, the fundamental rights to life, health and property are at the centre of the discussion.15 However, the effects of climate change on the undisturbed exercise of civil liberties have also been recognized and discussed from an early stage.16 Since greenhouse gases are predominantly emitted by private parties, fundamental rights as traditional limitations to state action do not offer any protection. Climate protection obligations can only be derived from fundamental rights to the extent that positive obligations are acknowledged. However, particularly with regard to the right to life and physical integrity, a fundamental duty of the state to protect against dangers from third parties or natural events is widely recognized.17 Protection against the impacts of climate change on life and health represents merely a specification of this obligation which in turn requires measures to mitigate climate change. In the constitutional assessment of climate protection measures, fundamental rights maintain their traditional role by ensuring the proportionality of obligations imposed and the equality of its distribution among different groups. What is new here is the question of whether this task also extends to the temporal dimension.

13

UNEP, Environmental Rule of Law, First Global Report, 2017, p. 2, 154–161; Lewis (2018), pp. 43–55; Gross (2021), p. 83. 14 For an instructive overview see Boyd (2015), pp. 171–186. 15 Jaimes (2015), pp. 170–181; Lewis (2018), pp. 157–165; Bickenbach (2020), p. 170; However, other fundamental rights can also be affected such as the right to private life, family and home or, especially in cases involving indigenous communities, rights concerning the preservation of culture (cf. UN HR Committee, Daniel Billy et al. v. Australia, CCPR/C/135/D/3624/2019). Kahl (2022b) observes that in absence of independent rights to climate protection the normative allocation of climate change-related human rights impacts are arbitrary. 16 See McInerney-Lankford et al. (2011), pp. 18 f. 17 Birchler (2020), pp. 192–202; Braig and Ehlers-Hofherr (2020), p. 591.

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Constitution Matters

It has become obvious that most constitutions contain provisions that could serve as a basis for climate change commitments, and that fundamental rights at least have some influence on climate protection measures. The constitution matters when it comes to climate change and so does the design of the applicable provisions. Climate protection clauses and environmental protection clauses can protect the climate regardless of its impact on human health and life. They may go beyond anthropocentric protection. Fundamental rights are generally tied to human beings. Furthermore, fundamental rights offer protection (only) against the impact of climate change on, inter alia, health and life. Thus, at least in the mid-term, and in some regions even in the long-term, climate adaptation measures that mitigate these impacts are equivalent to climate mitigation measures. Provisions may also differ with respect to access to courts.18 General clauses may only be constitutional goals or obligations that are not enforceable in court, whereas fundamental rights generally give individuals access to the courts.19 In the end, the more precise the constitutional obligations to protect the climate are, the better existing climate protection measures can be related to them and thus the burdensharing over time can be assessed in the light of fundamental rights.

3 Constitutional Standard-Setting Against the Background of Climate Protection’s Special Features Regardless of the type of constitutional provision that can be used to anchor a climate protection imperative in the respective national context, four central questions arise from the specifics of the climate protection challenge.

3.1

Climate Protection as a Global Challenge

The first challenge results from the global nature of anthropogenic climate change. This is caused by the cumulative effect of global emissions of greenhouse gases and 18 Burger and Grundlach (2017), pp. 28 f.; Payandeh (2021), para. 18; Kelleher (2022), pp. 108–110. 19 However, individual standing provisions might also be narrowly interpretated or applied. For instance, access to the CJEU is particularly restricted by its jurisprudence on individual standing. For a critique, see Winter (2022b), pp. 367 ff. See also the decision of the Swiss Supreme Court, Association of Swiss Senior Women for Climate Protection v. Federal Department of the Environment Transport, Energy and Communications, judgement of 20.5.2020, 1C_37/2019, where the court held that the plaintiffs’ asserted rights had not been affected with sufficient intensity. For a critical discussion see Reich (2020), pp. 501 ff.

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their associated increase in concentration in the atmosphere. Therefore, no state can stop global warming through national measures alone. Individual national contributions to the increase in greenhouse gas concentrations still differ considerably.20 However, even the complete transformation of the currently largest emitters to greenhouse gas neutrality would only slow down the global temperature rise, but not stop it in the long term. At the same time, due to the cumulative effect of greenhouse gas emissions, no country’s emissions are so insignificant that its reductions would not contribute to solving the problem.21 No country could therefore fundamentally refuse to make the long-term transition to a GHG-neutral economy, in view of its currently small percentage share in causing the increase of GHG concentrations in the atmosphere or because other countries are still willing to increase their greenhouse gas emissions.22 If this were to happen, it would seriously undermine the necessary momentum in international negotiations. The operationalisation of constitutional climate protection requirements must therefore be adjusted to the basic structure of the atmosphere as a “global common”23 and climate protection as a problem of collective action.24 Due to the limited power of individual state action in climate issues, the formulation of constitutional obligations can only be carried out with special consideration of the international context of action. National constitutional law therefore has the task of activating state action to solve problems at the international level and of embedding national climate policy in the international climate protection regime as a crucial framework for global coordination.

3.2

Climate Protection as a Knowledge-Dependent Challenge

The second challenge is the various scientific uncertainties that exist regarding climate change and its appropriate mitigation. There is no longer any scientific disagreement that anthropogenic greenhouse gas emissions are causing current global warming.25 However, with regard to complex interactions within the climate system, the exact consequences of a certain increase of the global average temperature can still only be predicted abstractly at best. The same applies to the questions of when and where such consequences are to be expected. Even on the issue of 20

Data collected from the reported national GHG inventories can be accessed via https://di.unfccc. int/time_series. 21 See e.g. Rechtbank Den Haag, Urgenda v The Netherlands, Judgment of 24.06.2015, C/09/ 456689/HA ZA 13-1396, paras. 4.79 and 4.90; Hoge Raad of the Netherlands, Urgenda v The Netherlands, Judgment of 20.12.2019, 19/00135, no. 5.7.8. 22 See Supreme Court of United States, Massachusetts et al. v. Environmental Protection Agency, Judgement of 2.4.2007, 549 U.S. 497 (2007), p. 23. 23 Edenhofer et al. (2015), pp. 260 ff.; Stoll (2016), pp. 131–141. 24 IPCC (2014), p. 17. 25 IPCC (2021), p. 5.

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causation, the seemingly simple relationship between human greenhouse gas emissions, the increase in GHG concentrations in the atmosphere and the rise in average temperature may lose its linearity and thus its predictability once certain tipping points are reached.26 For the same reason, the ecological consequences of reaching a particular temperature threshold can only be roughly predicted with varying degrees of probability, even though scientific projections on the danger of exceeding the 1.5 ° C threshold in particular have become increasingly substantiated and consolidated over time.27 Constitutional climate protection requirements must therefore align normative specifications with scientific evidence without petrifying current states of scientific knowledge into normative provisions too hastily. Therefore, a sufficiently flexible link between constitutional law and scientific knowledge is required. In this context, a science-oriented specification of the climate protection imperative must avoid disguising genuine normative issues as scientific questions. In particular, the question of the acceptable level of risk cannot be passed off as a question of pure scientific knowledge.

3.3

Climate Protection as a Temporal Challenge

The third challenge is the temporal dimension of climate change.28 The current level of global greenhouse gas emissions and the associated increase in greenhouse gas concentrations determines the timeframe remaining for society to transition to climate neutrality if global temperatures are not to rise above a certain threshold. This time frame must be brought into line with that required for a successful transformation. Government climate policy must therefore, on the one hand, radically decelerate the consumption of the remaining total emission budget by reducing emissions. On the other hand, it must sufficiently accelerate the necessary structural transformation processes in the economy and society through appropriate regulations, knowledge-generating measures and the promotion of innovation.29 The main political challenge here is that an enormous reduction and transformation efforts must be made at a time when the catastrophic impacts of global warming are just becoming apparent. The transformation to a net-zero emission society is a necessarily long-term process whose start can no longer be postponed without significantly increasing the already considerable burdens of transformation and shifting them into the future. As a rule, however, the future or long-term interests that are central here remain systematically underrepresented in the democratic

26

IPCC (2021), pp. 630–635. IPCC (2018), pp. 7–11. 28 Pahl et al. (2014), p. 376; Eifert (2022a), p. 75. 29 von Landenberg-Roberg (2022), p. 280. 27

Climate Change Challenges Constitutional Law: Contextualising the. . .

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process because its legitimation cycles are structured by short-term election periods.30 Constitutional requirements for climate protection must call for timely political action and also develop normative safeguards with regard to the temporal distribution of transformation burdens. Without timely initiation of the transformation, stabilization of the Earth’s temperature at a tolerable level and effective health protection are unlikely, and a one-sided shift of then outsized burdens of transformation to future generations is likely.

3.4

Climate Protection as an Institutional Challenge

If the temporal dimension of climate change and the systematic underrepresentation of long-term interests in the political process imply that constitutional law is legitimately intended to oblige the legislature to protect the climate, the relationship between the legislature and (constitutional) courts in specifying this obligation becomes of central importance.31 On the one hand, courts are needed to remedy the short-sighted neglect of timely climate protection; on the other hand, the design of the path to climate neutrality involves numerous trade-offs and prioritization and distribution issues, so that it is also necessarily a political process.32 Striking the balance is very difficult and must be embedded in the respective constitutional separation of powers.33 The task of constitutional interpretation is therefore to specify climate protection obligation in a way that assigns the overall responsibility for the concrete design of the transformation path to climate neutrality to the legislature.34 It can only be entrusted to a parliament to make the manifold weighing, prioritising and burdendistributing decisions that inevitably go hand in hand with the implementation of the transformative process to climate neutrality. This is because only the legislative process is capable of balancing all the interests affected and providing a public forum to politicise and debate the fundamental strategic choices.

30

Steinberg (1998), pp. 335 ff.; Franzius (2021a), pp. 140–142. See also High Court of New Zealand, Thomson v. The Minister for Climate Change Issues, Judgment of 2.11.2017, CIV 2015-485-919 [2017] NZHC 733, paras. 133 f.; Cremer (2019), pp. 278 f.; Franzius (2021a), pp. 133 f. 32 Wegener (2019), p. 15. 33 See Franzius (2021a), pp. 133 f.; Payandeh (2021), pp. 76–80. 34 See also Gross (2019), p. 362. 31

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4 Obligations to Protect Against Climate Change: Determination and Application of the Constitutional Standard Although most constitutions can respond to climate change in some way, its characteristics make it difficult to derive constitutional requirements. This applies to the requirements from environmental protection clauses and to the requirements from fundamental rights. In the following, we will address the difficulties and present the Federal Constitutional Court’s response in its first leading climate change decision as an example. We will first address the obligation to climate protection and then the requirements for the transformation path. The German constitution does not contain an explicitly formulated climate protection clause. However, it provides for a general environmental protection clause in Article 20a Basic Law.35 In the absence of any specific right to a healthy environment, individual rights against the state to offer protection against climate change and its dangerous consequences could only be derived from general fundamental rights, in particular the right to life and health from Article 2 (2) of the Basic Law (GG).36 The Federal Constitutional Court uses both options—the general environmental protection clause (Sect. 4.1) and the right to life and health (Sect. 4.2)—to embed climate protection as a state obligation in the constitution.

4.1

Constitutional Climate Protection Obligations Arising from General Environmental Protection Clauses

Given the impact of the earth’s climate on almost all ecosystems, it is protected as a central component of the environment by a general environmental protection clause. This also applies to Article 20a of the Basic Law.37

According to Article 20a of the Basic Law, the state shall protect “mindful also of its responsibility towards future generations” the “natural foundations of life and animals by legislation and, in accordance with law and justice, by executive and judicial action, all within the framework of the constitutional order”. For an analysis of the provision, see Durner (2021), paras. 61–71; SchulzeFielitz (2015), paras. 23–54; with special regard to climate protection Gross (2009), pp. 366 f.; Härtel (2020), pp. 578 f. 36 Arguing for the introduction of a procedural fundamental right to environmental protection, Calliess (2021a), pp. 323 ff. 37 In Germany the global climate was recognised early on by constitutional jurisprudence as an object of protection under Article 20a of the Basic Law without any special reasoning. See BVerfGE 118, 79 (110 f.); 137, 350 (368 f. paras. 47, 378 para. 73); 155, 238 (278 para. 100). 35

Climate Change Challenges Constitutional Law: Contextualising the. . .

4.1.1

13

Normative Openness of a Climate Protection Obligation as an Initial Problem

However, deriving normative implications from such a general and open obligation requires a conceptual framework that translates highly complex climate change into manageable targets (Sect. 4.1.2) and enables the determination of a level of protection (Sect. 4.1.3).

4.1.2

Preserving a Temperature Threshold as the Core of Climate Protection

The global average temperature is a key parameter in climate science and can also serve as a point of reference for constitutional climate protection targets. It represents the complex processes of change in the Earth’s climate system and their likely effects in a simplified form. The obligation to climate protection can be translated into the aim of not exceeding a temperature threshold and has been used in this way by the Federal Constitutional Court.38 However, the determination of a temperature threshold is necessarily associated with further requirements. Because of the almost linear relationship between the increase in greenhouse gas concentrations in the atmosphere and the increase in the Earth’s temperature, further increase in greenhouse gas concentrations above a level corresponding to the temperature threshold must be prevented.39 It is therefore not only necessary to take measures to reduce greenhouse gas emissions. Rather, when the relevant temperature threshold is approached, the level of human greenhouse gas emissions must reach climate neutrality. A temperature threshold as core of the constitutional climate protection requirement thus includes the demand for a timely transition to greenhouse gas neutrality.40

4.1.3

Constitutionally Bound Prerogative of the Legislature to Determine the Relevant Temperature Threshold

Determining the temperature threshold at which global warming should be halted is the central issue for a specific constitutional climate protection requirement. Three potential points of reference are available for this purpose. The first option would be to draw directly on the findings of climate science. IPCC reports, in particular, could provide an essential point of reference.41 Based on

38

BVerfG, Climate Decision, para. 198. IPCC (2021), pp. 27–31. 40 BVerfG, Climate Decision, para. 198. 41 Hinting in this direction High Court of New Zealand, Thomson v. The Minister for Climate Change Issues, Judgment of 2.11.2017, CIV 2015-485-919 [2017] NZHC 733, para. 133. 39

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their forecasts of the anticipated effects of certain degrees of global warming, a temperature threshold could be determined, which, if exceeded, would threaten severe and incalculable consequences for humans and the environment. It could mark the constitutionally tolerable degree of global warming. However, scientific forecasts are still subject to considerable uncertainties. Secondly, any determination of a tolerable temperature threshold is accompanied by considerable questions of normative assessments. This applies in particular to the level of acceptable risk. Dealing with scientific uncertainty and assessing and weighing the risks to be taken is, however, first and foremost a task of the political process. Climate science findings and constitutional benchmarking should therefore not be short-circuited even when setting the relevant temperature threshold. The second option is to draw on normative decisions already found in the international climate protection regime. The temperature target contained in the Paris Agreement (PA) is obviously particularly suitable for this. The advantage would be that this temperature target already represents a deliberative decision of an international political process that has taken into account climate science findings and risk analyses as well as conflicting social and economic interests. The criticism of concealing the inescapable assessment and valuation dimension in dealing with climate science findings therefore does not apply to this approach. However, international law provisions like the temperature target in the Paris Agreement might only prove to be the lowest common denominator of the contracting parties. Direct adoption might also weaken international negotiation dynamics in the future. Furthermore, the notion of incorporating international law provisions without a legislative act of implementation does not fit easily in jurisdictions with a dualistic approach to international law obligations. This has been pointed out for the German constitution.42 Although national climate protection efforts will only be successful in the end if they are embedded in the international context, there is no reason to conclude that the state’s constitutional obligations should simply be short-circuited with the results it has achieved in the negotiation process at the international level. The disadvantages of the first two approaches are avoided if the specification of the constitutional temperature threshold is initially left to the prerogative of the legislature, while binding the exercise of this prerogative to limiting constitutional directives that reflect the specific challenges of climate change (see Sect. 3). This conception was chosen by the Federal Constitutional Court in its climate decision, invoking in particular the wording of Article 20a of the Basic Law. It explicitly assigns a central role to legislation in the protection of the natural foundations of life.43 When the legislature specifies the temperature threshold, two constitutional directives become central: Firstly, the legislator must be guided by the state of climate science.44 Its decision must be science-based. New and sufficiently

42

Kahl (2022a), p. 16; Schlacke (2021), p. 915. BVerfG, Climate Decision, para. 205; Britz (2022), pp. 827 f. 44 BVerfG, Climate Decision, para. 211. 43

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substantiated findings on the progression of global warming, its consequences and its manageability could therefore oblige the legislature to adjust the target. This would be subject to constitutional review.45 Secondly, the temperature target must be selected in such a way that it does not impede the search for a solution at the international level, but rather facilitates it. The legislature must therefore not set a temperature target that falls short of the ambition agreed upon at the international level. This approach involves the legislature in the specification of the constitutional climate protection requirement, without exempting it entirely from constitutional restraints. It allows for a flexible alignment of constitutional standard-setting with science and the international climate protection regime.46 It also takes into account the importance of the parliamentary decision-making process in public debate without ignoring its structural weaknesses concerning long-term responsibility. If such an approach is to lead to a general request for the legislature to determine a temperature threshold, it presupposes an existing fundamental provision by the national legislator to which further reference can be made. For Germany, the Federal Constitutional Court was able to refer to Section 1 Sentence 3 of the Federal Climate Change Act (Bundes-Klimaschutzgesetz—KSG).47 This cites the obligation under the Paris Agreement as the basis for the German Climate Protection Act. According to the Court, the temperature limit set is thus intended to serve as a basic orientation for climate protection measures and to specify the constitutional obligation. This interpretation is supported by the fact that this climate target is the internationally agreed temperature limit of Art. 2(1)(a) PA, which the legislator has deliberately and explicitly taken as a basis. Since the state can ultimately achieve the objective of slowing climate change only through international cooperation, the legislator, in adopting the temperature limit of Art. 2(1)(a) PA, has set the fundamental course of national climate protection law in a direction that allows the constitutional mandate for climate protection to be effectively embedded in an international framework.48 In reviewing this specification of the temperature target, the Court held that the legislator is “currently” operating “within the leeway to specify the law granted by Article 20a GG”, because the Paris Agreement was adopted “on the basis of scientific findings compiled in preparation for the Paris Climate Change

45

BVerfG, Climate Decision, para. 212. For a positive evaluation in this regard, see also Gärditz (2021), pp. 314 f. 47 § 1 Federal Climate Change Act reads: “The purpose of this Act is to provide protection from the effects of worldwide climate change by ensuring achievement of the national climate targets and compliance with the European targets. The ecological, social and economic impacts shall be taken into consideration. The basis of the Act is the obligation according to the Paris Agreement, under the United Nations Framework Convention on Climate Change, to limit the increase in the global average temperature to well below 2°C and, if possible, to 1.5°C, above the pre-industrial level so as to minimise the effects of worldwide climate change, as well as the commitment made by the Federal Republic of Germany at the United Nations Climate Action Summit in New York on 23 September 2019 to pursue the long-term goal of greenhouse gas neutrality by 2050.” 48 BVerfG, Climate Decision, para. 210. 46

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Conference”.49 Although the IPCC Special Report from 2018 on the impacts of global warming of 1.5 °C indicates that the climate-related risks for natural and human systems—especially the probability of crossing tipping points—are greater in a 2 °C warming scenario than in a 1.5 °C scenario,50 the Court found that in view of the explicitly stated ranges and uncertainties, Article 20a of the Basic Law still leaves the legislator with leeway to determine the climate goal in terms of how it evaluates the dangers and risks. The limits of this legislative leeway have not been violated, as the Court added, “at least not at present”.51 In sum, the temperature limit set out in the third sentence of Section 1 of the KSG, in accordance with the PA and scientific findings, is therefore currently the essential specification of the constitutional obligation under Article 20a of the Basic Law.52

4.1.4

Addressing the International Dimension and Advancing Knowledge

Setting a temperature target is not sufficient to establish constitutional requirements. While it includes a requirement for a (timely) transition to greenhouse gas neutrality (see Sect. 4.1.2), it does not relate the national contribution along this path to the contributions of other states. Nor does it define how to deal with scientific advances in climate science. Obligation to Participate in International Climate Protection Efforts Due to the global nature of the climate change challenge (see Sect. 3.1), a constitutional obligation to take climate action cannot be confined to the obligation to adopt national measures alone.53 It inherently has an international dimension from which the German Federal Constitutional Court has derived the obligation to engage internationally to tackle climate change at the global level and to promote climate protection measures within an international framework.54 However, climate protection does not become effective through agreements alone; it must also be implemented. The Court has therefore extended the constitutional obligation to take climate protection measures to the implementation of agreed solutions.55 Since all states depend on international cooperation to protect the climate, all states must avoid creating incentives for others to undermine that cooperation. This is all the more important as the Paris Agreement, with its core

49

BVerfG, Climate Decision, para. 211. IPCC (2018), pp. 5 f. 51 BVerfG, Climate Decision, para. 211. 52 BVerfG, Climate Decision, para. 213. 53 See also Schlacke (2022), p. 123. 54 BVerfG, Climate Decision, para. 201. 55 BVerfG, Climate Decision, para. 201. 50

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concept of nationally determined contributions (NDCs),56 very much relies on mutual trust. Creating and fostering trust in the willingness of the parties to achieve the target is key to the effectiveness of the current UN Climate Protection Regime in general. The Federal Constitutional Court has therefore particularly emphasised that every state should strengthen international confidence that ambitious climate action—particularly the pursuit of treaty-based climate targets—can be successful while safeguarding decent living conditions and fundamental freedoms.57 Commitment to National Climate Protection Independent of Success at the International Level The collective action problem of climate change definitely cannot be solved if constitutional climate protection obligations are made dependent on the success of international climate protection efforts. Rather, the problem can only be addressed if states cannot escape their shared responsibility simply by referring to greenhouse gas emissions in other states.58 Due to the causal contribution of even the smallest emission of GHGs, national climate action remains obligatory even if international cooperation cannot be legally fixed in an agreement. The Federal Constitutional Court has established the state’s obligation to protect the climate irrespective of any such agreement and stressed that the state must continue seeking opportunities to make national climate action efforts more effective within an international framework.59 Adaptation of Climate Policy to the Progress of Scientific Knowledge Climate protection is strongly linked to climate science. The temperature target (see Sect. 4.1.2), as well as national and international climate protection measures, must be dynamically aligned with scientific findings in order to provide effective protection. Both general environmental protection clauses and fundamental rights protection must take this into account. The Federal Constitutional Court has interpreted the environmental protection clause (Art. 20a GG) to place the legislator under a permanent obligation to adapt environmental and climate change law to the latest scientific findings.60 It has explicitly noted that in the event that the temperature target under Art. 2(1)(a) PA should prove insufficient to adequately prevent climate change, Art. 20a GG would oblige the state to reach a more stringent international agreement.61

56

Art. 4 (2) Paris Agreement. See further Bodle and Oberthür (2017), pp. 93 f.; Winkler (2017), pp. 146 f. 57 BVerfG, Climate Decision, para. 203. 58 See also Hoge Raad of the Netherlands, Urgenda v The Netherlands, Judgment of 20.12.2019, 19/00135, no. 5.7.7. 59 BVerfG, Climate Decision, para. 201. 60 BVerfG, Climate Decision, para. 212. 61 BVerfG, Climate Decision, para. 212.

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Constitutional Review by Applying the Temperature Target with Recourse to a Budget Approach

The remaining key challenge is if and to what extent such still general obligations translate into a specific GHG reduction contribution or even a reduction pathway. To translate temperature targets into emissions targets, climate science has developed what is referred to as the budget approach.62 Notwithstanding all remaining uncertainties, this approach allows in principle to determine a remaining global CO2 budget with regard to a certain temperature target in a comprehensible and reliable way.63 The budget approach can therefore be used as a potential guiding parameter for climate policy to comply with a temperature target. The total emissions perspective differs from legislature’s widespread use of GHG budgets to set reduction targets.64 The Federal Constitutional Court has referred to the residual budget approach as a scientific basis for a judicial review of the required level of climate protection.65 Remaining National Emission Budget as the Only Approximately Identifiable Parameter However, here too the global dimension (see Sect. 3.1) complicates the matter. While the determination of the remaining global CO2 budget for complying with the temperature target is essentially a question of climate science, its allocation among states is not. The determination of the remaining national budget depends in particular on questions of global equity. Since these issues also cannot be determined by national constitutional law, a residual national budget cannot be derived in purely scientific or constitutional terms. It can only be precisely determined at the price of ignoring scientific uncertainties and declaring the normative criterion of allocation as constitutionally prescribed. An appropriate use of this approach in the constitutional framework is therefore only possible as an “approximately identifiable” parameter, not as a fixed quantity.66

62 See, with further references, WBGU (2008), pp. 21–40; IPCC (2018), pp. 104–107; SRU (2020), pp. 5–58. 63 References to the budget approach have also been made in, among others, Hoge Raad of the Netherlands, Urgenda v The Netherlands, Judgment of 20.12.2019, 19/00135, no. 4.6, 7.4.3 and implicitly in The Supreme Court of Ireland, Friends of the Irish Environment v The Government of Ireland, Judgement of 31.7.2020, Appeal No 205/19, no. 4.6. 64 Examples are Germany and France. Such a use, however, enables courts to evaluate climate protection measures against the legislative budget targets (cf. Conseil dÉtat, Decision of 1.7.2021, 427301 (Grand-Synthe II)). 65 In the absence of alternative control variables, it is highly reasonable for the legislature to also take this approach, but it is not obliged by the constitution to do so (see BVerfG, Climate Decision, para. 218). The budget approach is therefore not constitutionalised, but only used in the context of necessary scientific controls. As long as there is no alternative, however, this boundary is blurred in practical applications. For a constitutionalisation of the budget approach argues Abel (2022), p. 336. 66 Clearly stated in BVerfG (Chamber), Decision of 18.1.2022, 1 BvR 1565/21, para. 5; Britz (2022), p. 832.

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Despite this restriction, the approach of a residual national CO2 budget allows for meaningful constitutional control of national climate policy against the benchmark of the temperature target. A two-step approach can be followed. The first step is to calculate a residual national budget by taking the residual global budget for the temperature target into question and selecting a hypothetical allocation criterion from a range of possible criteria or rather by defining a range that corresponds to plausible criteria. The range is determined by the criteria’s compatibility with the abstract constitutional climate protection principles, in particular the postulate that international cooperation based on mutual trust must be facilitated (see Sect. 4.1.4). The second step is to evaluate the national climate policy and its effect on emission reduction in the light of this residual national budget. Due to the above-mentioned uncertainties and evaluations involved in the definition of the national budget (or range), as well as in forecasts of future emissions, any judicial control along these lines is limited to obvious mismatches between the self-imposed target and the measures taken and needs to allow for legislative leeway. However, even such limited judicial control has proven to be meaningful in many areas of constitutional law. The German Federal Constitutional Court has taken this approach.67 As a starting point it took the national residual budget calculated by the German Advisory Council on the Environment (SRU). This was calculated based on per capita emission rights for the world’s population.68 The per capita distribution is not only a plausible and potentially mutual agreeable figure in the middle range of the broad spectrum of internationally discussed allocation keys,69 but it is also highly compatible with the common, but differentiated responsibility and respective capability principle as the main reference point under international law.70 Furthermore, it is in line with the constitutional requirement to participate in international efforts to solve the climate crisis in a way that enhances their success and the fact that the Paris Agreement on Climate Change is based on mutual trust and national contributions that are recognized by all parties as appropriate.71 The Court then addressed the uncertainties associated with this point of reference and the national temperature target. It explicitly acknowledged the uncertainties within the SRU budget calculations, potential increases of the budget due to international cooperation according to Article 6 of the Paris Agreement and negative emission technologies in the future. On the other hand, the Court has highlighted the not overly restrictive temperature threshold of 1.75 °C on which the calculations of the remaining national budget by the SRU were based. In light of these factors, the Court did not consider the emission paths of the Federal Climate Act to be currently in violation of the requirements of Article 20a GG, although it expressly stated that it

67

BVerfG, Climate Decision, para. 212. SRU (2020), pp. 5–58. 69 SRU (2020), pp. 15–20. 70 Voigt and Ferreira (2016), pp. 288–303; Rajamani and Guérin (2017), pp. 81–88. 71 For a more detailed analysis, see von Landenberg-Roberg (2021), pp. 124–139. 68

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does not seem certain that the residual budget would not be exceeded.72 It also noted that there is increasing evidence in the scientific community that, particularly in view of the danger of reaching tipping points, the 1.5 °C temperature limit should be targeted to avoid the most serious climate change impacts and that therefore the legislature might have to adjust its current emission paths in the future.73 Thus, it did not find a violation of the environmental protection clause, but clearly noted that the legislature was approaching doing so.

4.2

Fundamental Rights Guarantees of Protection

State obligations to protect the climate and to adapt to the adverse effects of climate change can also be derived from fundamental rights. This has been discussed early on in both human rights and constitutional literature and is now widely recognised.74 This stems from the state’s duty to protect fundamental rights and legal interests affected by climate change. With regard to the classic constitutional guarantees, health, life and property are particularly affected.

4.2.1

Combining Climate Protection and Adaptation

Focusing on the protection of health, life and property has two implications, also emphasised by the Federal Constitutional Court. Firstly, such a duty is anthropocentric from the outset. In contrast to the environmental protection clauses, here the prevention of climate change is not an ecological end in itself, but serves to prevent climate change-associated damage to humans. The violation of duties to protect given by fundamental rights can therefore not be derived directly from normative assumptions and conclusions relating to climate action. Although there is a great deal of overlap between climate protection and the protection of human life and physical integrity, they are not identical.75 Secondly, protection can also be ensured through adaptation measures. Instruments that do not mitigate climate change, but merely counter the resulting hazards (heat waves, floods, hurricanes, etc.) are also suitable for fulfilling the duty to protect. However, if global warming exceeds a certain level, especially reaching tipping points, climate dynamics may lead to a hazardous situation that can no longer

72

BVerfG, Climate Decision, paras. 230 f. BVerfG, Climate Decision, para. 212. 74 See only Brown (2008), pp. 195 ff.; Bodansky (2010), pp. 519–522; McInerney-Lankford et al. (2011), pp. 11 ff.; Jaimes (2015), pp. 165 ff.; Peel and Osofsky (2018), pp. 42 ff.; Gross (2021), pp. 84 ff.; for a detailed analysis with regard to the European Convention on Human Rights, Peters (2021), pp. 177 ff. 75 BVerfG, Climate Decision, para. 163. 73

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be managed by adaptation measures alone. In the long term, therefore, the imperative not to let climate change exceed a certain temperature threshold with manageable impacts and to ensure a timely transition to greenhouse neutrality also derives from fundamental rights.76 Conversely, even the most ambitious climate protection measures today cannot limit all negative consequences and dangers from climate change that is already taking place. Thus, in addition to ambitious climate protection policies, the state must take precautions today against the already unavoidable consequences of climate change.77 The obligations to protect require combining reduction and adaptation measures.78

4.2.2

International Component of the Duty to Protect

The duties to protect must take into account the global dimension of climate protection in the same way as the general environmental protection clauses (see Sect. 4.1.4). The fact that a nation state is dependent on international commitment for effective climate protection does not excuse it from a duty to protect,79 but supplements it with the obligation to additionally engage within international frameworks.80

4.2.3

Legislative Discretion and Limited Standard of Review

Obligations to protect are generally difficult to determine; this is also true for protection against the effects of climate change. This follows the general doctrines on obligations to protect and the corresponding applicable standard of judicial review. Since there are many different measures that could be taken, it is generally up to the legislature and not to the courts to decide how risks should be addressed, what a strategy should look like and how it should be implemented.81 In German constitutional law, the legislature is given a margin of appreciation and evaluation concerning the level of protection as well as leeway concerning the measures taken.82

76

BVerfG, Climate Decision, para. 157; Rechtbank Den Haag, Urgenda v. The Netherlands, Judgment of 24.6.2015, C/09/456689/HA ZA 13-1396, no. 4.75.; Hoge Raad of the Netherlands, Urgenda v. The Netherlands, Judgment of 20.12.2019, 19/00135, no. 7.5.2. 77 BVerfG, Climate Decision, para. 150. 78 See also UN HR Committee, Daniel Billy et al. v. Australia, CCPR/C/135/D/3624/2019, para. 8.3 with respect to Art. 6 ICCPR. 79 Rechtbank Den Haag, Urgenda v. The Netherlands, Judgment of 24.6.2015, C/09/456689/HA ZA 13-1396, no. 4.79; Gross (2020), pp. 340 f. 80 BVerfG, Climate Decision, para. 149. 81 BVerfG, Climate Decision, para. 152. 82 BVerfGE 96, 56 (64); BVerfG 121, 317 (356); BVerfG 142, 313 (337 para. 70).

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Correspondingly, the standard of judicial review leaves much deference to the legislature. The German Federal Constitutional Court will find a violation of a duty to protect only if no precautionary measures whatsoever have been taken, or if the adopted provisions and measures prove to be manifestly unsuitable or completely inadequate for achieving the required protection goal, or if the provisions and measures fall significantly short of the protection goal.83 According to this general doctrine, the Federal Constitutional Court concluded in the climate decision, that the Federal Climate Change Act 2019 did not constitute a completely unsuitable protection concept84 as it included a commitment to climate neutrality by 2050, a reduction target for 2030 of at least 55% compared to 1990, and the obligation to continue emission reductions beyond 2030. Supplemented by possible adaptation measures, this was also not considered to provide completely inadequate protection.85 In view of the forecast uncertainties, the level of protection aimed at with the specified temperature target was also within the legislature’s discretion, i.e. it did not fall significantly short of the protection target, “at least not presently”.86 The Court was therefore not (yet) prepared to establish a violation of the duty to protect in this specific case. From a comparative law perspective, however, it should be noted that the Federal Climate Protection Act 2019 is already a relatively ambitious and further developed climate protection law. It is worth emphasizing that the Court nevertheless derived some requirements from the duty to protect. In addition to requiring a combination of reduction and adaptation measures, it also required a limit on the total volume of greenhouse gases until greenhouse gas neutrality is achieved. Thus, the legislature must limit the total amount of emissions in a way that is consistent with an appropriate temperature target via annual budgeting or the establishment of continuous reduction targets.

5 Preserving Freedom on the Path to Climate-Neutrality Climate change policies regularly place some sort of burden on activities that involve GHG emissions to incentivize reductions and encourage the development of alternatives.87 Many of these activities are protected by fundamental rights, so interference with them must be justified. The justification of the measures follows the general rules that usually include some kind of proportionality test.88 The German constitution protects all types of activities and requires justification for every

83

BVerfGE 142, 313 (337 f. para. 70); BVerfG, Climate Decision, para. 152. BVerfG, Climate Decision, paras. 155 f. 85 BVerfG, Climate Decision, para. 157. 86 BVerfG, Climate Decision, para. 165. 87 See e.g. Bowen and Fankhauser (2017), pp. 123–135. 88 Bumke and Voßkuhle (2019), paras. 123–160. 84

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burdensome state action after a proportionality test, which focuses on whether the measure taken is suitable and necessary to achieve its goal and the interference is appropriate. This is standard constitutional standard procedure.89 The interesting point and innovative approach of the German Federal Constitutional Court concerns the time dimension of climate policy. The regular proportionality test is limited to the current intervention and its effects. It may cover future effects that are foreseeable direct consequences of the intervention but it does not extend beyond that. The Federal Constitutional Court has expanded the proportionality test as to include the relationship between current interventions on the one hand and future interventions that have not yet been specified but whose severity is required by constitutional law on the other hand.90 This extension aims to adapt the proportionality test to the special circumstances of climate policy, at least where it is subject to a constitutional obligation. The Court convincingly assumes that today’s measures are a decisive factor regarding the severity of future measures and that only by taking the latter into account when assessing today’s interventions can a burden shift into the future be prevented.91

5.1

The Inextricable Connection Between Present and Future Freedom

Climate protection must achieve climate neutrality before the threshold of acceptable temperature increase is exceeded. Since temperature rise depends directly on GHG emissions, especially carbon dioxide, this amounts to allocating a fixed remaining GHG budget over time. The path to climate neutrality can be represented as a curve of available GHG emissions over time that starts in the present at the current level of emissions and must end near zero before the remaining budget is exceeded. As with any fixed budget, you can only spend a tonne of GHG once. The more greenhouse gases are emitted in the near future, the fewer are available before climate neutrality must be achieved. The flatter the emissions curve is in the near future, the steeper it must fall afterwards.92 This fundamental relationship has significant constitutional implications because GHG emissions are closely linked to the exercise of freedom. Almost all activities today involve direct or indirect GHG emissions. Although in some areas the emitting processes may be completely replaced by carbon-neutral alternatives in the near future, many of them will involve at least some GHG emissions before the entire transformation to a climate neutral economy is achieved. Given this relationship, it is

89 Jackson (2015), p. 3095; Schlink (2012), p. 718; Barak (2012), p. 738; Kühling (2011), pp. 501–511. 90 BVerfG, Climate Decision, paras. 120, 192. 91 BVerfG, Climate Decision, paras. 192–194. 92 IPCC (2022), pp. 21–43.

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very plausible that the more stringent the GHG emission reduction requirements, the more freedom will be constrained. Therefore, the slope of the curve that represents the path to climate neutrality is also an indicator of the degree of endangered freedom. The flatter the emissions curve in the near future, the greater future freedom is threatened by the inherently even steeper curve in the future.

5.2

Necessity to Protect Future Freedom at Present

This inextricable connection between present and future freedom also means that future freedom must already be protected at present. If very stringent measures have to be taken later due to a high utilization of the remaining total budget in the near future, then they can then no longer be prevented. Since these stringent measures would be necessary to achieve the temperature target, they would be justified.93 This is mandatory if achieving the temperature target is itself constitutionally binding. It is equally compelling if the measures are necessary to fulfill constitutional obligations to protect human health or human life. In the view of the Federal Constitutional Court, both are the case in German constitutional law.94 However, in view of the elementary importance of climate protection for society as a whole and the particular weight of human health and life, it is difficult to imagine that the interventions would not be justified even without these constitutional obligations. They would then only not be legally mandatory to take.

5.3 5.3.1

The Intertemporal Preservation of Freedom and Its Difficulties Making the Future the Present

The Federal Constitutional Court has developed the “intertemporal preservation of freedom” as a constitutional answer to this problem.95 The doctrinal argumentation is explicitly based on the described connection between present and future freedom and is essentially as follows: because current GHG restrictions also determine the severity of future restrictions, they interfere not only with current freedom but also with future freedom. Even though the constraining measures on future freedom have yet to be determined by the state and are therefore not technically part of a current “impairment”, their severity is determined by current measures to such an extent that

93

Britz (2022), p. 832. BVerfG, Climate Decision, para. 187. 95 BVerfG, Climate Decision, paras. 116–123, 183. 94

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this effect in the future already corresponds to a current “impairment”. Consequently, this effect is treated as a current impairment and requires justification.96

5.3.2

Assessing Current Climate Protection Measures’ Future Impact on Freedom

Such a justification initially follows the usual pattern. German constitutional law doctrine requires that all impairments to fundamental rights must fully comply with constitutional law (known as the Elfes-Doktrin).97 This includes full compliance with requirements that cannot be enforced as such by individuals, such as the distribution of competences in the federal state or purely “objective” constitutional obligations like Art. 20a GG. Current climate protection measures that impair a fundamental right must therefore comply with the general environmental clause of Art. 20a GG and its climate protection requirements. This inhibits what would be completely inadequate measures, but does not necessarily include specifications on the temporal distribution of burdens.98 However, the time dimension is (also) addressed by the proportionality test. Because of the “impairment-like” effect of current measures, the legislature must also achieve an “intertemporal preservation of freedom” by maintaining temporal proportionality. Burdens must not be shifted so far into the future that future freedoms are necessarily unduly impaired because of the then remaining (too-small) GHG emissions budget.99 This proportionality test differs from the traditional one. It does not examine the relationship between the goal of an intervention on the one hand and the impairment of freedom on the other. The goal, climate protection, is indispensable because it is constitutionally required. What is examined is the distribution of the impairments over time, comparing the impairments of the current climate protection measures and the expected impairments (derived from the constraints of the remaining budget) in the subsequent period(s). This comparison is not trivial, though. It is easy to compare the available GHG emission budgets for different time periods—at least if national climate protection plans follow a budget-driven approach or allow a conversion to budgetconsumption. These problems are associated with deriving the required degree of freedom sacrifice from budget constraints. Transforming the economy into a net zero economy is a complex, non-linear process that depends on the pace and diffusion of crucial innovations, which are highly uncertain. It is plausible to assume that

96

BVerfG, Climate Decision, paras. 184–189. BVerfGE 6, 32 (41). For further discussion see Eifert (2021b), paras. 84 ff. 98 The German Federal Constitutional Court has also included a time dimension in the environmental protection clause. The obligation to sustainably protect the environment prevents its use in such a way that future generations can only preserve it at the price of radical abstinence of their own (BVerfG, Climate Decision, para. 193). 99 BVerfG, Climate Decision, paras. 192 ff., 243. 97

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excessively high short-term emission reduction targets will entail unreasonably high restrictions on freedom, since available innovations and replacement technologies will also require a certain amount of time to implement. It is also plausible to assume that substantial residual budgets will be needed in the final stages of the transformation process because processes that are particularly difficult to transform or replace will then be excluded. The difficulties of converting remaining budgets into expected impairment of liberty are such that this proportionality test will exclude only gross disproportions and obvious misallocations as a substantive test. In the case of the German Climate Protection Law at issue in the Federal Constitutional Court’s climate protection decision, the climate protection plan allowed such a high volume of GHG emissions until 2030 that (based on the expected level of GHG emission in 2030), the state’s underlying residual national budget would have been used up by the following year.100 Nevertheless, the German Constitutional Court did not assume an unconstitutional impairment of future freedom. It did, however, state that there was a danger that freedom would then be unreasonably restricted. This danger did not make the Climate Protection law unconstitutional in substance, but the Court required procedural safeguards to mitigate the danger.101

5.3.3

Procedural Safeguards to Internalize Future Effects and Trigger Innovations

Because the transformation process is so complex and depends on innovation, a long-term orientation regarding emission budgets for different sectors and industries is crucial. Only such a long-term orientation would allow for anticipation of future impacts, provide a basis for specific expectations and trigger investment and innovation in response to climate change. The German Federal Constitutional Court has called for such a long-term orientation as a guideline and incentive for timely planning and innovation.102 It demanded emission budgets, or at least the criteria for future emissions budgets, to be set by the legislature and continuously developed through 2030. The requirement of such an act of legislation is rooted in German constitutional dogma, which demands legislation on all issues of significant importance to fundamental rights, thereby ensuring a high level of legitimacy and public debate on these issues.103

100

BVerfG, Climate Decision, para. 246. BVerfG, Climate Decision, paras. 243 ff. 102 BVerfG, Climate Decision, paras. 252 ff. 103 Bumke and Voßkuhle (2019), paras. 1413–1440. 101

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6 Conclusion The particular challenges of climate change do not make it easy to translate the obvious need for climate protection into constitutional requirements. The Climate Change decision of the Federal Constitutional Court in Germany, however, is one plausible way to deal with them. It determines the climate protection target in a way that is sensitive to science and international law while respecting the prerogative of the legislature. It transforms the crucial time dimension of climate protection into constitutional requirements that, on the one hand, force legislators to extend their time horizon and chart a path to greenhouse gas neutrality, while, on the other hand, respecting the political nature of the many compromises that must be made along the way.

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Kahl V (2022b) Rising before sinking. VerfBlog, 3 October 2022. https://verfassungsblog.de/ rising-before-sinking/ Kahl W, Weller MP (eds) (2021) Climate change litigation, a handbook. Beck/Hart/Nomos, München/Oxford/Baden-Baden Kelleher O (2022) Systemic climate change litigation, standing rules and the Aarhus Convention: a purposive approach. J Environ Law 34(1):107–133 Kirchhoff G (2022) Intertemporale Freiheitssicherung. Mohr Siebeck, Tübingen Kloepfer M, Wiedmann JL (2021) Die Entscheidung des BVerfG zum Bundes-Klimaschutzgesetz. Deutsches Verwaltungsblatt 136(20):1333–1340 Kotzé LJ, Du Plessis A (2022) Putting Africa on the stand: a bird’s eye view of climate change litigation on the continent. Environ Law Rev 50(3):615–663 Krämer-Hoppe R (2021) The climate protection order of the Federal Constitutional Court of Germany and the North-South Divide. German Law J 22(8):1393–1408 Kühling J (2011) Fundamental rights. In: von Bogdandy A, Bast J (eds) Principles of European constitutional law, 2nd edn. Beck/Hart/Nomos, München/Oxford/Baden-Baden, pp 479–514 Ladeur KH (2022) Bundesverfassungsgericht und Klimaschutz: Kann das Verfassungsrecht Komplexität bewältigen? Recht und Politik 58(1):13–31 Lange F, Lippold M (2022) Höchstrichterliche Klimaentscheidungen und Demokratieprinzip – Eine rechtsvergleichende Betrachtung. JuristenZeitung 77(14):685–736 Lenz S (2022) Der Klimabeschluss des Bundesverfassungsgerichts – eine Dekonstruktion. Der Staat 61(1):73–111 Lewis B (2018) Environmental human rights and climate change: current status and future prospects. Springer Nature, Singapore Lin J, Kysar AD (eds) (2022) Climate change litigation in the Asia Pacific. Cambridge University Press, Cambridge Markell D, Ruhl JB (2012) An empirical assessment of climate change in the courts: a new jurisprudence or business as usual? Florida Law Rev 64(1):15–86 May J, Daly E (2019) Global climate constitutionalism and justice in the courts. In: Jaria-Manzano J, Borràs S (eds) Research handbook on global climate constitutionalism. Edward Elgar, Cheltenham McInerney-Lankford S, Darrow M, Rajamani L (2011) Human rights and climate change: a review of the international legal dimensions. The World Bank, Washington DC Minnerop P (2022) The ‘Advance Interference-Like Effect’ of climate targets: fundamental rights, intergenerational equity and the German Federal Constitutional Court. J Environ Law 34(1): 135–162 Mitkidis K, Valkanou TN (2020) Climate change litigation: trends, policy implications and the way forward. Transnatl Environ Law 9(1):11–16 Möllers C, Weinberg N (2021) Die Klimaschutzentscheidung des Bundesverfassungsgerichts. JuristenZeitung 76(22):1069–1078 Okubo N (2013) Climate change litigation: a global tendency. In: Ruppel OC, Roschmann C, Ruppel-Schlichting K (eds) Climate change: international law and global governance. Nomos, Baden-Baden, pp 741–758 Pahl S, Sheppard S, Boomsma C, Groves C (2014) Perception of time in relation to climate change. WIREs Clim Change 5:375–388 Payandeh M (2021) The role of courts in climate protection and the separation of powers. In: Kahl W, Weller MP (eds) Climate change litigation. Beck/Hart/Nomos, München/Oxford/ Baden-Baden, pp 62–80 Peel J, Lin J (2019) Transnational climate litigation: the contribution of the global south. Am J Int Law 113(4):679–726 Peel J, Markey-Towler R (2021) Recipe for success? Lessons for strategic climate litigation from the Sharma, Neubauer, and Shell Cases. German Law J 22(8):1484–1498 Peel J, Osofsky HM (2015) Climate change litigation: regulatory pathways to cleaner energy. Cambridge University Press, Cambridge

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Peel J, Osofsky HM (2018) A rights turn in climate change litigation? Transnatl Environ Law 7(1): 37–67 Peel J, Osofsky HM (2020) Climate change litigation. Annu Rev Law Soc Sci 16:21–38 Peters B (2021) Zur Anwendbarkeit der Europäischen Menschenrechtskonvention in Umwelt- und Klimaschutzfragen. Archiv des Völkerrechts 59(2):164–198 Polzin M (2021) Menschenrechtliche Klimaklagen: Kreative Justiz und überforderte Grundrechte. Die Öffentliche Verwaltung 74(24):1089–1099 Posner EA (2007) Climate change and international human rights litigation: a critical appraisal. Univ Pa Law Rev 155(6):1925–1945 Preston BJ (2011) Climate change litigation (Part 1). Carbon Clim Law Rev 5(1):3–14 and (Part 2) Carbon Clim Law Rev 5(2):244–263 Preston BJ (2021) The influence of the Paris Agreement on climate litigation: causation, corporate governance and catalyst (Part I). J Environ Law 33(1):1–32 and (Part II) J Environ Law 33(2): 227–225 Rajamani L, Guérin E (2017) Central concepts in the Paris Agreement and how they evolved. In: Klein D, Carazo MP, Doelle M, Bulmer J, Higham A (eds) The Paris Agreement on climate change. Analysis and commentary. Oxford University Press, Oxford, pp 74–90 Reder M (2012) Climate change and human rights. In: Edenhofer O, Wallacher J, Lotze-Campen H, Knopf B, Müller J (eds) Climate change, justice and sustainability. Springer, Heidelberg, pp 61–67 Reich J (2020) Kommentar zu Verfahrensrecht – Umweltschutz: Bundesgericht, I. öffentlichrechtliche Abteilung, 1C_37/2019, Urteil vom 5. Mai 2020. Schweizerisches Zentralblatt für Staats- und Verwaltungsrecht 121(9):489–507 Rodi M, Kalis M (2022) Klimaklagen als Instrument des Klimaschutzes. Klima und Recht 1(1):10 Saiger AJ (2020) Domestic courts and the Paris Agreement’s climate goals: the need for a comparative approach. Transnatl Environ Law 9(1):37–54 Saiger AJ (2022) Nationale Gerichte im Klimaschutzvölkerrecht: Eine rechtsvergleichende Untersuchung zum Pariser Übereinkommen. Nomos, Baden-Baden Saurer J (2018) Strukturen gerichtlicher Kontrolle im Klimaschutzrecht – Eine rechtsvergleichende Analyse. Zeitschrift für Umweltrecht 15(12):679–686 Schlacke S (2021) Klimaschutzrecht – Ein Grundrecht auf intertemporale Freiheitssicherung. Neue Zeitschrift für Verwaltungsrecht 40(13):912–917 Schlacke S (2022) Climate justice and responsibility– rethinking climate protection and constitutional requirements. In: Scholz I, Busse L, Fues T (eds) Transboundary cooperation and global governance for inclusive sustainable development, contributions in honour of Dirk Messner’s 60th Birthday. Nomos, Baden-Baden, pp 119–124 Schlink B (2012) Proportionality (1). In: Rosenfeld M, Sajó A (eds) The Oxford handbook of comparative constitutional law. Oxford University Press, Oxford, pp 718–737 Schulze-Fielitz W (2015) Kommentierung zu Art. 20a GG. In: Dreier H (ed) Grundgesetz Kommentar, 3rd edn. Verlag Mohr Siebeck, Tübingen Setzer J, Bangalore M (2017) Regulating climate change in the courts. In: Averchenkova A, Frankenhauser S, Nachmany M (eds) Trends in climate change legislation. Edward Elgar, Cheltenham, pp 175–192 Setzer J, Benjamin L (2019) Climate litigation in the global south: constraints and innovations. Transnatl Environ Law 9(1):77–101 Setzer J, Higham C (2021) Global trends in climate change litigation: 2021 snapshot. Grantham Research Institute on Climate Change and the Environment and the Centre for Climate Change Economics and Policy. London School of Economics and Political Science, London Setzer J, Vanhala L (2019) Climate change litigation: a review of research on courts and litigants in climate governance. WIREs Clim Change 10(3):1–19 Sinder R (2021) Anthropozänes Verfassungsrecht als Antwort auf den anthropogenen Klimawandel. JuristenZeitung 76(22):1078–1087 Sindico F, Mbengue M (eds) (2021) Comparative climate change litigation: beyond the usual suspects. Springer Nature Switzerland, Cham

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SRU German Advisory Council on the Environment (2020) Using the CO2 budget to meet the Paris climate targets. Environmental Report 2020, Chapter 2. https://www.umweltrat.de/SharedDocs/ Downloads/EN/01_Environmental_Reports/2020_08_environmental_report_chapter_02.pdf? __blob=publicationFile&v=2. Last accessed 3 Oct 2022 Stark A (2021) Klimaschutz als intertemporaler Freiheitsschutz – Zum Klimaschutz-Beschluss des Bundesverfassungsgerichts. Kritische Vierteljahresschrift für Gesetzgebung und Rechtswissenschaft 104(3):237–269 Steinberg R (1998) Der ökologische Verfassungsstaat. Suhrkamp, Frankfurt a.M. Stoll PT (2016) The climate as a global common. In: Faber DA, Peeters M (eds) Climate change law. Edward Elgar, Cheltenham, pp 131–141 Torre-Schaub M (2021) Dynamics, prospects, and trends in climate change litigation making climate change emergency a priority in France. German Law J 22(8):1445–1458 United Nation Environment Programme (2015) Climate change and human rights. https://web.law. columbia.edu/sites/default/files/microsites/climate-change/climate_change_and_human_rights. pdf. Last accessed 3 Oct 2022 Vanhala L (2013) The comparative politics of courts and climate change. Environ Polit 22(3): 447–474 Voigt C (2021) The first climate judgement before the Norwegian Supreme Court: aligning law with politics. J Environ Law 33(3):697–710 Voigt C, Ferreira F (2016) ‘Dynamic Differentiation’: the principles of CBDR-RC, progression and highest possible ambition in the Paris Agreement. Transnatl Environ Law 5(2):285–303 Volkmann U (2022) Im Dienste der guten Sache. Anmerkungen aus Anlass des Klimabeschlusses des Bundesverfassungsgerichts. Merkur 76(875):5–17 von Landenberg-Roberg M (2021) Die Operationalisierung der ‘Ambitionsspirale’ des Pariser Klimaschutzabkommens. Archiv des Völkerrechts 59(2):119–163 von Landenberg-Roberg M (2022) Verantwortungsstrukturierung durch Emissionsbudgets, Zur Funktion eines zentralen Konstruktionselements des Klimaschutzrechts. Die Verwaltung 55(2):249–286 von Weschpfennig A (2022) Kommentierung zu § 3 KSG. In: Fellenberg F, Guckelberger A (eds) Klimaschutzrecht: KSG TEHG BEHG Kommentar. C.H. Beck, München, pp 72–93 Wagner G (2021) Klimaschutz durch Gerichte. Neue Juristische Wochenzeitschrift 74(31): 2256–2263 Wahnschaffe T, Lücke F (2021) Die eingriffsähnliche Vorwirkung auf Freiheitsrechte als Ansatz intertemporaler Freiheitssicherung. Die Öffentliche Verwaltung 74(24):1099–1109 WBGU German Advisory Council on Global Change (2008) Solving the climate dilemma: the budget approach, Special Report. https://www.wbgu.de/fileadmin/user_upload/wbgu/ publikationen/sondergutachten/sg2009/pdf/wbgu_sn2009_en.pdf. Last accessed 3 Oct 2022 Wegener B (2019) Urgenda – Weltrettung per Gerichtsbeschluss? Klimaklagen testen die Grenzen des Rechtschutzes. Zeitschrift für Umweltrecht 30(1):3–13 Wegener L (2020) Can the Paris Agreement help climate change litigation and vice versa? Transnatl Environ Law 9(1):17–36 Wegener B (2022) Menschenrecht auf Klimaschutz? Grenzen grundrechtsgestützter Klimaklagen gegen Staat und Private. Neue Juristische Wochenzeitschrift 75(7):425–431 Winkler H (2017) Mitigation (Art. 4). In: Klein D, Carazo MP, Doelle M, Bulmer J, Higham A (eds) The Paris Agreement on climate change. Analysis and commentary. Oxford University Press, Oxford, pp 141–165 Winter G (2022a) The intergenerational effect of fundamental rights: a contribution of the German Federal Constitutional Court to climate protection. J Environ Law 34(1):209–221 Winter G (2022b) Not fit for purpose. Die Klagebefugnis vor dem Europäischen Gericht angesichts allgemeiner Gefahren. Europarecht 57(3):367–399 Zhao Y, Lyu S, Wang Z (2019) Prospects for climate change litigation in China. Transnatl Environ Law 8(2):349–377

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Martin Eifert holds the Chair of Public Law, in particular Administrative Law, at HumboldtUniversität zu Berlin since 2012. Prior to that, he was Professor of Public Law at the Justus Liebig University in Gießen from 2005 to 2012. After his legal studies in Hamburg, Geneva and at the University of California, Berkeley (LL.M.), he completed his doctorate and habilitation (“Electronic Government”) at the University of Hamburg. He is co-editor of various series and journals, including the “Archiv des öffentlichen Rechts” (AöR), and a co-sponsor of the Humboldt European Law School. His main research interests include constitutional and administrative law, environmental law, media and information law. Michael von Landenberg-Roberg is post-doctoral research assistant and lecturer at HumboldtUniversität zu Berlin, Faculty of Law. He studied at Humboldt-Universität zu Berlin, King’s College London and the University of Cambridge, Clare College (LL.M.). During his legal clerkship, he worked at the German Federal Chancellery in Berlin and the German Federal Constitutional Court in Karlsruhe. He has been research assistant to Professor Christoph Möllers (2009–2012) and Professor Martin Eifert (since 2012) at Humboldt-Universität zu Berlin, where he also received his doctorate in 2019 with the dissertation “Elternverantwortung im Verfassungsstaat” (Parental Responsibility in the Constitutional State). His main research interests include environmental and climate change law, constitutional law and theory, administrative law, political and legal theory.

Trans-Nationally Determined Contributions for Climate Justice: Resolving a Paris Agreement’s Contradiction That Is Working Against Developing States Nciko wa Nciko

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Historicising the Contradiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 The Law of Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The Law of Negative Side Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Developing a Cure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Adoption of TNDCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Compliance with TNDCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Applying the Compliance Mechanism to TNDCs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 (In)effective Compliance Mechanism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 A Few Remarks: The Place of Climate Justice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract As part of tackling climate change, the Paris Agreement expects that developing states impose its temperature goal upon the Transnational Corporations (TNCs) that are operating in them. This expectation contradicts the principle of common but differentiated responsibility (CBDR-RC). The CBDR-RC principle expects developed states to be best placed to impose the temperature goal upon theseTNCs. This is so because developed states caused climate change and possess more capabilities to impose the Paris Agreement’s temperature goal upon TNCs than developing states do. I argue that this contradiction has a much deeper cause that cannot be unravelled and its underlying disease correctly diagnosed unless we historicise it. Only in the process of such historicisation can we develop an adequate cure. The deeper cause, I venture to demonstrate, lies in capitalism; and a possible adequate cure, in what I am coining “Trans-Nationally Determined Contributions (TNDCs).” By TNDCs, I mean the most ambitious efforts that a TNC’s home state (usually a developed state) commits to account for the greenhouse gas emissions that its TNC is responsible for in a host state (usually a developing state). Guided by Issa N. wa Nciko (✉) Geneva Graduate Institute of International and Development Studies, Geneva, Switzerland e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 35–62, https://doi.org/10.1007/8165_2022_94, Published online: 26 January 2023

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Shivji, my point of departure is that law is the concentrated form of politics. As such, TNDCs will offer an adequate cure to the contradiction I am dealing with only if we present them in a manner that appreciates the politics that define how decisions are adopted at a United Nations Climate Change Conference of the Parties (COP) and how such decisions are complied with within the climate change regime. I conclude with a few remarks on the place of climate justice in this contribution, noting that if we are to act on TNDCs, we have to do so before 2030.

1 Introduction Standing on the stage of the 76th session of United Nations General Assembly, Barbados Prime Minister, Mia Amor Mottley, contented herself with stating in a few words the sheer frustration of many developing states in climate change governance. She stated: How much global temperature rise must there be? before we end the burning of fossil fuels? And how much more must sea level climb in small island developing states before those who profited from the stockpiling of greenhouse gas emissions can contribute to the loss and damage that they occasioned? rather than asking us, to crowd out the fiscal space that we have for development, to cure the damage caused, by the greed of others? . . .It is not beyond us to solve this problem. . . If we can find the will to send people to the moon and solve male baldness.1

The Paris Agreement’s principle of common but differentiated responsibility (CBDR-RC principle), on the face of it, seems to provide some answers to the sentiments embodied in this quotation. Under this principle, the Paris Agreement provides that developed states have more historical responsibility, which has given them “present” capabilities, to tackle climate change.2 However, the Paris Agreement goes ahead to contradict this principle by requiring that developing states impose, through their Nationally Determined Contributions (NDCs),3 the Paris Agreement’s temperature goal upon the Transnational Corporations (TNCs) that are operating in them.4 This temperature goal is to keep us on a globe whose surface temperature is below 2 °C, although best efforts shall pursue 1.5 °C, above pre-industrial levels.5 1

Mia Amor Mottley, Barbados - Prime Minister Addresses United Nations General Debate, 76th Session, 21–27 September 2021, New York, https://www.youtube.com/watch?v=wz_lDnay3H8 (last accessed on 8 December 2022). 2 Paris Agreement, art. 2. 2, Dec 12, 2015. 3 Paris Agreement, art. 4, Dec 12, 2015. 4 Bäckstrand et al. (2015), pp. 566–567. When it comes to non-state actors such as TNCs, the PA expects them to simply play a role, somewhat limited, of consultation in the formulation of NDCs. See also PA, art. 3., Dec 12, 2015. 5 Paris Agreement, art. 2. 1.a, Dec 12, 2015.

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NDCs are the most ambitious efforts that each party to the Paris Agreement commits to account for the greenhouse gas (GHG) emissions that are emanating from within its borders. Evidence published in the peer-reviewed scientific journal Nature Climate Change (2020) reveals that about a fifth of global GHG emissions come from TNCs.6 A bulk of TNCs’ transactions that lead to these emissions occurs in TNCs’ host states (usually developing states) rather than in their home states (usually developed states).7 Yet, and this further buttresses the contradiction that I am dealing with, developing states have been unable to impose obligations arising out of many international instruments, for reasons not only to do with the lack of political goodwill in some developing states but also to do with the lack of technological capabilities. Glencore Plc, Royal Dutch Shell, and Chinese state-owned construction TNCs can help illustrate this. Glencore Plc is a mining company that has Switzerland, a developed state, as its home state. It operates in more than 50 states and8 most of these states have been unable to impose international obligations upon it. Glencore is, for instance, about 30 times wealthier than the Democratic Republic of the Congo (DRC),9 a developing state in which it controls the Kamoto Copper Company and Mutanda-Kansuki Company. These are its subsidiaries and have given it dominion over about 30% of the global cobalt production.10 Glencore produces at this scale without paying attention to the GHG emissions it is concentrating in the atmosphere.11 The DRC does not have the technological capabilities to assess the amount of GHG emissions that Glencore has been concentrating in the atmosphere from its mining operations. This is, many a times, coupled up with a lack of political goodwill on the part of DRC government officials.12 A 2019 influential report on China’s Belt and Road Initiative (BRI) has also found that the 126 states—most of which are developing states—that have joined China’s BRI represented 28% of the global GHG emissions in the year 2015. The

6

Zhang et al. (2020), pp. 1–13. Itzhak et al. (2021), pp. 377–437. 8 See Statista, Glencore’s number of employees from 2015 to 2021, https://www.statista.com/ statistics/315055/number-of-employees-at-glencore/ (last accessed on 6 December 2022). 9 Swissinfo.ch, NGOs accuse Glencore of human rights violations, https://www.swissinfo.ch/eng/ business/congolese-copper_ngos-accuse-glencore-of-human-rights-violations/38800880 (last accessed 6 December 2022). 10 Ibid. See also Holslag (2021), p. 8. 11 In the months of April and May 2022, I was conducting fieldwork in the DRC mining cities of Lubumbashi and Kolwezi. The fieldwork led me to this conclusion after interviewing civil society organisations such as l’Initiative Bonne Gouvernance et Droits Humains (IBGDH), l’Observatoire Africain de Ressources Naturelles (Afrewatch), le Carter Center, et l’Action Contre l’Impunité pour les Droits Humains (ACIDH). I also interviewed state institutions such as le Ministère de l’Environnement et Tourisme in Kolwezi, la Direction pour la Protection de l’Environnement Minier (DPEM) in Kolwezi, l’Agence Congolaise de l’Environnement (ACE) in Kolwezi, le Procureur Général près la Cour de Lualaba in Kolwezi, la Générale des Carrières et des Mines (Gécamines) in Lubumbashi, la Division des Mines in Lubumbashi, and le bureau de la Météorologie in Lubumbashi. 12 Ibid. 7

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28% was arrived at based on historical infrastructure and investment patterns as well as growth projections of these states.13 China’s BRI mainly spearheads carbonintensive mega infrastructural development projects in mostly developing states through Chinese state-owned construction TNCs. The developing states across which the BRI cuts have been unable to impose the obligations arising out of international agreements such as the Paris Agreement upon these TNCs.14 A domestic court in the Netherlands, a developed state, gives yet another example of the inability of developing states to impose the Paris Agreement’s temperature goal upon TNCs. In the 2021 case of Four Nigerian Farmers and Stichting Milieudefensie v Shell, this court issued a decision obliging Royal Dutch Shell to ensure that, by 2030, it should have reduced the GHG emissions for its entire value chain by 45% below its 2019 levels.15 Part of the motivation behind this case was that developing states such as Nigeria have been unable to align Shell’s extractive activities with the Paris Agreement’s temperature goal.16 Examples that demonstrate how developing states not only lack the political goodwill but also the technological capabilities to impose the Paris Agreement’s temperature goal upon TNCs are so many that discussing them would go beyond the remit of this contribution. It may, however, suffice to note that Kofi Annan, former United Nations (UN) Secretary-General, would never have instigated conversations around giving TNCs a human face at the Davos World Economic Forum in 1999 if it were not for developing states’ lack of political goodwill and/or capabilities to impose international obligations upon TNCs.17 Further, there would never have been any appointment of a UN Special Representative on the subject of business (mostly alluding to TNCs) and human rights in 2005 if it were not for the same lack.18 I argue that the contradiction of leaving developing states with the obligation to impose the Paris Agreement’s temperature goal upon TNCs yet they do not have the political good will and/or capabilities to do that has a much deeper cause that cannot be unravelled and its underlying disease correctly diagnosed unless we historicise it. Only in the process of such historicisation can we develop an adequate cure. The

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Jun and Zadek (2019), p. 4. Ibid. 15 Four Nigerian Farmers and Stichting Milieudefensie v Shell, para 4.4.18. 16 Friends of the Earth International, Justice at last – Dutch court orders Shell to compensate Nigerian farmers for oil spill harm, 5 February 2021, https://www.foei.org/justice-at-last-dutchcourt-orders-shell-to-compensate-nigerian-farmers-for-oil-spill-harm/ (last accessed 6 December 2022). 17 United Nations, Secretary-General Proposes Global Compact On Human Rights, Labour, Environment, In Address To World Economic Forum In Davos, 1 February 1999, https://press.un.org/ en/1999/19990201.sgsm6881.html (last accessed 6 December 2022). 18 Ruggie J, Celebrating Kofi Annan’s contributions to business and human rights, Business and Human Rights Resource Centre, 18 September 2018, https://www.business-humanrights.org/en/ blog/celebrating-kofi-annans-contributions-to-business-and-human-rights/ (last accessed 6 December 2022). 14

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deeper cause, I venture to demonstrate, lies in capitalism; and a possible adequate cure, in what I am coining “Trans-Nationally Determined Contributions (TNDCs).” By TNDCs, I mean the most ambitious efforts that a TNC’s home state (usually a developed state) commits to account for the GHG emissions that its TNC is responsible for in a host state (usually a developing state). Guided by Issa Shivji, my point of departure is that law is the concentrated form of politics.19 As such, TNDCs will offer an adequate cure to the contradiction I am dealing with only if we present them in a manner that appreciates the politics that define how decisions are adopted at a United Nations Climate Change Conference of the Parties (COP) and how such decisions are complied with within the climate change regime. I conclude with a few remarks on the place of climate justice in this contribution, noting that if we are to act on TNDCs, we have to do so before 2030. Before unravelling the deeper cause, diagnosing the underlying disease, and, in the process, developing an adequate cure, it is proper to make one thing clear. My use of “developing states” in this contribution is more symbolic than anything else. I have in mind only developing states that are host—rather than home—states for TNCs, and that do not have enough political goodwill and/or technological capabilities to impose the Paris Agreement’s temperature goal upon TNCs. Developing states such as China should be understood as developed states, at least in the context of this contribution. The 2014 US-China Joint Announcement on Climate Change may give some legal effect to this understanding. Thanks to this Announcement, the CBDR-RC principle became “common but differentiated responsibility and respective capabilities in light with national circumstances” in the Paris Agreement.20 Experts on climate governance have held that the addition “in light of national circumstances” should be understood to have come in to place more obligations even upon a developing state, which, by way of its current emissions, Gross Domestic Product, geographical situation, and status in the world, has enough capabilities to tackle climate change China, for example, has risen to the rank of world powers with enough capabilities to tackle climate change. It should not, therefore, hide behind the veil of a “developing state” and exempt itself from obligations that TNDCs may call for.21

2 Historicising the Contradiction Situating law in the well-known distinction between transactions and negative side effects can help us locate the deeper cause of the CBDR-RC contradiction in capitalism. This distinction emphasises the fact that a certain transaction has

19

Shivji (2020), pp. 157–161. The White House, President Barack Obama, obamawhitehouse.archives.gov/the-pressoffice/2014/11/11/us-china-joint-announcement-climate-change (last visited Jan. 25, 2022). 21 Hilton and Kerr (2017), pp. 53–54. 20

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“negative side effects on those not participating in [it] and, hence, on overall utility”.22 In essence, since 1603–1604, there has been a law—international law and TNCs’ home states domestic law—that has been facilitating TNCs’ transactions such as those over resources, property rights, capital movement, and market access. However, this law has had minimal to zero interest in dealing with the side effects arising out of such transactions.23 Other than dehumanizing projects such as the trans-Atlantic slave trade and colonialism, other side effects that have resulted from TNCs’ transactions have been concentrations of GHG emissions in the atmosphere. Unfortunately, the Paris Agreement of 2015, as a relatively recent additional layer to this law, only came to deal with these concentrations without interfering with the transactions from which they emerge.24

2.1

The Law of Transactions

The Treaty of Westphalia, written in 1648, for which Hugo Grotius is celebrated as the father of international law, and which made states the only powerful entities that international law had to have for subjects, should not be taken as the beginning of international law. Around 1648, “state” could only mean “European state”.25 Anthony Anghie draws our attention to an alternative history of international law, one which still celebrates Grotius as its father but which was written with 1603–1604 as its beginning.26 This hidden history can help us understand how the CBDR-RC contradiction is embedded in capitalism and the different shapes it kept on taking across time and space. In his first lecture at the Afronomicslaw Academic Forum, and hopefully not his last, Anthony Anghie takes us to the fact that, in 1603–1604 Grotius was drawn into the sensational controversy over privateering in the Southeast Asian trade [. . .] acts of piracy by a private concern did not sit well in the public opinion of many citizens and allies. When asked by a friend with [Dutch East India] Company connections to write a brief justifying a recent and very lucrative seizure of a Spanish cargo, Grotius went on to produce not only an ardent defense of the capture but an investigation into the deep principles of law that connected those separated by nation and culture. The resulting manuscript, provisionally titled De Indis (On the Indies), was never published in full until long after Grotius’ death (appearing in 1868 as Commentary on the Laws of Prize and Booty). [. . .] Many of the arguments worked out in the manuscript—that there is a basic law of nature determined by the need to reconcile self-preservation with social life, that the authority to govern and even to punish derive from the rights of natural persons before the

22

Viñuales (2020), p. DOI30. Ibid, pp. DOI30-31. 24 Ibid, p. DOI32. 25 Chimni (2004), p. 7. 26 Anghie (2022) Afronomicslaw, https://www.afronomicslaw.org/category/video-content/ afronomicslaw-academic-forum-guest-lecture-series-sovereign-alien-history (last accessed 4 July 2022). 23

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founding of civil societies, and that claims to jurisdiction over the open seas are invalid— would give direction to his later works.27

Anghie’s point is that the Eastern Grotius—as he refers to Grotius the corporate lawyer who did a legal consultancy for the Dutch East India Company (VOC— Vereenigde Oostindische Compagnie) as seen in the excerpt above—heavily influenced the Western Grotius—as he refers to Grotius (the same person) who is celebrated as the father of international law.28 Anghie establishes that it is from this legal consultancy for VOC that Grotius developed his ideas on the sovereignty doctrine. Grotius elaborated upon these ideas in his foundational treaties, which ended up informing the content of the Treaty of Westphalia in 1648. Grotius, arguing for the VOC, submitted that a trading company (a TNC) could legitimately engage in a private war against other merchants, or even against the agents of a sovereign state, to enforce natural law, which mandated that TNCs should enjoy absolute freedom to trade in the name of self-preservation.29 This submission was made before the conceptualisation of the sovereignty doctrine.30 Anghie’s point that the Eastern Grotius influenced the Western Grotius is compelling because, in Westphalia in 1648, it was accepted as a maxim of international law that “every sovereign nation has the power, as inherent in sovereignty, and essential to self-preservation, to forbid the entrance of foreigners within its dominions, or to admit them only in such case and upon such conditions as it may see fit to prescribe.”31 We can readily see similarities between this accepted maxim of international law and Grotius’s submission for the VOC. The history of international law, written with 1603–1604 as its beginning, makes one fact loud and clear—that, even before declaring states as the only powerful entities that international law should regulate, the young and brilliant Grotius had sufficient knowledge that TNCs such as the VOC were as powerful as European states. The VOC is the largest TNC to have ever existed in the history of humankind.32 Its trade routes, with its affiliate the Dutch West India Company, went from Japan, through the Cape of Good Hope, all the way to the Americas.33 Present-day

27 Blom A, Internet Encyclopedia of Philosophy, https://iep.utm.edu/grotius/ (last accessed 4 July 2022). 28 Anghie (2022) Afronomicslaw, https://www.afronomicslaw.org/category/video-content/ afronomicslaw-academic-forum-guest-lecture-series-sovereign-alien-history (last accessed 4 July 2022). 29 Haakonssen (2006), pp. xviii–xix. 30 Anghie (2022) Afronomicslaw, https://www.afronomicslaw.org/category/video-content/ afronomicslaw-academic-forum-guest-lecture-series-sovereign-alien-history (last accessed 4 July 2022). 31 Martin (1989), pp. 547–578. 32 Sipalla H (2022) Afronomicslaw, https://www.afronomicslaw.org/index.php/category/analysis/ twail-asserting-pride-global-south-epistemes-through-critiquing-silences (last accessed 4 July 2022). 33 Anghie (2022) Afronomicslaw, https://www.afronomicslaw.org/category/video-content/ afronomicslaw-academic-forum-guest-lecture-series-sovereign-alien-history (last accessed 4 July 2022).

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TNCs such as Apple, Saudi Aramco, Amazon, and Alphabet are nowhere near the net worth of VOC and its peers. When adjusted to the present-day value of the United States dollar, VOC’s net worth stood at $7.9 trillion in 1637, Mississippi Company at $6.5 trillion in 1720, and South Sea Company at $4.3 trillion in 1720.34 TNCs were as powerful as European states. Nevertheless, Grotius went ahead to afford them absolute freedom to trade, in the name of self-preservation. Perhaps this was not problematic for Grotius because, at the time, a “Europe” in which powerful European TNCs would be going to war against European states was not conceivable, given the market structure that the trans-Atlantic slave trade established. This market structure brought European states and their TNCs together in a united front to plunder, delegitimise and subordinate other peoples. Indeed, European TNCs’ focus was on the trans-Atlantic slave trade around the time Grotius was defending the VOC. The slave trade began in the fifteenth century and went on for about 400 years. It was succeeded by close to a century of colonialism. Both the slave trade and colonialism as well as their enduring badly bifurcated legacies have benefitted and continue benefitting European states, and now a few others, immensely.35 Walter Rodney documents how the slave trade developed Europe’s technological capabilities to the point that, up to date, TNCs rarely outdo their home states in terms of economic power and even legal power.36 It is true that capitalism, as a mode of economic production that concentrates wealth in the hands of a few, precipitated the development and strengthening of European domestic law in a way that was strong on the protection of the capitalistic interests of TNCs. On this, Rodney notes that, in its political aspects, capitalism triggered the birth of constitutions, parliaments, and freedom of the press in Europe.37 However, even domestically, the law did not pay attention to the negative side effects that were resulting from TNCs’ transactions outside of Europe. As a former French colonial minister, Jules Ferry explained, for instance, “the French Revolution was not fought on behalf of the blacks of Africa. Bourgeois liberty, equality, and fraternity were not for the colonial subjects. Africans – and Asians and Latin Americans – had to make do with bayonets, riot acts, and gunboats”. We can also add to this that the atmosphere had to make do with unprecedented concentrations of GHG emissions in it.38 We cannot separate damage to the atmospheric commons from human history. The fact that international law aligned with European domestic law to allow TNCs to operate their transactions without paying attention to the side effects resulting from such transactions should not be surprising.39 Thio Li-ann has

34

Sipalla H (2022) Afronomicslaw, https://www.afronomicslaw.org/index.php/category/analysis/ twail-asserting-pride-global-south-epistemes-through-critiquing-silences (last accessed 4 July 2022). 35 Rodney (1982). 36 Ibid. 37 Ibid. 38 Ibid. 39 Ibid.

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deconstructed international law as a field of study and found particularly striking the fact that European public law concepts of global governance were, and still are, in so many ways, the central tenets of international law.40 The 1603–1604 history of international law demonstrates, I believe, how international law and even European domestic law did not have any interest in the regulation of their TNCs’ negative side effects outside of Europe. It is this history that can help us understand how TNCs have accelerated climate change. Carmen Gonzalez notes: The Anthropocene is the epoch under which ‘humanity’ – but more accurately, [TNCs] and those invested in and profiting from petrocapitalism and colonialism – have had such a large impact on the planet that radionuclides, coal, plutonium, plastic, concrete, genocide and other markers are now visible in the geologic strata. [The] early marker of the Anthropocene coincided with the importation of slave labour to extract gold, silver, and copper and later the sugar and cotton that fuelled the Industrial Revolution. Starting the Anthropocene in 1610 captures all impacts of the Industrial Revolution, which many scientists and historians consider a key part of the Anthropocene – because European annexing of the Americas was an essential factor in providing food energy and raw material imports that were critical elements allowing an Industrial Revolution to take place.41

We can spot TNCs’ absolute freedom to cause the negative side effects being maintained across a spectrum of historical continuities. After the abolition of the slave trade, the Berlin Conference of 1884–1885, for example, which justified colonialism in Africa, further sanctioned the fact that European TNCs’ negative side effects outside of Europe should not attract any obligations, both under international law and European domestic law.42 Then, after colonialism, the overt brutal side effects that TNCs’ transactions had on present-day developing states were replaced by bilateral investment treaties (BITs). Developed states did pre-draft BITs for the then-newly-independent developing states, to preserve, among other things, their TNCs’ absolute freedom to continue “transacting” without bearing the cost of the side effects. Being pre-drafted, these BITs were very imbalanced. Up to date, most of them still are. They still grant TNCs rights to engage in transactions such as those over resources, property rights, capital movement, and market access without imposing upon them any direct responsibility for the negative side effects resulting from such transactions.43 Under the regime of BITs, international law protects TNCs when developing states interfere with their transactions. However, neither international law nor domestic law in TNCs’ home states has taken the task to tackle TNCs’ GHG emissions from developing states.44

40

Anghie and Real (2020), p. 14. Gonzalez (2021), p. 117. 42 Craven (2015), p. 38. 43 Mbengue (2019), pp. 1–27. 44 Fry (2007), p. 77. 41

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The Law of Negative Side Effects

Overemphasising the sovereignty doctrine in climate change negotiations is what might have blinded developing states not to pay attention to how TNCs’ transactions are imposing upon them more climate change responsibility that should have, in principle, been imposed upon developed states. In 1992, both developed and developing states gathered in Rio de Janeiro for the first United Nations Conference on Climate Change (UNFCCC), otherwise known as “The Earth Summit”. How to address the threat of climate change for the first time in a multilateral agreement was on the agenda.45 Aware of their developed counterparts’ historical responsibility for climate change, which gave them the “present” capabilities to tackle it, developing states started pushing for the CBDR-RC principle—a trend that they have sustained in all climate change negotiations up to date.46 Jason Hickel was able to quantify the historical responsibility for climate change that should be attached to individual states. He based his quantification on territorial emissions from 1850 to 1969 and consumption-based emissions from 1970 to 2015. His findings were that developed states were responsible for 92% of GHG emissions in excess of the planetary boundary, hence by far largely responsible for climate change.47 On the face of it, it seems very fair that the CBDR-RC principle is effortlessly noticeable throughout the Paris Agreement. Under this principle, the Paris Agreement places more climate change mitigation, adaptability, and financing responsibilities on developed states.48 But, the fact that developing states have been historically made unable to regulate TNCs is not part of the reason why the CBDR-RC principle was pushed for.49 The primary reason was the sovereignty doctrine—that being equal to states that had already developed, developing states also had the right to develop.50 This developmental focus of the CBDR-RC principle did not, therefore, encompass TNCs’ transactions such as those over resources, property rights, capital movement, and market access. Yet those transactions are the ones that have made TNCs responsible for about a fifth of concentrations of GHG emissions in the atmosphere. The approach to climate action that pervades the Paris Agreement reinforces the fact that the Paris Agreement cannot deal, at least directly, with TNCs’ transactions. Indeed, before adopting the Paris Agreement, it was very difficult to arrive at a broad-based multilateral consensus on which approach to climate action to adopt. Historical records associate this difficulty with the top-down approach that formed

45 United Nations, https://www.un.org/en/conferences/environment/rio1992 27 January 2022). 46 Stalley (2018), pp. 141–146. 47 Ibid, pp. 399–403. 48 Paris Agreement, Art. 4.4-7, Dec 12, 2015. 49 Bodansky et al. (2017). 50 Mickelson (2020), pp. 19–20.

(last

accessed

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the basis of climate change negotiations for more than two decades.51 The 1997 Kyoto Protocol had legally binding targets and timetables for emission reductions. However, it could only be applied to developed states because developing states found such targets and timetables as interfering with their sovereignty.52 In 2009, climate change negotiations again failed to secure a multilateral consensus because of following the same top-down approach at the United Nations Climate Change Conference of the Parties (COP) in Copenhagen. That was COP 15. There, Brazil, China, and India consistently frustrated substantive policy proposals made by developed states.53 Other developing states such as Bolivia and Sudan opposed the adoption of the Copenhagen Accord into a binding international agreement. They saw the Accord as a small arrangement that great powers wanted to impose upon them.54 Expectedly then, arriving at the Paris Agreement in 2015 necessitated a new approach to climate action. French diplomacy spearheaded a shift from “a top-down approach based on mandatory emissions commitments imposed [upon] states to a bottom-up [approach] of voluntary government pledges.”55 Under this bottom-up approach, the Paris Agreement leaves developed and developing states free to accomplish their emissions reduction targets in a manner that suits them best within their territories. States are to do this by way of their NDCs (Nationally Determined Contributions), which they are to be setting for themselves.56 The Paris Agreement is carefully crafted in a manner that does not allow it, by its letter and spirit, to impose mandatory commitments on both developed and developing states.57 How can we impose TNDCs (Trans-Nationally Determined Contributions) upon them? It may be worth reiterating at this juncture of the contribution that, by TNDCs, I mean the most ambitious efforts that a TNC’s home state (usually a developed state) can commit to account for the GHG emissions that its TNC is responsible for in a host state (usually a developing state).

2.3

Developing a Cure

I hope to have now unravelled and diagnosed the underlying cause of the CBDR-RC contradiction. The cause lies in capitalism. In the process of unravelling and diagnosing the cause of this contradiction, I have identified four characteristics that, I believe, any adequate cure to the CBDR-RC contradiction will have to

51

Hale (2016), pp. 12–13. Bäckstrand et al. (2015), pp. 561–563. 53 Dimitrov (2010), p. 796. 54 Ibid. 55 Michaelowa et al. (2019), p. 12. 56 Paris Agreement, art. 2. 1.a, Dec 12, 2015. 57 Dupuy and Viñuales (2018), Chapter 5. 52

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appreciate. As already noted, adequacy in the context of this contribution is a politically-charged term. It is determined by the politics that define how decisions are adopted and complied with within the climate change regime generally and particularly within the framework of the Paris Agreement. Issa Shivji has noted: [We] must disabuse [ourselves] of the notion that law is neutral and apolitical. It is not. If politics is the concentrated form of economics, as Lenin said, I add, law is the concentrated form of politics.58

An adequate cure to the CBDR-RC contradiction should therefore have, at least, the following four characteristics: 1. It should align dealing with TNCs’ transactions with dealing with the negative side effects (concentrations of GHG emissions in the atmosphere) that result from such transactions. 2. For both developed and developing states to be more likely to adopt it, it should fit comfortably within the bottom-up approach to climate action that occasioned a broad-based multilateral adoption of the Paris Agreement. 3. Conscious of such an approach to climate action, it should not dictate how domestic law in TNCs’ home states should impose the Paris Agreement’s temperature goal upon their TNCs. 4. Although such an adequate cure may assume extraterritoriality, it should not place obligations on developing states in a manner that interferes with their sovereign right to develop as reflected in their push for the CBDR-RC principle. With these characteristics in mind, I turn to discuss how TNDCs can appreciate these four points to form an adequate cure for the CBDR-RC contradiction. I discuss first how TNDCs can secure a broad-based multilateral adoption at a COP. Then, I discuss how they can be complied with in the climate change regime.

3 Adoption of TNDCs Given that NDCs epitomise the Paris Agreement’s bottom-up approach to climate action, we would therefore not be wrong in concluding that TNDCs are more likely to secure a broad-based multilateral adoption if we model them around NDCs. Being a framework agreement in the sense that it anticipates how further agreements can be made based on it, the Paris Agreement provides for an already-available framework within which TNDCs could be adopted. This is at a COP and a COP takes place every year. All the parties to the Paris Agreement are represented at a COP. There, they adopt decisions such as legal instruments, and institutional and administrative arrangements that are necessary to promote the effective implementation of the Paris Agreement.59 58

Shivji (2020), pp. 157–161. United Nations Climate Change, Conference of the Parties, https://unfccc.int/process/bodies/ supreme-bodies/conference-of-the-parties-cop (last accessed 6 December 2022).

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The purpose of the Paris Agreement is “to strengthen the global response to the threat of climate change in the context of sustainable development and efforts to eradicate poverty.”60 To meet this purpose, one of the distinguishing implementing tools of the Paris Agreement is of course NDCs. As is the case for NDCs, TNDCs too should be geared towards attaining the Paris Agreement’s temperature goal as enshrined in Article 2 of the Paris Agreement.61 This goal, which I have already alluded to, targets a global surface temperature that is below 2 °C—and encourages best efforts to pursue 1.5 °C—above pre-industrial levels. Meeting this temperature goal through TNDCs could incidentally help meet the Paris Agreement’s adaptation goal and financial goal too. The adaptation goal aims to foster low greenhouse emission development and climate resilience.62 By adopting TNDCs, developed states may see themselves starting to coincidentally require TNCs for which they are home states to foster low greenhouse emission development and climate resilience in their operations in host states (usually developing states). Developed states carry the weight of the financial goal on their shoulders. In tandem with the CBDR-RC principle, these states are to commit to assisting developing states with an amount that goes beyond USD 100 trillion, every year.63 While USD 100 trillion is not even enough for developing states to adapt to climate change, developed states have had difficulty fulfilling this financial goal, as COPs have so far revealed.64 TNDCs could partly help address this difficulty. Given the rate at which TNCs are concentrating GHG emissions in the atmosphere, TNDCs could drastically reduce the amount of USD that developing states need in assistance for them to adapt to climate change. This is because developing states could be dealing with fewer climate change adverse effects that could come with less GHG emissions if developed states were to carry the burden of dealing with GHG emissions that emanate from their TNCs in developing countries. In the spirit of the CBDR-RC principle and with respect to NDCs’ content, Article 4(2) of the Paris Agreement places an obligation upon developed states to have absolute emissions reduction targets in all sectors.65 To account for TNDCs, an addition to this Article could read as “. . .in all sectors, including the emissions that their TNCs are responsible for in host states.” These absolute emissions reduction

60

Paris Agreement, art. 2, Dec 12, 2015. Paris Agreement, art. 2.1, Dec 12, 2015. 62 Paris Agreement, art. 2.1, Dec 12, 2015. 63 See for instance The Glasgow Climate Pact, art. 25, 2021. 64 Kaya and Stoetzer (2021) The 100 Billion Dollar Question: COP26 Glasgow and Climate Finance. Global Policy. https://www.globalpolicyjournal.com/blog/16/11/2021/100-billion-dollarquestion-cop26-glasgow-and-climate-finance (last accessed 4 July 2022). See also McDonnell T et al., COP27: The $100 billion question, Quartz 4 November 2022, https://qz.com/emails/cop27/1 849732899/cop27-the-100-billion-question (last accessed 6 December 2022). See also Mia Amor Mottley, Barbados - Prime Minister Addresses United Nations General Debate, 76th Session, 21–27 September 2021, New York, https://www.youtube.com/watch?v=wz_lDnay3H8 (last accessed on 8 December 2022). 65 Paris Agreement, art. 4.2, Dec 12, 2015. 61

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targets are not required of developing states. If anything, the Paris Agreement provides developing states with the leeway to decide which priority sectors to make the first subjects of their NDCs until they can progressively end up catering for all sectors.66 Assuredly, leaving such leeway to powerful developing states such as China could collapse the relevance of TNDCs. China could argue, as a developing state, that reducing its TNCs’ emissions is not yet its priority as it has directed its emissions reduction targets towards other sectors. This is why I made it clear from the outset of this contribution that the developing states that I have in mind are only those that are host—rather than home—states for TNCs, and that do not have political goodwill and/or technological capabilities to impose the Paris Agreement’s temperature goal upon TNCs. Another key element should be that, just like NDCs, successive TNDCs should present a progression beyond the previous ones.67 In other words, as is the case for NDCs, TNDCs should also feature in the global stocktake every 5 years. This would mean that every 5 years, a TNC’s home state should be increasing its efforts to account for the GHG emissions that its TNC is responsible for in host states. Succeeding TNDCs should therefore display more ambition than the previous ones. In addition, for efficiency purposes, the United Framework Convention on Climate Change Secretariat should establish a registry for TNDCs—the TNDC Registry—that should be recording each party’s communicated TNDCs.68 Letting a (developed) state provide for its TNDCs as part of its NDCs may run the risk of confusing the level of ambition that such a (developed) state is taking in its TNDCs and the one that it is taking in its NDCs. Also, there is a point in calling a problem by its name. Why do we not refer to climate justice, gender justice or racial justice simply as “justice”? Why do we not refer to women’s rights, children’s rights or peoples’ rights simply as “human rights”? “Trans-Nationally” in “Trans-Nationally Determined Contributions (TNDCs)” is to communicate a message and to call for a specific action, which I believe NDCs are not best placed to communicate or call for. This is why we need a separate registry for TNDCs. We can also make a fair prediction. If NDCs were to assume extraterritoriality (allowing one state to conduct certain activities in another state), they could have done so within the bottom-up approach to climate action that made arriving at a broad-based multilateral adoption of the Paris Agreement possible. Put differently, they could not have allowed a state to intervene in the sovereign territory of another state without the cooperation of the latter. With this prediction in mind and since TNDCs assume extraterritoriality, if a TNC’s home state is to intervene in the sovereign territory of its host state in a manner that aligns with the bottom-up approach, such intervention should be premised upon cooperation.

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Paris Agreement, art. 4.2, Dec 12, 2015. Paris Agreement, art. 4.3 & 4.5 Dec 12, 2015. 68 United Nations Climate Change, Nationally Determined Contributions: NDC Registry, https:// unfccc.int/NDCREG?gclid=Cj0KCQiA-JacBhC0ARIsAIxybyM1FQTujWpmXmJ1sZ8yxBU_ IMmLLPboJbJzsuY25FpjXnBj0YWyiH8aAvtDEALw_wcB (last accessed 6 December 2022). 67

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In conclusion, modelling TNDCs around NDCs gives them the four characteristics that I believe appreciate the politics that define how decisions are adopted (I am dealing with compliance shortly) within the climate change regime, and particularly with the framework of the Paris Agreement. TNDCs, judging from their definition in this contribution, align dealing with TNCs’ transactions with dealing with the negative side effects (concentrations of GHG emissions in the atmosphere) that result from such transactions. TNDCs provide for such an alignment within the bottom-up approach to climate action that occasioned a broad-based multilateral adoption of the Paris Agreement. While TNDCs are more likely to have effects on TNCs’ home states domestic law, they do not dictate how this law should impose the Paris Agreement temperature goal upon TNCs. Finally, TNDCs do not assume interfering with developing states’ sovereignty, particularly their sovereign right to develop.

4 Compliance with TNDCs Even if TNDCs could enjoy a broad-based multilateral adoption, how could they be complied with? Reflecting upon compliance in the context of the Paris Agreement’s bottom-up approach to climate action, Christina Voigt observes: [This bottom-up approach made] the Paris Agreement [contain] several legally binding obligations for all parties, such as the communication and updating of NDCs as well as reporting and accounting obligations. However, these obligations are of a procedural nature only, while the substance of mitigation, adaptation and finance obligations is not legally binding and left to the sovereign discretion of parties.69

For states, not to comply with NDCs, has been the general rule rather than the exception. Indeed, before COP 27, which took place from 6 to 20 November 2022 in in Sharm El Sheikh, the Paris Agreement’s compliance mechanism was only peer pressure.70 This was discernible from the Paris Agreement’s Enhanced Transparency Framework (ETF). The ETF calls upon parties to inform each other about the types of climate action they are taking and to provide some clarity as to their execution of such action.71 The ETF applies generally to NDCs. If TNDCs are ever adopted, the ETF could also call upon the parties to the Paris Agreement to be making their respective TNDCs known to each other—a role that a TNDC registry, as alluded to in the preceding part, could best perform. Before COP 27, the Paris Agreement could have been best described as an open gym where people are expected to see other people exercising in order for them to exercise. And while everyone was clear about the gains they were after, there was no coach to keep them exercising in a disciplined manner so that they could meet such gains. COP 27 produced a coach—the Paris 69

Voigt (2016), p. 166. Paris Agreement, art. 13 Dec 12, 2015. 71 Paris Agreement, art. 4.3 & 4.9 Dec 12, 2015. 70

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Agreement’s Compliance Mechanism—to guarantee compliance with NDCs. Can this coach guarantee also compliance with TNDCs?

4.1

Applying the Compliance Mechanism to TNDCs

Compliance with an international agreement is, essentially, its implementation. This is why compliance is one of the central methods of assessing the effects and effectiveness of international law, and, in our case, the Paris Agreement.72 The Paris Agreement Implementation and Compliance Committee is established under Article 15 of the Paris Agreement to facilitate the implementation of and promote compliance with the Paris Agreement. In its third annual report, which was adopted at COP 27 in Sharm el-Sheikh, the Paris Agreement Compliance Committee provides for a compliance mechanism for NDCs. We have already seen how TNDCs can be modelled around NDCs. As such, the sets of rules that the Compliance Committee has developed in its third annual report to guarantee compliance with NDCs may also be applied to TNDCs. My reading of the sets of rules, with TNDCs in mind, reveals that these sets of rules are broadly speaking to three layers of cooperation. The first layer may be between the Compliance Committee and a given TNC’s home state. The second may be between the Compliance Committee and the Intergovernmental Panel on Climate Change (IPCC). The third may be between a TNC’s home state and its host state. With regard to the cooperation between the Compliance Committee and a TNC’s home state, the sets of rules note that: At least four weeks in advance of each scheduled meeting. . .the secretariat [of the Paris Agreement] shall make available to the Committee the most up-to-date information on: (a) Communication and maintenance of nationally determined contributions by Parties in the public registry referred to in Article 4, paragraph 12, of the Paris Agreement.73

Based on such most up-to-date status of communication, the sets of rules state, the Committee is to initiate the consideration of issues in cases where a party fails to communicate and maintain an NDC.74 Once the issues are identified, the Committee shall promptly notify the concerned party in writing, requiring its consent before the Committee can engage and consult it in a facilitative consideration of the issues in question.75 If consent is granted, “the Committee shall endeavour to constructively engage with and consult the Party concerned at all stages of the process, including by inviting written submissions and providing opportunities to comment.”76 This

72

Kingsbury (1998), p. 345. Paris Agreement’s Compliance Mechanism (2022), Set of Rules XVIII. 74 Paris Agreement’s Compliance Mechanism (2022), Set of Rules XVIII. 75 Paris Agreement’s Compliance Mechanism (2022), Set of Rules XIX. 76 Paris Agreement’s Compliance Mechanism (2022), Set of Rules XV. 73

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cooperation between the Compliance Committee and a TNC’s home state can help track and guarantee compliance with TNDCs if the home state triggers it. The second layer of cooperation that my reading of these sets of rules reveals when it comes to their application to TNDCs is one between the compliance committee and the IPCC. Indeed, the sets of rules also allow the Committee to identify issues that require expert advice and to identify which expert can speak to them.77 For credibility purposes, it may help that the IPCC be such an expert on matters that are related to TNDCs because it yields a lot of normative power in “the science of climate change”. This can help clear any uncertainty as to the emissions of a party’s TNC(s) that are emanating from within the borders of another party. Achieving a fair level of certainty is critical to guaranteeing compliance with TNDCs. The reason for this is that certainty as to a TNC’s GHG emissions is critical to determining the level of ambition that we are to expect in a TNC’s home state TNDCs. Established in 1998,78 within a decade the IPCC was a Nobel Peace Prize awardee owing to its efforts in laying the foundations for measures needed to tackle climate change. The institution produces, summarises, and disseminates knowledge about human-induced climate change.79 It is the authoritative institution that could speak to the emissions of each party’s TNC(s) because the knowledge that the IPCC produces is what the Paris Agreement refers to as the best available science that shall inform climate action.80 It has been scientifically possible to establish the share of GHG emissions that states have individually released into the atmospheric commons. Sophisticated studies have established this for Australia,81 India, China, and the United States.82 This indicates that the IPCC authors could be assessing scientific papers each year, with the aim of determining the net emissions that a TNC registered in one state (its home state) is responsible for in another state (its host state).83 In determining the emissions of a TNC, the IPCC could be drawing inspiration from the 2021 case of Four Nigerian Farmers and Stichting Milieudefensie v Shell. This case was before a domestic court in the Netherlands. This court issued a decision obliging Royal Dutch Shell to ensure that, by 2030, it should have reduced the CO2 emissions for its entire value chain by 45% below its 2019 levels. Particularly, this court found that Royal Dutch Shell’s liability extends not only to Scope 1 emissions but also to Scope 2 and Scope 3 emissions.84

77

Paris Agreement’s Compliance Mechanism (2022), Set of Rules XXI(2). The Intergovernmental Panel on Climate Change, https://www.ipcc.ch/ (last accessed 6 December 2022). 79 Hulme (2010), p. 705. 80 Paris Agreement, art. 4.3 Dec 12, 2015. 81 Suppiah et al. (2007), p. 131. 82 Hicke (2020), pp. 399–403. 83 The Intergovernmental Panel on Climate Change, https://www.ipcc.ch/about/ (last accessed 6 December 2022). 84 Four Nigerian Farmers and Stichting Milieudefensie v Shell, para 4.4.18. 78

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N. wa Nciko Scope 1 emissions are ‘direct emissions from sources that are owned or controlled in full or in part by the organisation’; Scope 2 emissions are ‘indirect emissions from third-party sources from which the organisation has purchased or acquired electricity, steam, or heating for its operations, and Scope 3 emissions encompass ‘all other indirect emissions resulting from activities of the organisation, but occurring from greenhouse gas sources owned or controlled by third parties, which includes emissions released by the end-users.85

Extending liability to Scope 1, 2, and 3 emissions can lead to efficient outcomes in calculating the emissions of a TNC, together with those of its subsidiaries, in a host state. Shell has, for example, 1100 subsidiaries (the general corporate policy which it determines) in various jurisdictions.86 The IPCC authors could therefore be drawing inspiration from this domestic court to establish how to calculate the amount of GHG emissions concentrated in the atmosphere and that belongs to each TNC. As already suggested, such calculations can bring about a certain level of certainty that is relevant to determining the level of ambition that we may have to expect from developed states in their TNDCs. The third layer of cooperation that my reading of the sets of rules of the third annual report of the Paris Agreement Compliance Committee reveals, still with TNDCs in mind, is between a TNC’s home and its host state. The sets of rules note that the Committee shall pay particular attention to the respective national capabilities and circumstances of the party concerned. In complying with TNDCs, therefore, the Committee should be engaging and consulting not only a TNC’s home state but also its host state, at all stages of the process as they may need assistance from and collaboration with each other to bring about compliance with TNDCs.87 This cooperation between a TNC’s home state and its host state echoes the sentiments that Obiora Okafor (UN Independent Expert on International Solidarity) has regarding developed states’ regulation of their TNCs extraterritorially: The increasing use of unilaterally enacted domestic and regional legislation to regulate the global value chain of [TNCs], reflects, in part, the failures so far by states to establish multilateral rules to regulate transnational corporations extraterritorially. While these efforts could be viewed as legitimate expressions of solidarity by the Global North home states of these [TNCs], they could also result in an infringement of already weakened host state sovereignty while bolstering the regulatory power of home states, however unintended, especially in the context of global power imbalances.88

This third layer of cooperation, between a TNC’s home state and its host state, should be there for a developing state to facilitate a developed state’s compliance with its TNDCs. This cooperation should not be there to impose obligations upon developing states. On a side note, it may also help to bear in mind that the “increasing use of unilaterally enacted domestic and regional legislation” in Okafor’s 85

World Resources Institute, wri.org/initiatives/greenhouse-gas-protocol (last accessed 31 January 2022). 86 Hösli (2021), p. 196. 87 Paris Agreement’s Compliance Mechanism (2022), Set of Rules XV. 88 UN Human Rights Council https://twitter.com/un_hrc/status/1543806809802059776?s=24&t= PqaIUKIfKBf-cZThKN0wjg (last accessed 9 July 2022).

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sentiments has not been modelled around achieving the Paris Agreement’s temperature goal as we are trying to do with TNDCs in this contribution.

4.2

(In)effective Compliance Mechanism

In this part of the contribution, I am asking the question how (in)effective the Paris Agreement’s Compliance Mechanism is. I will first critique this compliance mechanism by assessing whether or not states, particularly developed states (because they are usually TNCs’ home states), are more likely to comply with it. Then, I will proceed to identify the value of this compliance mechanism within the traditional role of compliance mechanisms.

4.2.1

Critique

The Compliance Mechanism that the third annual report has established, like the Paris Agreement itself, is very state-centric and founded upon the bottom-up approach to climate action that made the Paris Agreement secure a broad-based multilateral adoption from states. It is therefore not surprising that states did not engage in any heated debate that was worthy of media attention at COP 27 while adopting the sets of rules that form this compliance mechanism.89 Although it led to the broad-based multilateral adoption of the Paris Agreement (and now of the Paris Agreement Compliance Mechanism), this bottom-up approach to climate action has paved the way for states’ cavalier behaviour, which is largely lacking in a high level of ambition to tackle climate change.90 This bottom-up approach has been usually at the centre of understanding issues and major controversies surrounding the Paris Agreement’s effectiveness. Voigt, for example, tells the story of effectiveness as encompassing three main interlinked components. These components are participation, ambition, and compliance.91 Participation aims to bring to climate change negotiations those actors who not only have more responsibility for climate change but also more capabilities to tackle climate change. We cannot help but admit that the discussion on TNDCs in this contribution thus far has shown that TNDCs are more likely to attract a lot of participation from the parties to the Paris Agreement. This is if these parties are A simple good search of “compliance mechanism COP 27” for example, brings up nothing about the Paris Agreement’s Compliance Mechanism. See https://www.google.com/search?q=compli ance+mechanism+COP+27&oq=compliance+mechanism+COP+27&aqs=chrome..69i57j33i10i1 60l2.6731j1j4&sourceid=chrome&ie=UTF-8 (last accessed 6 December 2022). See also Voigt (2022), https://www.linkedin.com/posts/activity-6999095040530632704-tOWW?utm_source= share&utm_medium=member_desktop (last accessed 6 December 2022). 90 Pauw (2018), p. 23. 91 Voigt (2016), p. 161. 89

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faced with adopting TNDCs in a manner that is modelled around the bottom-up approach that NDCs epitomise. COP 27 has also shown that there was a lot of state participation in adopting the sets of rules that form the Paris Agreement’s Compliance Mechanism because they are carefully tailored around a bottom-up approach to climate action. This Compliance Mechanism is also more likely to be adopted for TNDCs if we stick to the same bottom-up approach to climate action.92 However, the stringency of compliance, as well as the level of ambition that comes with it, Voigt notes, disincentivises broad-based participation.93 The Paris Agreement Compliance Committee had to thus forgo the stringency of compliance and the level of ambition for the sake of a broad-based multilateral participation for states to adopt its proposed compliance mechanism.94 The sets of rules note that the decision of the Committee shall be included in the report of the Committee to the COP except for any parts of it relating directly to the information that the such a party has marked as being confidential.95 But we can see how this confidentiality can act against compliance. The lack of stringency of compliance lies in the fact that only the concerned party—and, in the case of TNDCs, the TNC’s home state—can trigger the Compliance Mechanism. The parties to the Paris Agreement are more likely to adopt the application of this Compliance Mechanism to TNDCs if only the home state—which is the one expected to communicate and comply TNDCs—has the power to trigger it. Allowing a host state to trigger the Compliance Mechanism against such a home state or allowing the Compliance Committee or the IPCC to do so would be inconsistent with the bottom-up approach to climate action. Yet, this is the approach that determines how decisions are adopted during COPs. The consequences of not complying with NDCs—and, in the case of TNDCs— are non-existent in the Paris Agreement’s Compliance Mechanism. A critique can therefore conclude, and fairly so, that the Paris Agreement’s Compliance Mechanism is ineffective. We should hope that (some developed) states could nevertheless rise in ambition to subject themselves to this Compliance Mechanism if TNDCs are ever adopted and the Compliance Mechanism that third annual report has established is ever applied to them. Hope here, as an emotion, should not be underestimated. Anne Saab would observe that: “While responses to [climate change] are based on the best available scientific evidence, no amount of facts and evidence can fully resolve questions of [climate change] that ultimately require deeply emotional considerations.”96

92

Ibid. Ibid. 94 Ibid, 164–165. 95 Ibid. 96 Saab A, ESIL Reflection – Emotions and International Law, https://esil-sedi.eu/esil-reflectionemotions-and-international-law/ (last accessed 6 December 2022). 93

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The Value

In addition to hope, even if (some developed) states decide to become politically hostile to the Compliance Mechanism, such hostility to refuse to trigger this mechanism or to comply with its outcomes cannot bring its value to naught. Precisely because a compliance mechanism under an environmental agreement has two major roles. The first is to track and guarantee compliance.97 The Paris Agreement’s Compliance Mechanism is more likely to fail in this first role because it cannot be performed without the consent of a host state. The second role of a compliance mechanism, which is a logical consequence of the first, is that, in the course of trying to track and guarantee compliance, a compliance mechanism furnishes information that is necessary to know whether or not and the extent to which a party to an agreement is complying with the obligations arising out of such agreement.98 The Paris Agreement’s Compliance Mechanism is more likely to succeed in this second role. The reason for this is that a state’s refusal to trigger the Compliance Mechanism is already enough information necessary to help track and guarantee compliance from other fora. Further, a state’s disruption of the Compliance Mechanism, at any of its several stages, is also already enough information necessary to help track and guarantee compliance from other fora. The other fora that I have in mind, in order to track and guarantee compliance with TNDCs despite the refusal of a TNC’s host state to trigger such a compliance mechanism are national, regional, and international courts and tribunals. Climate change litigation has cast these courts and tribunals as important players in shaping multilevel climate governance. Climate change litigation has allowed, for instance, national courts in developed states to play a significant role in advancing the goals of the Paris Agreement, by holding their states liable for their failure to abide by their self-differentiated responsibility in the global climate change response.99 We are also noticing an increasing level of partnering between climate justice movements in developed states and developing states. Those in developed states have been bringing cases (in developed states) that profile or include the experiences of the plaintiffs from developing states.100 Some courts and tribunals already serve as fertile lands in which claims regarding compliance with TNDCs can be flourishing. We have noted that complying with TNDCs, as presented in this contribution, may call for three layers of cooperation; namely, between a TNC’s home state and the Compliance Committee, between the Compliance Committee and the IPCC, and between a TNC’s home state and its host state. Cooperation is an important principle in the protection of global commons such as the atmosphere. Cooperation has also been traditionally used to attend to the

97

Sachariew (1991), pp. 32–33. Ibid. 99 See generally Peel and Lin (2019) as well as Setzer and Higham (2021). 100 Peel and Lin (2019), pp. 683–684. 98

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settlement of disputes arising out of the management of such commons.101 The International Court of Justice (ICJ), in the 2010 Pulp Mills case elaborated on the obligations that a state should have to another in terms of notifying, consulting, and conducting environmental impact assessments. This, the ICJ observed, underlines the principle that states that are parties to an environmental dispute should cooperate so that they can jointly address damage to the environment.102 Similarly, in the 2001 Mox Plant case, the International Tribunal for Law of the Sea (ITLOS) emphasised that the duty to cooperate is fundamental to preventing marine pollution and is accepted as such under customary international law.103 While states, such as TNCs’ host states, and state-control intergovernmental organs, such as the Compliance Committee are the two principal actors that may be involved in operationalising the Paris Agreement’s Compliance Mechanism, climate justice movements have been playing a critical role in helping track and guarantee compliance under environmental agreements, despite these movements not being recognised as “subjects” under such agreements.104 This trend has been seen in their role in climate litigation to help track and guarantee compliance with some NDCs, regardless of state inertia vis-à-vis such NDCs. We can then predict, and fairly so, that TNDCs as discussed in this contribution, if adopted, can further amplify climate litigation. Article 24 of the Paris Agreement offers also states the possibility to accept the compulsory jurisdiction of the ICJ or any other tribunal for them to resolve any disputes arising out of the Paris Agreement.105 However, none of them has so far called upon Article 24 to bring about compliance with the Paris Agreement. Other than climate justice movements, developing and well-meaning developed states could also be breathing life into complying with TNDCs, by taking to the ICJ a state that refuses to trigger the Paris Agreement’s Compliance Mechanism, undergo all its stages and comply with its outcomes.106

5 A Few Remarks: The Place of Climate Justice This contribution has looked into how the Paris Agreement expects developing states to impose its temperature goal upon the TNCs for which they are host states. This contradicts the principle of common but differentiated responsibility because developing states do not have the capabilities to do that. We should urgently resolve

101

Boisson de Chazournes and Rudall (2019), p. 142. Pulp Mills on the River Uruguay (Argentine v. Uruguay) (Judgment) (2010). 103 Mox Plant case (2001). 104 Sachariew (1991), p. 33. 105 Paris Agreement, art. 24. 1.a, Dec 12, 2015. 106 Dupuy and Viñuales (2018), p. 197. 102

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this contradiction. The more the emissions (even below a global surface temperature of 2 °C above pre-industrial levels), the more the tipping points. Unlike developed states, developing states do not usually have the capabilities to mitigate and adapt to most tipping points. [The] so-called ‘tipping points’ are critical thresholds beyond which the climate system sets into a fundamentally different dynamic, which cannot be reverted, even if ambitious action is taken to do so. Proving to people that there is no going back once these thresholds have been crossed is a difficult challenge as it goes against the common assumption that anything can be returned to its original state with the right intervention. Let’s take a common expression as an example: ‘the straw that breaks the camel’s back. Over time, small incremental changes occur as we load more straw onto the camel’s back, each time adding further pressure to the spine. At some point, adding a straw would mark that tipping point and break the camel’s back. Once the back is broken, removing the straw, or even a substantial burden, would make little difference. This image can be used to understand a change in the dynamics of the climate system resulting from incremental emissions of greenhouse gases.107

The IPCC warned that the global surface temperature was at 1 °C above preindustrial levels in the year 2018. Since then, the global surface temperature was set to continually increase by 0.2 °C, for every decade that passes.108 Looking at emission pathways then, the global surface temperature is likely to reach 1.5 °C above pre-industrial levels between 2030 and 2050.109 This is very problematic when we think of carbon budgets. A carbon budget refers to the cumulative amount of GHG emissions that are permitted to be concentrated in the atmosphere within a certain global temperature threshold.110 As of January 2018, scientists found, with a probability of 50–66% (which we should take seriously) that, to limit the global average temperature to no more than 1.5 °C, the remaining carbon budget is 420–580 gigatonnes of GHG. To limit it to no more than 2 °C, the remaining carbon budget is 1170–1500 gigatonnes.111 These carbon budgets make one fact clear: there is only a small threshold within which more emissions can be accommodated before multiple tipping points can be triggered. At 1.5 °C, which, as noted, we can reach between 2030 and 2050 unless we take ambitious climate action (such as TNDCs), the probability of tipping points in the form of droughts and heavy precipitation will increase in several regions, they will also lead to a sea level rise, ocean de-oxygenation, and increased ocean acidity, and all this will have adverse impacts on biodiversity and ecosystems—hence

107

Viñuales J, The Point of no Return: Is there still time for Cop27 to make a difference?, https:// www.graduateinstitute.ch/index.php/communications/news/point-no-return-there-still-time-cop27make-difference (last accessed 12 December 2022). 108 The Intergovernmental Panel on Climate Change, https://www.ipcc.ch/sr15/chapter/spm/ (last visited Jan. 27, 2022), pp. 51–54. 109 Cook and Viñuales (2021), para 7 and Points I(1) and I(2). 110 Carbon Tracker, Carbon budgets explained, https://carbontracker.org/carbon-budgets-explained/ (last accessed 8 December 2022). 111 Cook and Viñuales (2021).

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creating significant climate-related existential risks to developing states’ people (s) and their cultures.112 The more the global temperature goes up, the more the tipping points intensify. Some tipping points do trigger other tipping points.113 Scientists have already pointed out that at 1.1 °C some large ice sheets have already crossed their tipping point in Antarctica, leading to sea level rise adversely affecting many developing states. Much of the Amazon Forest—this GHG-storing sink—is also close to its tipping point, which is likely to turn it into a savannah. This is the fate that many forests that support the life and the cultures of many developing states’ peoples can face.114 It may probably be easier for some to dismiss resolving the contradiction that I am dealing with in this contribution. They can try to dismiss it, treating it as a simple mistake that is yet to catch the eyes of climate change negotiators and that can be resolved by a “climate” fund, in case the available funds are not yet catering for it. Experience with the USD-100-trillion-yearly pledge from developed states to assist developing states in their adaptation to climate change is sadly showing that “climate funds” have not been working. Others may argue that we may not even need to resolve the contradiction that I am dealing with because of the energy transformation. Indeed, two-thirds of global GHG emissions come from the energy sector. In 2019, the Global Commission on the Geopolitics of the Energy Transformation released a comprehensive report—the first on the matter—that demonstrates how there is an unprecedented shift from fossil fuel and carbon-intensive products and services to renewables due to incentives that TNCs, among many other actors, are facing in the global market. Given this shift, the report suggests that the current energy transformation is more likely to coincidentally meet the Paris Agreement’s temperature goal. Nothing in the report, however, guarantees whether the energy transformation will keep the global average temperature to no more than 1.5 °C or no more than 2 °C or slightly beyond this because there is no regulation aligning this transformation with the Paris Agreement’s temperature goal.115 It is not certain whether the transformation will spare us from tipping points, more of which, as already mentioned, will start being triggered at a global average temperature of 1.5 °C. The energy transformation should then not

112

Voigt (2022) pp. 51–54. Voigt (2022), pp. 51–54. 114 Damian Carrington, World on brink of five ‘disastrous’ climate tipping points, study finds, The Guardian, 8 September 2022, https://www.theguardian.com/environment/2022/sep/08/world-onbrink-five-climate-tipping-points-study-finds (last accessed 6 December 2022). See also Damian Carrington, Climate tipping points could topple like dominoes, warn scientists, The Guardian, 3 June 2021, https://www.theguardian.com/environment/2021/jun/03/climate-tipping-pointscould-topple-like-dominoes-warn-scientists (last accessed 6 December 2022). See also Damian Carrington, Climate tipping points could topple like dominoes, warn scientists, The Guardian, 3 June 2021, https://www.theguardian.com/environment/2021/jun/03/climate-tipping-pointscould-topple-like-dominoes-warn-scientists (3 June 2021). See also generally Mckay et al. (2022). 115 The Global Commission on the Geopolitics of Energy Transformation (2019), pp. 16–22, 23–33, 39–54, and 55–73. 113

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excuse ambitious emissions reduction targets, which TNDCs can offer us a chance to arrive at. TNDCs offer, I want to believe, a practical way to help promote climate justice. Climate justice is used to account for and contest how climate change is having the most severe effects on those with the least responsibility for causing it, and who, at the same time, do not have the capabilities to tackle it.116 The recommendations made in this contribution are based on observable patterns in climate change governance. These recommendations are therefore provisional. They are part of an ongoing debate. They might not stand the test of time. For instance, future research may have to investigate how the relevance of TNDCs could still stand in an event where a ‘GHG-intensive’ TNC decides to de-register itself from a developed state and to go on to re-register itself in a developing state so as to have such a developing state—which does not have the capabilities to subject it to the Paris Agreement’s temperature goal—as its home state.

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Haakonssen K (2006) Commentary on the law of prize and booty. Liberty Fund, Inc. Hale T (2016) “All hands-on deck”: the Paris Agreement and nonstate climate action. Glob Environ Polit 16(3):12–22 Hicke J (2020) Quantifying national responsibility for climate breakdown: an equality-based attribution approach for carbon dioxide emissions in excess of the planetary boundary. Lancet Planet Health 4:e399–e404 Hilton I, Kerr O (2017) The Paris Agreement: China’s ‘new normal’ role in international climate negotiations. Clim Policy 17(1):48–58 Holslag J (2021) Controlling the mine? Assessing Chinas emergence as a minerals super power. J Contemp China 31(137):663–674 Hösli A (2021) Milieudefensie et al. v. Shell: a tipping point in climate change litigation against corporations? Clim Law 11:195 Hulme M et al (2010) Climate change: what do we know about the IPCC? Progr Phys Geogr Earth Environ 34(5) Itzhak B et al (2021) Exporting pollution: where do multinational firms emit CO2? Econ Policy 36(107):377–437 Jun M, Zadek S (2019) Decarbonizing the belt and road: a green finance roadmap Kingsbury B (1998) The concept of compliance as a function of competing conceptions of international law. Mich J Int Law 19:345 Martin A (1989) Effects of international law on migration policy and practice: the uses of hypocrisy. Int Migr Rev 23(3):547–578 Mbengue M (2019) Africa’s voice in the formation, shaping, and redesign of international investment law. ICSID Rev 34(2):455–481 Mckay A et al (2022) Exceeding 1.5°C global warming could trigger multiple climate tipping points. Sciences 377(6611):eabn7950 Michaelowa A et al (2019) Evolution of international carbon markets: lessons for the Paris Agreement. Wiley Interdiscip Rev 10(6):e613 Mickelson K (2020) Hope in a TWAIL register. TWAIL Rev 1(1):14–27 Newell P et al (2021) Towards transformative climate justice: an emerging research agenda. Sussex Research Online Pauw P (2018) Beyond headline mitigation numbers: we need more transparent and comparable NDCs to achieve the Paris Agreement on climate change. Clim Change 147:23–29 Peel J, Lin J (2019) Transnational climate litigation: the contribution of the global south. Am J Int Law 113:4 Rodney W (1982) How Europe underdeveloped Africa. Howard University Press Sachariew K (1991) Promoting compliance with international environmental legal standards: reflections on monitoring and reporting mechanisms. Yearb Int Environ Law 2(1):31–52 Setzer J, Higham C (2021) Global trends in climate change litigation: 2021 snapshot’ global trends in climate change litigation: 2021 snapshot’ policy report Shivji I (2020) Do constitutions matter? The dilemma of a radical lawyer. Strathmore Law Review 5(1):157–161 Stalley P (2018) Norms from the periphery: tracing the rise of the common but differentiated principle in international environmental politics. Camb Rev Int Aff 31(2):141–161 Suppiah R et al (2007) Australian climate change projections derived from simulations performed for the IPCC 4th assessment report. Aust Met Mag 56:131–152 The Global Commission on the Geopolitics of Energy Transformation (2019) A new world: the geopolitics of the energy transformation. IRENA

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Viñuales JE (2020) Two layers of self-regulation. Transnatl Leg Theory 11(1–2):16–32 Voigt C (2016) The compliance and implementation mechanism of the Paris Agreement. Rev Eur Comp Int Environ Law 25(2):161–173 Voigt C (2022) ANZSIL conference keynote 2019: climate change, the critical decade and the rule of law. Koninklijke Brill Nv Zhang Z et al (2020) Embodied carbon emissions in the supply chains of multinational enterprises. Nat Clim Change 10:1096–1101

Nciko wa Nciko LL. M in International Law at the Geneva Graduate Institute of International and Development Studies. He wishes to thank the ILINA Programme (its 2022 Fellowship cohort) for its special support both in the ‘researching’ and ‘writing’ phases of this contribution (https://ilinaf. org/).

The Green Climate Fund, Climate Change and Corporate Due Diligence: What Role for the Private Facility Sector? Rainer Maria Baratti

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 UNFCCC, COP and Green Climate Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 The Private Sector Facility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Corporate Climate Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract The United Nations Conference on Environment and Development in 1992 inaugurated the beginning of the “environmental globalism” phase. This coincides with the extension of international cooperation to global environmental issues, governed by conventions with a universal vocation. The Rio conference represents the starting point for environmental protection standards. On this occasion, the need to protect global environmental assets such as climate and biodiversity was acknowledged, stating that their degradation and loss are a “common concern for humanity”. With the Rio conference, the United Nations Framework Convention on Climate Change (UNFCCC), which came into force on March 21, 1994, was opened for signature and, through the Conferences of the Parties (COP), States try to complete this agreement. During the COP in Cancun in 2010, the Green Climate Fund was established, this provides funding in terms of loans, grants, actions or guarantees to its Accredited Entity (AE) which are responsible for the implementation of projects. Accredited entities include private and public, non-governmental, sub-national, national, regional or international entities. Accreditation is a due diligence process that ensures that partners share the same goals as the Fund, have extensive experience, and a strong financial and managerial infrastructure. The Fund is an operational entity of the UNFCCC financial mechanism (Art. 11) and the main innovation is the Private sector facility. The study we propose aims to investigate the functioning of this mechanism and what transformative role it can play in the R. M. Baratti (✉) Large Movements APS, Rome, Italy e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 63–82, https://doi.org/10.1007/8165_2022_93, Published online: 26 November 2022

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involvement of companies in the fight against climate change. In addition to addressing the institutional aspects, the contribution aims to investigate the merits and demerits of the Green Climate Fund with particular attention to the criticisms made by the Indigenous People Organization regarding the Country-ownership approach and the Policies mechanism. In addition, we will try to outline what role they have in the definition of due diligence mechanisms for companies.

1 Introduction The United Nations Conference on Environment and Development (UNCED)1 held in Rio de Janeiro in 1992 has marked the beginning of the so-called “environmental globalism” phase.2 This is characterized by the extension of international cooperation to global environmental issues and by the emergence of conventions with a universal vocation. The beginning of this phase represents a focal point for environmental protection norms and marks the starting point of the transposition into international law of the need to protect global goods such as climate, environment and biodiversity. It states that the degradation and loss of these is a ‘common concern for humanity’. In this pivotal step, the Rio Conference starts, among others, the opening for signature of the United Nation Framework Convention on Climate Change (UNFCCC),3 which contains framework rules and outcome obligations to fight climate change but, at the same time, the choice of forms to achieve these goals is left to the contracting parties. It is therefore stipulated that through the Conferences of the Parties (COPs), states complement the framework agreement by meeting annually to negotiate key aspects to complete the UNFCCC. In recent years, Climate Finance has been at the centre of the debate at the different COPs, marking the importance of climate finance, technology exchange and the growing role of business in fighting climate change.4 The negotiating environment of the COP, however, suffers from the difficulties in finding a common basis of consensus between developed and developing countries. This is especially so since developing countries initially demanded a correlation between the amount donor countries should pay and the amount of greenhouse emissions they produce, in line with the

1

UN General Assembly, UN Conference on Environment and Development: resolution/adopted by the General Assembly, 22 December 1989, A/RES/44/228, available at: https://www.refworld.org/ docid/3b00f18730.html. 2 Cordini et al. (2017), pp. 20 f. 3 UN General Assembly, United Nations Framework Convention on Climate Change: adopted by the General Assembly, 20 January 1994, A/RES/48/189, available at: https://www.refworld.org/ docid/3b00f2770.html. 4 Vanderheiden (2015), pp. 31 f.

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principle of “common but differentiated responsibilities”.5 Despite the difficulties in the negotiations and the geo-economic reasons, it was thanks to the COPs that a compromise solution was found and the Green Climate Fund (hereinafter GCF) was introduced. The Fund would seem to be an opportunity to undertake and finance important climate change adaptation measures of the most vulnerable countries because they are more exposed, more sensitive, and less resilient to impacts from the Climate. Failure to implement such measures properly and timely would increase inequalities between and within countries.6 In the author’s opinion, in order for the GCF to effectively contribute to progress in the safeguarding of fundamental rights related to Climate, it must advocate for the instances of Climate Justice. This is a concept that is not yet well structured but which can be defined as the link between human rights and the contrast to Climate Change. In order to analyse this concept, it is possible to refer to the following principles identified by the Mary Robinson Foundation – Climate Justice:7 (1) Respect and Protect Human Rights; (2) Support the Right to Development; (3) Share Benefits and Burdens Equitably; (4) Ensure that Decisions on Climate Change are Participatory, Transparent and Accountable; (5) Highlight Gender Equality and Equity; (6) Harness the Transformative Power of Education for climate stewardship; (7) Use Effective Partnerships to Secure Climate Justice. In order to evaluate the work of the GCF as a whole, reference will also be given to this framework. Climate change is a global phenomenon and does not occur exclusively where greenhouse gases are released or in the surrounding areas. In other words, everyone is impacted independently of their contribution. While this is undoubtedly true, it must be specified that this impact is not uniformly distributed. In addition, the violence of these effects differs depending on the fragilities of each territory and the adaptive capacity, which sometimes also depends on the economic and technological capacity of each country. For these reasons, we consider the proper functioning of the Green Fund and its financing to be a core issue of Climate Justice.

5

UN General Assembly, United Nations Framework Convention on Climate Change adopted by the General Assembly, 20 January 1994, A/RES/48/189, art. 3. 6 For further details, please refer to Global Center on Adaptation, State and Trends in Adaptation Report 2021. How Adaptation Can Make Africa, Safer, Greener and More Prosperous in a Warming World, 2021, available at: https://gca.org/wp-content/uploads/2022/08/GCA_ STA_2021_Complete_website.pdf. 7 The foundation defines Climate Justice as “links human rights and development to achieve a human-centred approach, safeguarding the rights of the most vulnerable and sharing the burdens and benefits of climate change and its resolution equitably and fairly. Climate justice is informed by science, responds to science and acknowledges the need for equitable stewardship of the world’s resources”. For further details, please refer to Mary Robinson Foundation – Climate Justice, Principles of Climate Justice, available at: https://www.mrfcj.org/principles-of-climate-justice/. For a discussion of human rights at risk in the face of climate change see Baratti (2021b), pp. 411 f.

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2 UNFCCC, COP and Green Climate Fund The first 15 years of climate negotiations were characterised by a top-down approach that started to break down in 2005, when the Kyoto Protocol signed in 1997 finally came into force. However, the year 2005, also due to the major delays with the protocol, was supposed to be the year in which to start laying the ground for a new commitment period post-2012. This was done 2 years later at COP 13 in Bali, where four main pillars on which to build a new pathway were identified: (1) mitigation; (2) adaptation; (3) finance; and (4) development and technology transfer in developing countries. The time seemed ripely right and the whole world was looking forward to COP 15 in Copenhagen in 2009. The COP was seen as a decisive turning point but this was not the case. The Copenhagen’s COP was the last step of the top-down approach due to the lack of sufficient political will. It was a clear signal that the approach taken with the Kyoto Protocol was not well pursued by many countries, especially developed ones. In contrast, in Copenhagen it was proposed for the first time to establish the GFC and it was the developed countries that agreed to the mobility of USD 100 billion per year for a new additional fund by 2020.8 A way was thus seen to breathe new life into the climate negotiations. The following year, there was a shift to a bottom-up approach with the aim of reaching a global agreement among all countries. During what can be described as a transitional year, the GFC was established at COP 16 in Cancun: the largest global fund to provide financial assistance to developing countries for the implementation of mitigation and adaptation projects. Under the Cancun Agreements, the Fund supports projects, programmes, policies and other activities in developing countries that are parties to the agreement using thematic funding windows.9 These windows have been defined as a sub-structure within the fund that allows specialisation and give a focus on a particular sector.10 The Fund is governed by a Board, composed of equal numbers of members from developed and developing countries, with special consideration given to representatives of Small Island Developing States (SIDS) and Least Developed Countries (LDCs). With the Durban COP, the High Contracting Parties decided to grant the Board full responsibility for funding decisions and the authority to add, modify and remove additional thematic windows to the initial two, i.e. the one for adaptation and the one for mitigation.11 The GFC is based on a ‘country-ownership’ philosophy that recognises the need to ensure that partner 8 Yamineva (2016), pp. 174 f.; Cui and Huang (2018), pp. 173 f.; Cui et al. (2014), pp. 266 f.; de Sépibus (2015), pp. 298 f.; Kalinowski (2020), pp. 8827 f.; Linnenluecke et al. (2013), pp. 397 f. 9 Conference of the Parties, Report of the Conference of the Parties on its 16th session, held in Cancun from 29 November to 10 December 2010, 15 March 2011, FCCC/CP/2010/7, available at https://unfccc.int/decisions?such=j&volltext=%22cancun%20agreements%22#beg. 10 Transitional Committee, second meeting, workstream III: Operational Modalities Sub-workstream III.2: Managing Finance Background note: Thematic windows, 29 giugno 2011, TC-2/WSIII/4, available on https://unfccc.int/process/bodies/funds-and-financial-entities/greenclimate-fund/meetings-of-the-transitional-committee-for-the-design-of-the-green-climate-fund. 11 Conference of the Parties, Report of the Conference of the Parties on its 17th session, held in Durban from 28 November to 11 December 2011, 15 March 2012, FCCC/CP/2011/9.

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countries exercise ownership of climate change funding in a way that complements their national action plans. In line with this philosophy, partner countries appoint a National Designated Authority (NDA) which interacts with the country government and the GFC in order to operate at two levels: on the one hand it ensures that its activities are approved in the country, and on the other hand it ensures that the Fund operates in harmony with national climate policy. At the same time, the GFC encourages, through a country-driven approach, the involvement of stakeholders, including the most vulnerable groups also through a gender perspective. The GCF assists UNFCC partner countries in pursuing programmatic and project-based approaches approved by the GCF. In general, the GFC provides funding to its Accredited Entities (AEs) that are responsible for implementing approved projects through loans, grants, equity or guarantees. AEs include a broad spectrum of entities and include private and public, non-governmental, sub-national, national, regional or international entities. Within the GCF, there is an accreditation process that verifies and ensures that partners share the same objectives as the fund, that they have a proven track record and that they have a sound financial and managerial infrastructure adequate to implement the project. With regard to the accreditation process, the Board has adopted a framework for the accreditation of national and international entities that includes principles and minimum standards that the AE must comply with, such as environmental and social safeguards (ESS). In order to be granted accreditation, all applicant entities must meet fiduciary standards and environmental and social safeguards as defined by the Board. As is well recognised, under international law the legal status of an International Fund determines the rights, privileges, duties and powers with which the organisation operates internationally.12 This status is separate from that of the States Parties, determining the extent to which, for example, the GCF can operate independently to perform its functions. In other words, the Fund is only authorised to exercise the prerogatives explicitly or implicitly conferred by states. In general, a Fund can acquire or receive its legal status in three main ways: (1) through international treaty; (2) through the decision of the supreme body of an intergovernmental body; (3) through the national law of one or more States party to an intergovernmental body or an international agreement. The first profile includes, by way of example, the International Monetary Fund (IMF) and the World Bank Group (WB). The statutes of these two institutions derive their legal force from international agreements finalised at the Bretton Woods Conference in 1944.13 The statutes recognise the two institutions full legal personality and, in particular, the capacity to contract, to acquire and dispose of movable and immovable property, and to institute legal proceedings. Moreover, given their nature and relevance in the international scenario, the UN General Assembly granted these financial institutions the authority to request advisory opinions from the International Court of Justice. It should be noted at this point that since these institutions are the expression of an international

12 13

Bantekas (2021), pp. 210 f.; Bantekas (2011), pp. 224 f.; Sciso (2017), pp. 200 f. Bretton Woods Agreements Act, adopted on 31 July 1945.

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agreement, they have a plenary body made up of the 189 member states. This meets annually to deal with the admission of new states, the modification of quotas for voting power or the suspension of defaulting states. As such, the body is an expression and representation of the States Parties. As we have pointed out, however, international funds can also acquire their international legal status through a decision of the supreme body of an intergovernmental organisation. In this regard, we can refer to the Multilateral Fund, established through the London Amendment to the 1990 Montreal Protocol.14 This amendment made it possible to establish a financial mechanism to support developing countries but did not specify the legal status of the Multilateral Fund. It was only through Decision VI/1615 of the Meeting of the Parties that the legal personality of the Multilateral Fund was recognised and it was granted the legal capacity to exercise its functions and protect its interests. To this end, the Fund was granted the capacity to enter into contracts, to acquire and dispose of assets, and to bring legal actions in defence of its interests. At this point, it is appropriate to investigate the legal status of the GCF. In this regard, we can refer to an earlier attempt within the UNFCCC to establish a Climate Change Adaptation Fund. In particular, at COP7 in 2001 in Marrakech, Morocco, the Conference of the Parties to the Kyoto Protocol established the Adaptation Fund through a decision. The institution of the Fund finds its legal grounding in Article 12 of the Kyoto Protocol, which states in paragraph 8: The Conference of the Parties serving as the meeting of the Parties to this Protocol shall ensure that a share of the proceeds from certified project activities is used to cover administrative expenses as well as to assist developing country Parties that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation16

During the following years, the Conference of the Parties to the Kyoto Protocol defined approaches, principles and operational modalities. In Bali in December 2007, it was also decided to endow the Fund with an operational entity called ‘the Council’ which, according to Decision 1/CMP.3, paragraph 5.B,17 would hold the functions of developing and deciding policies and guidelines with the obligation to report to the Conference of the Parties to the Kyoto Protocol. Its activities would be supported by a Secretariat and a Trustee. The Parties invited, on an interim basis, the Global Environment Fund (GEF) to provide secretariat services to the Council and the World Bank to serve as Trustee. The following year, the Parties decided to grant

14

United Nation Environment Programme, The London Amendment (1990): The amendment to the Montreal Protocol agreed by the Second Meeting of the Parties, 29 June 1990, art. 10. 15 United Nation Environment Programme, The Montreal Protocol on Substances that Deplete the Ozone Layer. Decision VI/16: Juridical personality, privileges and immunities of the Multilateral Fund, 7 October 1994. 16 United Nations Framework Convention on Climate Change, Kyoto Protocol to the United Nations Framework Convention on Climate Change adopted by Conference of the Parties, 10 December 1997, FCCC/CP/1997/L.7/Add.1, art. 12, par. 8. 17 Conference of the Parties Serving as the Meeting of the Parties to the Kyoto Protocol, Decision 1/CMP.3 Adaptation Fund, 14 March 2008, art. 5, par. B.

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it the legal capacity to perform its functions through Decision 1/CMP.4.18 This decision, however, allows the Council to accept Germany’s offer to grant it legal capacity by an Act of Parliament. It follows from this that the Council may conclude and sign contracts with the implementing bodies of funded projects but, as it has no international legal personality, it cannot conclude and sign international treaties or agreements with governments or international organisations, nor can it appear before international courts. Currently, the Adaptation Fund has been brought under the umbrella of the Paris Agreement through decisions 12/CMA.119 and 1/CMP.14.20 As of 19 January 2019, the Fund no longer serves the Paris Protocol but will continue to receive as funding shares of the proceeds, if available, of activities under Articles 6, 12 and 17 of the Kyoto Protocol, which refer to the clean development mechanism and the emissions trading system. Mutatis mutandis, the current scenario of the GCF would seem to be comparable to that of the Multilateral Fund. As we have said, the COP in Cancun established the GFC and therefore Decision 1/CP.16 is its legal basis. This recognises it as an operational entity of the UNFCC’s financial mechanism. The Article 11 of the UNFCCC at the paragraphs 1 states that A mechanism for the provision of financial resources on a grant or concessional basis, including for the transfer of technology, is hereby defined. It shall function under the guidance of and be accountable to the Conference of the Parties, which shall decide on its policies, programme priorities and eligibility criteria related to this Convention. Its operation shall be entrusted to one or more existing international entities21

In line with the aforementioned provision, the GFC is an operational entity of the UNFCCC’s financial mechanism and plays the key role of catalysing climate finance specifically targeted at developing countries, maximising the impact of finance for climate change adaptation and mitigation measures, and promoting environmental, social and economic benefits both domestically and internationally. For these reasons, the GCF is accountable to the COP and performs its functions under its leadership.22 The abovementioned decision and the UNFCCC itself therefore give the Fund the capacity to support projects, programmes, policies and other types of activities in developing countries. In addition to this, Decision 3/CP.17, which defines the mandate and working methods of the GCF, should be recalled, and in paragraph 11 we can read:

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Conference of the Parties Serving as the Meeting of the Parties to the Kyoto Protocol, Decision 1/CMP.4 Adaptation Fund, 19 March 2009, art. 11. 19 Conference of the Parties serving as the meeting of the Parties to the Paris Agreement, Decision 12/CMA.1 Matters relating to the Adaptation Fund, 2 December 2018, art. 1. 20 Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol, Decision 1/CMP.14 Matters relating to the Adaptation Fund, 2 December 2018, art. 1. 21 UN General Assembly, United Nations Framework Convention on Climate Change adopted by the General Assembly, 20 January 1994, A/RES/48/189, art. 11, par. 1. 22 Schalatek et al. (2015), pp. 1 f.

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As a result, the GCF acquired full legal status and the ability to move relatively autonomously as long as it complied with the UNFCCC and the decisions concluded by the COPs, as the GCF’s authority derives from them. It should be noted that this decision made it possible to make a financial institution operational by significantly reducing the time it would have taken for a treaty to be formed and ratified, while still allowing the GCF a fairly broad legal personality. In the writer’s opinion, this confirms that the GCF’s mandate can only be concretely fulfilled if the Fund itself is able to comply with the Minimum Standards developed within the UNFCCC system on environment, sustainable development and climate change. By way of example, we can refer to the so-called principles of environmental democracy described by the Rio Declaration on environment and development.24 ‘Environmental Democracy’ means informing citizens of the problems and consequences, both immediate and latent, of polluting phenomena, listening to their needs and requests, enabling valid knowledge with reliable information and accurate data; it is a vital element for the conscious participation of civil society in democracy and for the definition of correct environmental policies. Firstly, we note that, according to principle 3: The right to development must be fulfilled so as to equitably meet developmental and environmental needs of present and future generations.25

To make this happen, the best way to mediate the different competing interests is found in principle 10 of the declaration: Environmental issues are best handled with the participation of all concerned citizens, at the relevant level. At the national level, each individual shall have appropriate access to information concerning the environment that is held by public authorities, including information on hazardous materials and activities in their communities, and the opportunity to participate in decision-making processes. States shall facilitate and encourage public awareness and participation by making information widely available. Effective access to judicial and administrative proceedings, including redress and remedy, shall be provided.26

The importance of these principles has been enshrined through the UNECE convention known as the Aarhus Convention on access to information, public participation in decision-making and access to Justice in environmental matters.27 The Convention can be divided into three pillars: (1) Access to Information, (2) Public

23

Conference of the Parties, Report of the Conference of the Parties on its 17th session, held in Durban from 28 November to 11 December 2011, 15 March 2012, FCCC/CP/2011/9, decision 3/CP.17, par. 11. 24 UN General Assembly, Rio Declaration on Environment and Development adopted by the General Assembly, 14 August 1992, A/CONF.151/26 (Vol. I). 25 Ibidem, principle 3. 26 Ibidem, principle 10. 27 UNECE, Convention on access to information, public participation in decision-making and access to Justice in environmental matters, done at Aarhus on 25 June 1998. For a more detailed

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Participation, (3) Access to Justice. The Convention is a legally binding instrument and has the particularity of focusing on the interaction between the public and public authorities in a democratic context: it guarantees rights to the former and imposes obligations on both States Parties and public authorities. The Convention rests on the perception that wider access to information and greater participation in decisionmaking processes improve the quality of environmental decisions and enhance their effectiveness. Many human rights instruments have incorporated these principles and elaborated on the obligation of states to take reasonable and sufficient measures, to inform the public and to involve the public in decision-making processes involving them. In short, these are a series of procedural obligations to ensure that public authorities have considered all competing interests and protected the rights of individuals and communities. In the writer’s opinion, it can be said that these principles represent a minimum standard to be adhered to necessary for the concrete achievement of climate justice in the different decision-making processes. Moreover, in line with what was stated, at present, for the GCF, reference should be made to the Paris Agreement and this is not without unresolved issues.28 The Agreement does not define a quantitative target in terms of GHG emission reductions and sets a generic target of peaking GHG emissions as soon as possible and achieving an equilibrium of GHG emissions by the second half of this century. According to Article 4.2 of the Paris Agreement: Each Party shall prepare, communicate and maintain successive nationally determined contributions (NDCs) that it intends to achieve. Parties shall pursue domestic mitigation measures, with the aim of achieving the objectives of such contributions29

As such, countries must independently undertake GHG emission reduction targets covering all sectors of the economy and must outline and communicate their climate actions to be taken after 2020. The NDCs were to be submitted to the UNFCCC Secretariat by 2020 and every 5 years thereafter (e.g. by 2020, 2025, 2030), but at COP 26 in Glasgow, there was a return to common time horizons with a 10-year timeframe starting in 2025—to be reported every 5 years so as to make them comparable. The final text adopted at the end of COP 26, however, contains a safeguard clause for those countries that, for whatever reason, will not be able to communicate their NDCs according to the new rules as early as 2025, postponing the presentation of the new commitments to 2030 with another possible extension to 2040. Another issue related to the Paris COP would seem to be the lack of a clear road map on how to reach the target for developed countries to collectively mobilise USD 100 billion per year by 2020, the target that was already set in 2009 during COP 15 in Copenhagen. At the end of COP 26, the USD 100 billion promised to vulnerable countries was not approved, and this negatively affected the positioning

discussion of the Convention’s regulatory impact see Baratti (2021a), pp. 127 f., and Baratti (2022), pp. 49 f. 28 United Nations Framework Convention on Climate Change (2015) Adoption of the Paris Agreement, 21st Conference of the Parties, Paris: United Nations. 29 Ibidem, art. 4, par. 2.

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of China and India on other parts of the final agreement. Furthermore, a compromise was not found on the quantification of a new climate finance target by 2025, opting to create an ad hoc working group on the topic that will meet in four annual meetings from 2022 to 2024. Even if increasingly precise communication of the NDCs would ensure greater transparency on climate change decisions, the difficulty noted on the financing of the Fund is a cause for concern. Indeed, this would allow efforts to be shared, support the right to development of communities living in fragile territories and guarantee their human rights. This should take on even greater importance and inform the decisions of individual states parties to the UNFCCC also in light of a specific United Nations Human Rights Council (UNHRC) resolution dedicated to the link between human rights and climate.30 In a nutshell, the resolution emphasises the urgent need to include the fight against climate change within human rights policies related to social and economic development. In doing so, the Council emphasised the increasing urgency of implementing not only mitigation actions, but also compensatory actions for damage and losses caused by climate change in low- and middle-income countries. In these nations, the gap between the capacity to implement sustainable development policies and the adaptation measures needed to address the consequences of the climate crisis is widening, leading to widespread human rights violations.

3 The Private Sector Facility Within the GCF, the so-called Private Sector Facility (PSF) was envisaged with the aim of promoting and mobilising private sector climate action in developing countries through the provision of direct and indirect financing. This is an explicit request from developed countries as they see business action as essential for the fund to have a ‘transformative’ impact. The PSF provides the necessary expertise and technical assistance for the implementation of GCF projects through the involvement of other financing entities such as pension funds, regional and local banks, financial institutions and businesses themselves. In order to ensure the proper management of the financing and due diligence of the enterprises, the Board set up a management framework composed of two committees, one dedicated to risk management and one to investment, which review proposals and supervise investment instruments. In line with the principles underpinning the GCF, recipient countries can review projects proposed by the private sector and then produce a ‘no objection letter’ guaranteeing that the business activities are consistent with the national plan. The letter, however, is the last step in the proposal approval process, which, as defined by the Board, is divided into several key stages corresponding to the different cycles of

30

United Nations Human Rights Council, Human Rights and Climate change, 1 July 2022, available at https://documents-dds-ny.un.org/doc/UNDOC/LTD/G22/394/99/PDF/G2239499.pdf? OpenElement.

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project activity. In general, all proposing entities must submit their project funding proposals through an implementing agency or an accredited intermediary. This proposal may be prepared spontaneously or in response to a call for proposals published by the GCF. Once approved, projects are regularly monitored in order to assess their impact, efficiency and effectiveness. This ‘result-oriented’ monitoring is also verified through the guidelines and policies, the Independent Redress Mechanism (IRM), the Risk Management Framework (RMF), the Independent Evaluation Unit (IEU) and the Independent Integrity Unit (IIU). Through Decision B.09/03, the Board clarified the relationship between the Fund and the AEs.31 Depending on the type of accredited entity, the relationship between the Fund and that entity will take the form of a private law contract or an agreement, governed by general international law. In most cases, the GCF enters into contracts with private sector entities or stateowned enterprises. The procedure requires, in each case, that at the time of accreditation the entity enters into a framework agreement with the accredited entity that sets out the general terms and conditions. After the Board’s approval of a project or activity, a project-specific agreement is instead finalised. The framework agreement, by way of example, may contain, among other, the duration of the contract, preparation of the project pipeline, involvement of the NDA and conditions for project approval, as well as adherence to fund guidelines and environmental and social safeguard clauses. The IRM, RMF, IEU and IIU are part of the mechanisms to ensure accountability through risk management and evaluation of the Fund’s activities to ensure the application of internationally recognised safeguards and standards. For proper project risk management, the GCF has implemented a system, both upstream (before project approval) and downstream (whilst projects are being implemented). The GCF states in the document ‘Portfolio Risk Management’ that its mandate is ‘to promote a paradigm shift towards low-emission and climateresilient development pathways in developing countries’.32 To achieve these objectives, each investment follows a ten-stage programming cycle from origination to closure consisting of the following: (1) Country and entity work programmes; (2) Targeted project generation; (3) Concept note submission; (4) Funding proposal development; (5) Funding proposal review; (6) Board approval; (7) Legal arrangements; (8) Monitoring for performance and compliance; (9) Adaptative management; (10) Evaluation, learning and project closure. In order to ensure proper accountability of the Fund, all due diligence and evaluation processes are designed to ensure that all investments contribute to its mandate and are in line with applicable policies and regulatory frameworks. In a nutshell, the Fund’s Due Diligence process aims to determine minimum standards that the project must meet and is divided into two distinct levels. Primary Due Diligence (1DD) is an extensive process that is 31

Green Climate Fund, Decision GCF/B.09/03: Legal and formal arrangements with accredited entities, annex XI, adopted by the Board, 26 March 2015, available at https://www.greenclimate. fund/boardroom/meeting/b09. For a discussion of the role of private in the Fund see Surminski (2013), pp. 943 f.; Xu et al. (2022), pp. 5 f. 32 Green Climate Fund, Portfolio risk management, 15 February 2022, available at https://www. greenclimate.fund/sites/default/files/document/gcf-project-risk-management_2.pdf.

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undertaken by the EAs themselves to document, assess and verify the details of the investment opportunity. At this stage, NDAs have a primary role in ensuring that the funding proposal sent to the GCF is selected and prioritised in line with national development needs, policies, regulations, and plans, including NDCs to the Paris Agreement, and other national plans related to climate change. The main output of this first stage is a ‘concept note’ on which the next stage is based. Secondary Due Diligence (2DD) consists of the assessment carried out by the Fund Secretariat, the independent units and the panels of experts of the documentation prepared in the first phase in order to evaluate the details provided by the counterparties. During this phase, any relevant risks, i.e. technical, financial, environmental and social risks, are ascertained and identified to ensure the fiduciary standards of the Green Climate Fund. The GCF may in any case request further clarification, information and documentation from the AEs. However, it should be noted that, in the writer’s opinion, in these Due Diligence phases there is no provision for informing or involving external parties, or stakeholders, who might be impacted by project activities. In accordance with risk management procedures, the PSF aims to break down barriers to private sector financing and evaluates projects according to eight focus areas (energy; transport; buildings, cities, industry; forests and land use; livelihoods of people and communities; health, food and water, i.e. food security; ecosystems; infrastructure), six investment criteria (paradigm shift potential sustainable development; needs of recipients; country ownership; efficiency and effectiveness; compliance with Green Climate Fund Policies) and the completeness of the documentation (feasibility study; financial model; project timetable; gender analysis; environmental studies; letter of “no objection” from the state). As part of its work, the Board must develop mechanisms to promote stakeholder input and participation in the design, development, implementation and monitoring of the project. In line with this, two representatives from Civil Society and two from business are invited to act as active observers within the Board. In each case, an independent appeals mechanism is provided to allow people to challenge funding decisions that may have a negative impact. The Policies mechanism is used by the Board to adopt best environmental and social safeguard practices to be applied to all GCF-funded programmes and projects.33 The Board has developed a policy to manage the outcomes of all GCF-funded activities effectively and equitably with the aim of fulfilling its mandate to promote a paradigm shift towards low-emission and climate-resilient development paths in the context of sustainable development. To this end, the GCF calls on all funded entities to avoid and, where avoidance is impossible, mitigate negative impacts on people and the environment as well as to improve access to the benefits of development. Furthermore, funded entities must give due consideration to people in vulnerable positions or situations. To this end, the policy requires accredited entities to implement their environmental and social management system in light of

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Green Climate Fund, Revised Environmental and Social Policy, 13 September 2021, available on https://www.greenclimate.fund/document/revised-environmental-and-social-policy.

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what is stated in the policy. The GCF also requires that the AEs implement or monitor and supervise the implementation of the activity in compliance with the obligations regarding environmental and social conditions, including addressing any shortcomings. Despite the above, the mechanism established through the GCF has raised several criticisms from Indigenous People Organisations (IPOs), as in the case of a project financed in Datém del Marañón.34 The case raised the issue of the impacts of GCF funded projects on the lives and rights of indigenous peoples. These had in fact protested that they were not consulted before the project was financed and raised the need for Free Prior and Informed Consent (FPIC) to be respected. Following the protests of the IPOs, the GCF adopted an ad hoc policy in February 2018, at which time, however, the Fund had already disbursed huge amounts of money without the necessary safeguards and rules prescribing full engagement with indigenous peoples through consent-seeking procedures and without the necessary arrangements to ensure that project information was understandable to the population that would be impacted. The draft facts were only made available in English and there was no evidence of the full scope and nature of operations. Therefore, the policy adopted by the Board, recognising the contribution of indigenous peoples in climate change adaptation and mitigation, explicitly requires their involvement in the design, development and implementation of GCF-funded activities. This applies, where indigenous peoples are present, to both private and public entities and regardless of the possible negative or positive impacts through the follow-up of eight guiding principles derived from international indigenous peoples’ law. Specifically: (1) development and implementation of FPIC; (2) respect for the rights of indigenous peoples to their own land, territories and resources; (3) recognition of key human rights; (4) respect for the right of indigenous peoples to voluntary isolation; (5) recognition of the role of traditional knowledge and traditional livelihood systems; (6) empowerment of indigenous peoples’ claimant capacity within the GCF system; (7) facilitating access to GCF resources for indigenous peoples; (8) respect for the system of self-governance. In our opinion, based on the above, it is possible to point out that the Policy tool within the GCF serves as a flexible and responsive instrument to the different challenges that arise within the projects financed by the Fund. By the same token, however, it should be noted that this tool is activated only at the time of different critical issues, resulting in an ex-post solution. In any case, Datem’s experience well represents the importance of the communities involved in the various project processes. However, aspects related to participation in project decision-making and monitoring, guaranteeing the component of consensus and not mere consultation, of communities should be implemented in order to ensure the desired transformative impact.

34

Giacomini (2020), pp. 102 f.

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4 Corporate Climate Due Diligence At this point it should be stressed that the GFC acts in line with the REDD+ safeguards provided in the UNFCCC, so the environmental and social requirements of the GCF will need to be consistent with all decisions made in this area.35 In accordance with this, the GCF should conduct environmental and social due diligence on the evaluation of funding proposals. As such, the GCF should assess whether the AEs have examined, evaluated, and planned for the mitigation of environmental and social risks and impacts, including cross-border impacts. Within this, the GCF should check the consistency of the AEs’ proposed assessments and management measures with the ESS standards and policies adopted by the Board. As part of the evaluation of its due diligence activities, the GCF may review the environmental and social assessment prepared by the AEs through field visits designed to assign and delimit any risk categories. Thereafter, there is a review phase by which the GCF, after consulting with the AEs, proposes a series of actions aimed at resolving the critical issues that have arisen. Generally speaking, it can be said that there is a double degree of due diligence consisting of two levels: (1) one in which the GCF implementing its duty of care examines and analyses whether the different AEs comply with the fund’s standards and policies; and (2) one in which the AEs illustrate their own due diligence actions put in place to comply with environmental and social standards and the Board’s different policies. In general, GCF’s Environmental and Social Due Diligence involves: (1) investigation, review and evaluation activities; (2) evaluation of environmental and social management systems and the effectiveness and independence of the recourse mechanism; and (3) direction activities to AEs for the development and implementation of measures for the management of risks and impacts.36 This activity is carried out on the basis of the most recent, reliable, and relevant information from the funded activities with the possibility of requesting additional information from the AEs. In turn, GCF requires the AEs to undertake environmental and social due diligence on all activities proposed for funding. The purpose of the AEs due diligence is to ensure that activities proposed for GCF funding meet their environmental and social safeguard standards under GCF’s ESS standards. If AEs perform an intermediary function, they will require that implementing entities undertake the same level of due diligence. With regard to climate change, however, it must be emphasised that the reduction targets would appear to be too dependent on the stated objective of the state party to the UNFCCC. While the GCF due diligence activities would also include REDD+ provisions, it is worth noting, with particular reference to the EU States, that in the Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability

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Conference of the Parties, 16th session held in Cancun from 29 November to 10 December 2010, decision 1/CP.16. 36 Green Climate Fund, Revised Environmental and Social Policy, 13 September 2021, parr. 36–40.

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Due Diligence.37 The proposal for a Directive is part of the European strategy outlined through the Green Deal which, in late 2019, recognised Climate Change and environmental degradation as threats to Europe and the World. In short, it is a series of initiatives and political commitments aimed at ‘transforming the EU into a fair and prosperous society with a modern, resource-efficient and competitive economy’. According to the European Commission Communication itself, both the participation of all stakeholders and accessible and interoperable data are crucial for the Green Deal to achieve its objectives. As part of the initiatives implementing the European Deal, Regulation 2021/1119 on ‘European Climate Law’ was approved, with which the European Union set itself the binding target of reducing greenhouse gas emissions by 55% by 2030 and achieving climate neutrality by 2050.38 It firstly recognises that climate change is an existential threat and calls for a greater commitment to climate action by the EU and its Member States. The Climate Law dedicates Article 9 to ‘Public Participation’ stating that: 1. The Commission shall engage with all parts of society to enable and empower them to take action towards a just and socially fair transition to a climate-neutral and climate-resilient society. The Commission shall facilitate an inclusive and accessible process at all levels, including at national, regional and local level and with social partners, academia, the business community, citizens and civil society, for the exchange of best practice and to identify actions to contribute to the achievement of the objectives of this Regulation. The Commission may also draw on the public consultations and on the multilevel climate and energy dialogues as set up by Member States in accordance with Articles 10 and 11 of Regulation (EU) 2018/1999. 2. The Commission shall use all appropriate instruments, including the European Climate Pact, to engage citizens, social partners and stakeholders, and foster dialogue and the diffusion of science-based information about climate change and its social and gender equality aspects.39

The provision under consideration starts from the perception that public participation in the effort towards climate neutrality must first of all be made concretely possible by the institutions through precise and comprehensive information. The right of informed participation of European citizens is enshrined as an inviolable right. These, in other words, must be informed and listened to in order to improve decision-making on climate issues. This would make it possible to exchange best practices and identify actions that contribute to achieving the goals. The reasoning behind the provision is fundamental for the promotion of Climate Justice throughout the European Union and should also animate future legislation. In line with these, the

37

European Commission, Proposal for a Directive on corporate sustainability due diligence and annex, 23 February 2022, available at https://ec.europa.eu/info/publications/proposal-directivecorporate-sustainable-due-diligence-and-annex_en. 38 Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021 establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (‘European Climate Law’), art. 1, available at https://eur-lex.europa. eu/legal-content/EN/TXT/HTML/?uri=CELEX:32021R1119&from=IT. 39 Ibidem, art. 9.

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proposed Directive on Due Diligence of Companies should fit into the track marked by the Green Deal and, according to the Climate Action Plan, each company should adopt a plan to ensure that its business model and strategy is compatible with the Green Transition and the Paris Agreement. The Article 15 of the recent proposal envisages due diligence obligations for companies in the area of climate change. In para. 1, the provision stipulates the obligation for companies to adopt a plan to ensure that the business model and the corporate strategy pursued are compatible with the goal of limiting global warming to 1.5 °C in accordance with the Paris Agreement, indicating the extent to which climate change poses a risk to the company’s activities or a possible impact thereof. However, the proposal is very vague on this point, and it should be pointed out that the list in its annex, which contains the human rights that businesses must respect, does not include the Paris Agreement. What is worrying is that, as formulated, it is a formal and not a substantial obligation to combat climate change. In fact, the proposal does not include short-, medium- and long-term reduction targets for companies, and neither quality requirements for such plans, nor an evaluation mechanism to ensure that such a plan is actually implemented. Finally, it would be necessary that violations of these obligations, if not complied with by companies, would give rise to civil liability and that potential victims would be able to seek an effective remedy before a court of law. While the commitment of companies to manage environmental and human rights risks through the Directive would take centre stage, it would be preferable for a broad view of human rights and environmental standards to be taken on board in the discussion. It would also be crucial to strengthen stakeholder participation in order to implement those principles of environmental democracy enshrined in the 1992 Rio Declaration and enshrined in the 1998 Aarhus Convention. On this topic, it is of interest to highlight the position of the United Nation Human Rights Office of the High Commissioner (OHCHR) through the document ‘Climate Change and the UN Guiding Principles on Business and Human Rights’.40 The document recognises that: Business plays a central role in climate change. Much of the CO2 emissions causing climate change come from business-driven economic activity. However, business activities can also contribute to innovation and solutions to prevent, mitigate and adapt to climate change and its adverse impacts on the planet and its people. To avert future climate harms and ensure climate justice, business enterprises must be part of the solution.41

Accordingly, with reference to the Guiding Principles, companies must respect human rights in the context of climate change by taking proactive steps to identify, prevent, mitigate and address adverse impacts with which they are involved, including impacts resulting from climate change. To fulfil their responsibility, they must: (1) Identify and assess any actual or potential adverse human rights impacts;

40

United Nation Human Rights Office of the High Commissioner, Climate Change and the UN Guiding Principles on Business and Human Rights, available at https://www.ohchr.org/sites/ default/files/Documents/Issues/ClimateChange/materials/KMBusiness.pdf. 41 Ibidem.

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(2) Integrate the findings, and take appropriate action to prevent and mitigate impact; (3) Track the effectiveness of their response; (4) Communicate how they address their human rights impacts externally. The aspects listed above should inform business activities in order to promote real progress in addressing climate change and responding to its impacts beyond current legislation. As we have seen both in the context of the GCF and in their own day-to-day activities, businesses can play a key role in both mitigation and adaptation to climate change. Monitoring compliance with the minimum standards outlined above can be a crucial step for the future of mankind. In this regard, the proposed European directive itself can be an opportunity to implement an EU-wide business due diligence obligation with effects even beyond the borders of the EU itself. Awaiting further developments, we highlight the need for a mandatory supranational due diligence standard as there is currently a real grey area in which companies can act with impunity.

5 Conclusion From what we have seen, the GFC is an important tool to create a good consensus base between developed and developing countries. One of the greatest potentialities of the Fund is that of having tried to carve out a proactive and transformative space for companies, or AEs. In this sense, the GFC lends itself to being a fundamental instrument to facilitate the path towards the achievement of the various national objectives of developing countries through, also, the involvement of companies from developed countries. The latter, should they be involved in this virtuous process, on the one hand would be able to internalise environmental and social standards useful for mitigating climate change, while on the other hand they would operate under the control of the GFC standards in contexts where they usually have few rules concerning the fight against climate change or environmental protection. Another valuable element is that in doing so, the AEs enjoy the technical support and advice of the Fund. However, it should be pointed out, as Datem’s experience tells us, that the policy mechanism has both merits and drawbacks. While it is a flexible tool that, at least at the moment, aims to set higher environmental standards in line with international standards, it suffers from a certain delay in response that could be problematic. It would also be appropriate to provide, alongside the appeals mechanism, useful mechanisms to increase involvement in decision-making processes and monitoring, including civic monitoring, of the various projects financed by the GCF. In our opinion, this would increase the level of prevention offered by the fund and facilitate the exchange with the best practices of a given place, thus enhancing local knowledge and expertise. However, the GCF project is a half-baked project that is experiencing political difficulties at national and international level. Particularly with regard to climate change, there seems to be a certain degree of vagueness which, at least for EU companies, could be overcome through the recent proposal of the European Commission. In this regard, more precise and useful rules for justiciability in the different national courts would be an important step forward towards climate

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neutrality and complementary protection to the GCF redress mechanism. The challenge is still open but, with the appropriate implementations, both the GCF and the commission’s recent proposal on corporate due diligence can be the necessary tools to guarantee intra-generational justice, thus avoiding the phenomena of environmental migration, and inter-generational justice, thus guaranteeing a new global scenario for future generations.

References Bantekas I (2011) The emergence of intergovernmental trusts in international law Bantekas I (2021) The legal personality of World Bank funds under international law. Tulsa Law Rev 56(2):210–254 Baratti RM (2021a) Lotta al cambiamento climatico e prospettive di tutela europea dei diritti in capo alle generazioni future. Diritti dell’Uomo. Cronache e Battaglie (1):127–144 Baratti RM (2021b) Vulnerabilità socio-ambientali e migrazioni. Diritti dell’Uomo. Cronache e Battaglie (2):411–434 Baratti RM (2022) Business & Human Rights nella giurisprudenza della Corte europea dei diritti umani in material d iambiente: limiti, sfide e prospettive. Diritti dell’Uomo. Cronache e Battaglie (1):49–82 Cordini G, Fois P, Marchisio S (2017) Diritto ambientale: profili internazionali, europei e comparati, pp 12–15 Cui L, Huang Y (2018) Exploring the schemes for Green Climate Fund Financing: international lessons. World Dev 101:173–187 Cui L, Zhu L, Springmann M, Fan Y (2014) Design and analysis of the Green Climate Fund. J Syst Sci Syst Eng:266–299 de Sépibus J (2015) Green Climate Fund: how attractive is it to donor countries? Carbon Clim Law Rev 9(4):298–313 Giacomini G (2020) Free prior and informed consent in the Green Climate Fund: the implementation of a project in the Datém del Marañón, Peru, CUHSO, pp 102–125 Kalinowski T (2020) Institutional innovations and their challenges in the Green Climate Fund: country ownership, civil society participation and private sector engagement. Sustainability 12(21):8827. https://doi.org/10.3390/su12218827 Linnenluecke MK, Griffiths A, Winn MI (2013) Firm and industry adaptation to climate change: a review of climate adaptation studies in the business and management field. WIREs Clim Change 4:397–416. https://doi.org/10.1002/wcc.214 Schalatek L, Nakhooda S, Watson C (2015) The Green Climate Fund, Heinrich Boll Stiftung North America Climate Funds Update, 11, 1–8 Sciso E (2017) Appunti di diritto internazionale dell’economia, pp 200–210 Surminski S (2013) Private-sector adaptation to climate risk. Nat Clim Change 3:943–945. https:// doi.org/10.1038/nclimate2040 Vanderheiden S (2015) Justice and climate finance: differentiating responsibility in the Green Climate Fund. Int Spectator 50(1):31–45 Xu M, Qin Z, Wei Y (2022) Exploring the financing and allocating schemes for the Chinese Green Climate Fund. Environ Dev Sustain. https://doi.org/10.1007/s10668-022-02137-5 Yamineva Y (2016) Climate finance in the Paris outcome: why today what you can put off till tomorrow? Rev Eur Comp Int Environ Law 25(2):174–185

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Rainer Maria Baratti is Vice President of Large Movements APS, where he leads the research team dedicated to environmental and climate migration. He has obtained a master’s degree in International Relation at the University of Rome La Sapienza, he obtained a Professional Master’s diploma (Italian post-graduate specialization) in International Protection of Human Rights “Maria Rita Saulle” at the same university. He has published scientific articles on international refugee and migration law and international environmental law in the scientific journals. He has always been active in the protection of human rights, the environment and the fight against discrimination and has collaborated with Service Civil International, Brigada de voluntarios bolivarianos del Peru, Unione forense per la tutela dei diritti umani, A SUD Onlus and ActionAid Italia.

Market Access Conditionality and Border Carbon Adjustments Christian Riffel

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Carbon Pricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Border Carbon Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Inconsistency with WTO Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Border Adjustability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Article I:1 GATT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 TBT Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Justifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Article XX(b) GATT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Article XX(g) GATT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Article XX(a) GATT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Chapeau . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5 Article XXI(b)(iii) GATT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

84 89 89 91 93 93 99 106 108 108 121 124 125 143 145 146

Abstract The present article explores the legality of making market access conditional upon non-product-related processes and production methods, with a view to protecting environmental commons. The article uses the European Commission proposal for a border carbon adjustment mechanism (CBAM) as a case study. It finds that CBAM, even though it infringes Articles I:1 and II:1(b) General Agreement on Tariffs and Trade, can be justified in principle. In coming to this conclusion, the article compares CBAM with alternative measures to prevent carbon leakage. One of the main criticisms levelled against CBAM, in light of the chapeau, is that it is the EU that sets the rate of the import charge to be paid for each ton of carbon emitted. This criticism will be refuted. The author proposes to revisit the interpretation of the chapeau and to reduce it to an arbitrariness test. On the basis of the prevailing reading, Members may be forced to rely upon the security exception to

C. Riffel (*) University of Canterbury, Christchurch, New Zealand e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 83–148, https://doi.org/10.1007/8165_2022_85, Published online: 30 September 2022

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justify (some aspects of) WTO-inconsistent climate measures instead of the general exceptions, which entails a lesser degree of scrutiny. That said, while overreliance on the security exception threatens to undermine the multilateral trading system, its invocation seems apposite in the case of climate change, considering the seriousness of its repercussions.

1 Introduction The conditioning of market access has irked the world trading order from its beginning.1 Albeit one of the most foundational issues of international trade law, the matter is still unsettled. One just think of the controversy around the European Commission proposal for a border carbon adjustment mechanism (CBAM),2 the recent EU – Palm Oil dispute,3 or the extension of mandatory (human rights/ environmental) due diligence obligations to foreign traders.4 Pronouncements by the Appellate Body that cannot be easily reconciled have further muddied the waters. In US – Shrimp, the Appellate Body condemned a measure that had an ‘intended and actual coercive effect on the specific policy decisions made by foreign governments’.5 The Appellate Body opined that it is not acceptable . . . for one WTO Member to use an economic embargo to require other Members to adopt essentially the same comprehensive regulatory program, to achieve a certain policy goal, as that in force within that Member’s territory, without taking into consideration different conditions which may occur in the territories of those other Members.6

It does not follow from this that no unilateral trade action with coercive effects could be taken. The Appellate Body later specified that ‘conditioning market access on the adoption of a programme comparable in effectiveness, allows for sufficient flexibil-

1

See e.g. Committee on Trade and Environment, Committee on Technical Barriers to Trade, ‘Negotiating History of the Coverage of the Agreement on Technical Barriers to Trade with Regard to Labelling Requirements, Voluntary Standards, and Processes and Production Methods Unrelated to Product Characteristics’ Note by the Secretariat, WT/CTE/W/10, G/TBT/W/11 (29 August 1995), pp. 37–54. 2 European Commission, Proposal for a Regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism, COM(2021) 564 final (14 July 2021), p. 48 (CBAM Proposal). 3 European Union – Certain Measures Concerning Palm Oil and Oil Palm Crop-based Biofuels, Request for Consultations by Indonesia, WT/DS593/1 (16 December 2019). For an analysis of the claims, see Mitchell and Merriman (2020), pp. 548 ff. 4 Ruggie et al. (2021), p. 194. 5 Appellate Body Report, United States – Import Prohibition of Certain Shrimp and Shrimp Products, WT/DS58/AB/R, adopted 6 November 1998, para. 161. 6 Ibid., para. 164 (emphasis in original).

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ity in the application of the measure so as to avoid “arbitrary or unjustifiable discrimination”.’7 By implication, this means that ‘A country can justifiably impose trade-related measures against foreign countries which do not adopt programs of comparable effectiveness in protecting the natural resource in question’.8 In US – Tuna II (Mexico), the Appellate Body went even further and found that the ‘objective of “contributing to the protection of dolphins, by ensuring that the [respondent’s] market is not used to encourage fishing fleets to catch tuna in a manner that adversely affects dolphins” is a legitimate objective’.9 It is undisputed that Members may make importation conditional upon compliance with domestic rules that have no extraterritorial effects, such as compliance with biosecurity laws, import licencing (if automatic),10 or customs procedures, including the payment of customs duties. In US – Shrimp, the Appellate Body stated in general terms that: conditioning access to a Member’s domestic market on whether exporting Members comply with, or adopt, a policy or policies unilaterally prescribed by the importing Member may, to some degree, be a common aspect of measures falling within the scope of one or another of the exceptions . . . of Article XX . . . It is not necessary to assume that requiring from exporting countries compliance with, or adoption of, certain policies (although covered in principle by one or another of the exceptions) prescribed by the importing country, renders a measure a priori incapable of justification under Article XX. Such an interpretation renders most, if not all, of the specific exceptions of Article XX inutile, a result abhorrent to the principles of interpretation we are bound to apply.11

The Appellate Body confirmed the importance of this pronouncement in US – Shrimp (Article 21.5 – Malaysia).12 That said, it is contested whether the same holds true for rules that make importation conditional upon the processes and production methods (PPMs) used in exporting countries, for instance, the carbon footprint of products. An explicit regulation can be found in Article 23.6.1 United States-Mexico-Canada Agreement (USMCA), which requires each Party to ‘prohibit the importation of goods into its territory from other sources produced in whole or in part by forced or compulsory labor, including forced or compulsory child labor.’13 Bäumler inferred from US – Tuna II (Mexico) that, in light of the regulatory interest of a Member in relation to its own market, it is accepted now that trade-restrictive measures are justifiable in

Appellate Body Report, United States – Import Prohibition of Certain Shrimp and Shrimp Products – Recourse to Article 21.5 of the DSU by Malaysia, WT/DS58/AB/RW, adopted 21 November 2001, para. 144 (emphasis in original). 8 Veel (2009), p. 788. 9 Appellate Body Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products, WT/DS381/AB/R, adopted 13 June 2012, para. 407(d). 10 Art. 2(2)(b) Agreement on Import Licensing Procedures. 11 Appellate Body Report, US – Shrimp, para. 121. 12 Appellate Body Report, US – Shrimp (Article 21.5 – Malaysia), para. 138. 13 United States-Mexico-Canada Agreement (signed 30 November 2018, entered into force 1 July 2020). 7

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principle even when requiring producers in other Members to adapt their PPMs to the regulating Member’s market entry conditions.14 By contrast, the WTO website maintains that ‘[f]irst, trade restrictions cannot be imposed on a product purely because of the way it has been produced. Second, one country cannot reach out beyond its own territory to impose its standards on another country.’15 Charnovitz concludes that it is ‘clearly WTO-illegal to condition trade on whether another country is pursuing a similar climate policy just as it would be WTO-illegal to condition trade on whether another country is pursuing a similar human rights policy or a similar foreign policy.’16 Using CBAM as an example,17 this article puts the veracity of those statements to the test and revisits the question of whether Members may leverage their market power (which the EU as the second largest consumer market in the word undoubtedly has)18 to pressure exporting Members to change their policies—in exchange for (better) access. As regards climate response measures, this question comes to a head when trade action is directed against PPMs in other Members. As per Recital 12, CBAM ‘would also encourage the use of more GHG emissions-efficient technologies by producers from third countries’. Nothing less than the legitimacy of the WTO is at stake, for the answer to the above question will decide if WTO law is part of the solution to the climate crisis. Bacchus rightly laments the continuing tension between international trade and international climate law: ‘Neither the climate institution nor the trade institution has considered seriously the consequences of the trade restrictions that are likely to be a part of many national measures enacted to address climate change.’19 Sifonios and Ziegler summarize the dilemma: While prohibiting PPM measures could represent a major obstacle to international environmental protection efforts, allowing unrestrained process-based import restrictions could conversely lead to a significant increase in barriers to international trade and could thereby interfere with the objectives of the world trading system.20

14

Bäumler (2020), p. 474. WTO, ‘The Environment: A Specific Concern’, https://www.wto.org/english/thewto_e/whatis_e/ tif_e/bey2_e.htm. 16 See comment in Bernard O’Connor, ‘Guest Post on Carbon Border Adjustment’ International Economic Law and Policy Blog (6 December 2019), https://ielp.worldtradelaw.net/2019/12/guestpost-on-carbon-border-adjustment.html. 17 For the status of the legislative procedure, see European Parliament, Legislative Observatory, ‘Carbon Border Adjustment Mechanism’ (17 September 2022), https://oeil.secure.europarl.europa. eu/oeil/popups/ficheprocedure.do?lang=en&reference=2021/0214(OLP). 18 Yuliia Oharenko, ‘An EU Carbon Border Adjustment Mechanism: Can It Make Global Trade Greener While Respecting WTO Rules?’ SDG Knowledge Hub (17 May 2021), https://sdg.iisd.org/ commentary/guest-articles/an-eu-carbon-border-adjustment-mechanism-can-it-make-global-tradegreener-while-respecting-wto-rules/. 19 Bacchus (2022), p. 181. 20 Sifonios and Ziegler (2020), p. 108. 15

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It bears stressing that, even after the demise of the Appellate Body, WTO compliance is not just a question of principle.21 Measures can still be challenged either because the disputing parties agreed not to appeal or under the interim arrangement. In addition, climate measures are exposed to litigation under free trade agreements. It is commonplace that trade interests may conflict with other non-commercial interests. To resolve these conflicts, the conflicting interests have to be weighed up, prioritization decisions have to be made. In international trade law, this is where exception clauses come into play. The conceptualization of non-commercial interests as exceptions has been questioned because it implies a systematic prioritization of commercial interests—not a hierarchy, however. The Appellate Body confirmed early on that merely characterizing a treaty provision as an ‘exception’ does not by itself justify a ‘stricter’ or ‘narrower’ interpretation of that provision than would be warranted by examination of the ordinary meaning of the actual treaty words, viewed in context and in the light of the treaty’s object and purpose, or, in other words, by applying the normal rules of treaty interpretation.22

In a subsequent ruling, the Appellate Body elaborated that by authorizing in Article XX(g) measures for environmental conservation, an important objective referred to in the Preamble to the WTO Agreement, Members implicitly recognized that the implementation of such measures would not be discouraged simply because Article XX(g) constitutes a defence to otherwise WTO-inconsistent measures.23

Against the backdrop that WTO law does not have conflict rules like Article 1.3 USMCA, the importance of these pronouncements cannot be overemphasized because they help, together with the principle of systemic integration in Article 31(3)(c) Vienna Convention on the Law of Treaties (VCLT),24 reconcile the trading regime with other international law regimes pursuing different mandates. Sifonios and Ziegler contend that ‘each country has the sovereign right to choose the conditions to which products can be imported in its territory.’25 The authors come to this conclusion because ‘there is no right to trade’.26 This is certainly true under customary international law. Likewise, WTO law does not guarantee freedom See e.g. James Bacchus, ‘When Two Global Agendas Collide: How the EU’s Climate Change Mechanism Could Fall Afoul of International Trade Rules’ World Economic Forum (7 July 2021), https://www.weforum.org/agenda/2021/07/how-the-eus-carbon-border-adjustment-mechanismcould-fall-afoul-of-wto-regulations/. 22 Appellate Body Report, EC – Measures Concerning Meat and Meat Products (Hormones), WT/DS26/AB/R, WT/DS48/AB/R, adopted 13 February 1998, para. 104. 23 Appellate Body Report, European Communities – Conditions for the Granting of Tariff Preferences to Developing Countries, WT/DS246/AB/R, adopted 20 April 2004, para. 95. 24 Vienna Convention on the Law of Treaties (concluded 23 May 1969, entered into force 27 January 1980) 1155 UNTS 331. Cf. Appellate Body Report, European Communities and Certain Member States – Measures Affecting Trade in Large Civil Aircraft, WT/DS316/AB/R, adopted 1 June 2011, para. 845. 25 Sifonios and Ziegler (2020), p. 125. 26 Ibid. 21

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to trade either.27 While this is the point of departure, what WTO law does is it disciplines the right of Members to restrict market access—and hence the Members’ freedom to attach conditions thereto. Indeed, disciplining the use of trade barriers is the primary objective of WTO law.28 Let us take the most-favoured-nation (MFN) obligations as an example:29 it cannot be inferred from the requirement ‘unconditionally’ that Members could not attach conditions to the grant of advantages, but those being attached must not modify competition in favour of traders from one country.30 There is the rub: to what extent do WTO commitments restrict the conditioning of market access, especially when market access is made conditional upon non-product-related PPMs, with a view to protecting environmental commons? Market access conditions range from mere standard-setting to imposing particular PPMs upon exporting countries, with the former being WTO-compatible and the latter not.31 In the former case, it is left to foreign traders how the market access condition (i.e. the standard) is met. What interests us in the following is the grey area in between. Linking market access to the carbon footprint of imports is different in that it targets the way imports have been manufactured abroad. This article has two main parts. After briefly describing the measure and its background, the article explores if CBAM, as envisioned by the European Commission, infringes WTO law and, in a second step, canvasses possible grounds of justification. In doing so, the article compares CBAM with alternative measures to prevent carbon leakage. Two of the key issues addressed will be, first, the chapeau analysis under the general exceptions—which is the main stumbling block to justifying WTO-inconsistent climate measures—and, secondly, the relevance of the security exception in this context. For better or worse, the chapeau is also used in free trade agreements, primarily through incorporating the WTO exceptions.32 Existing research largely concentrates upon the exceptions in Article XX(b) and (g) General Agreement on Tariffs and Trade (GATT).33 As will be seen, in actual 27

Dobson (2021), p. 71. Cf. Recs 3-4 Preamble to the Marrakesh Agreement Establishing the World Trade Organization (adopted 15 April 1994, entered into force 1 January 1995) 1867 UNTS 154 (WTO Agreement). 29 Arts I:1 General Agreement on Tariffs and Trade (GATT), II:1 General Agreement on Trade in Services (GATS), 4 Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS). 30 Appellate Body Report, European Communities – Measures Prohibiting the Importation and Marketing of Seal Products, WT/DS400/AB/R, WT/DS401/AB/R, adopted 18 June 2014, para. 5.88. 31 Porterfield (2019), pp. 34–36; Appellate Body Report, US – Shrimp, paras 161, 177. 32 See e.g. Art. 28.3 Comprehensive Economic and Trade Agreement Between Canada, of the One Part, and the European Union and its Member States, of the Other Part (signed 30 October 2016, provisionally applied since 21 September 2017) (CETA); Art. 29.1 Trans-Pacific Partnership Agreement (TPP) as incorporated into the Comprehensive and Progressive Agreement for TransPacific Partnership (signed 8 March 2018, entered into force 30 December 2018) by virtue of Art. 1(1) thereof; Art. 32.1 United States-Mexico-Canada Agreement (signed 30 November 2018, entered into force 1 July 2020); Art. 17.12 Regional Comprehensive Economic Partnership Agreement (signed 15 November 2020, entered into force 1 January 2022) (RCEP). 33 Cf. Boklan (2021), pp. 137–142; Dobson (2021), pp. 86–98. 28

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fact, the WTO conformity of climate measures hinges upon the chapeau and whether they come within the scope of the security exception in Article XXI GATT.

2 Measures The article uses CBAM as a case study to investigate the legality of making market access conditional upon non-product-related PPMs. In a nutshell, border carbon adjustments extend the domestic carbon pricing scheme to imports.34 The rationale is that imports should contribute to the objective of reducing carbon emissions just like domestic products.35 One of the key questions for WTO compatibility will be whether the actual financial ‘burdens imposed on imported products, on the one hand, and like domestic products, on the other hand’ are equivalent.36 As an aside, CBAM does not apply to exports, with the consequence that it does not constitute a prohibited export subsidy in terms of Article 3.1(a) Agreement on Subsidies and Countervailing Measures (SCM Agreement)—a question often raised in the context of border carbon adjustments.37

2.1

Carbon Pricing

The science proving climate change, and the adverse effects resulting from it, is overwhelming.38 In the Paris Agreement, the Parties agreed to hold ‘the increase in the global average temperature to well below 2°C above pre-industrial levels and pursu[e] efforts to limit the temperature increase to 1.5°C above pre-industrial levels’.39 With 193 parties, the Paris Agreement, which replaced the Kyoto Protocol,40 has an even wider membership than the WTO Agreement.41 Greenhouse gases

34

Veel (2009), pp. 749–750. Cf. ibid., p. 771. 36 Dias et al. (2020), pp. 16, 19. Cf. Appellate Body Report, Brazil – Certain Measures Concerning Taxation and Charges, WT/DS472/AB/R, WT/DS497/AB/R, adopted 11 January 2019, para. 5.35. 37 It is disputed if carbon border adjustments amount to a subsidy in light of fn. 1 to Art. 1.1(a)(1) (ii) SCM Agreement. Cf. Evans et al. (2021), p. 314; Trachtman (2017), pp. 486–487, 490–491; Mehling et al. (2019), pp. 470–471; Marceau (2016), p. 34. 38 Intergovernmental Panel on Climate Change (IPCC), Working Group II, Sixth Assessment Report, Headline Statements from the Summary for Policymakers (28 February 2022) D.5, 1st sentence, https://www.ipcc.ch/report/ar6/wg2/resources/spm-headline-statements/. 39 Art. 2(1)(a) Paris Agreement (signed 22 April 2016, entered into force 4 November 2016). 40 Kyoto Protocol to the Framework Convention on Climate Change (signed 11 December 1997, entered into force 16 February 2005). 41 For the membership of the Paris Agreement, see United Nations Climate Change, ‘Paris Agreement – Status of Ratification’ (2022), https://unfccc.int/process/the-paris-agreement/status35

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(GHGs), in particular carbon dioxide (CO2), are widely held to be the ‘main driver of climate change’.42 The Hague District Court in Milieudefensie v. Royal Dutch Shell observed that ‘reduction pathways aiming for a net 45% reduction of CO2 emissions in 2030, relative to 2010 levels, offer the best possible chance worldwide to prevent the most serious consequences of dangerous climate change.’43 Climate change and GHG emissions are clearly connected. Furthermore, the High-level Commission on Carbon Prices found that ‘the explicit carbon-price level consistent with achieving the Paris temperature target is at least US$40–80/ tCO2 by 2020 and US$50–100/tCO2 by 2030, provided a supportive policy environment is in place.’44 Albeit not an intergovernmental standard,45 it is worth noting that the High-level Commission links the Paris temperature target to a carbon price. Carbon pricing mechanisms put a price on goods relative to the amount of GHGs emitted during their manufacture. With a view to incentivizing ‘both producers and consumers to limit the use of carbon intensive . . . products’, carbon pricing internalizes the cost of pollution, which otherwise would not have been taken into account in production processes,46 and thus helps overcome this market failure, known as the ‘tragedy of the commons’.47 More and more countries are introducing, or at least considering, carbon pricing mechanisms.48 Canada has had a carbon tax across the entire country since 2019.49 The EU has been using a cap-and-trade system since 2005, a world’s first.50 The of-ratification. For the membership of the WTO Agreement, see WTO, ‘Members and Observers’, https://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm. 42 European Commission, ‘Causes of Climate Change’ Climate Action, https://ec.europa.eu/clima/ change/causes_en; National Aeronautics and Space Administration, ‘The Causes of Climate Change’ Global Climate Change: Vital Signs of the Planet (14 September 2022), https://climate. nasa.gov/causes/. 43 Rechtbank Den Haag, Milieudefensie v. Royal Dutch Shell, ECLI:NL:RBDHA:2021:5339, C/09/ 571932 / HA ZA 19-379, para. 4.4.29, https://uitspraken.rechtspraak.nl/inziendocument?id=ECLI: NL:RBDHA:2021:5339. 44 High-level Commission on Carbon Prices, Report (29 May 2017), p. 3, https://static1. squarespace.com/static/54ff9c5ce4b0a53decccfb4c/t/59b7f2409f8dce5316811916/150522733274 8/CarbonPricing_FullReport.pdf. 45 Christian Häberli in O’Connor (2019). 46 Bacchus (2022), p. 179; Leal-Arcas (2021), p. 145; Will (2019), p. 210; Marceau (2016), p. 25. 47 High-level Commission on Carbon Prices (2017), p. 3; Leal-Arcas (2021), p. 135. 48 World Bank, State and Trends of Carbon Pricing (2021), p. 21, https://openknowledge. worldbank.org/handle/10986/35620. For the US proposal, see US Congress, ‘Clean Competition Act’, https://www.congress.gov/bill/117th-congress/senate-bill/4355?s=1&r=6. 49 Greenhouse Gas Pollution Pricing Act (SC 2018, c 12, s 186), https://laws-lois.justice.gc.ca/eng/ acts/G-11.55/. See also Government of Canada, ‘Carbon Pollution Pricing Systems Across Canada’ (22 March 2022), https://www.canada.ca/en/environment-climate-change/services/climate-change/ pricing-pollution-how-it-will-work.html. 50 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 Establishing a System for Greenhouse Gas Emission Allowance Trading Within the Union (as amended) (ETS Directive), consolidated version available at https://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:02003L0087-20200101&from=EN. See also European

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difference between those two pricing mechanisms lies in whether the price of carbon or the amount of carbon allowed to be emitted has been fixed.51 Under a cap-andtrade system, the price of carbon is determined through auctioning off emission allowances. That is, the price fluctuates depending on supply and demand.52 The idea is to reduce the available allowances over time, thereby increasing the carbon price. Even though market-based mechanisms are preferred by economists, they are not the only way to combat climate change. Another policy option is prescriptive regulations, such as mandates to use particular technologies.53

2.2

Border Carbon Adjustments

Carbon pricing has competitive effects:54 ‘by putting a price on carbon, countries may drive up costs for domestic businesses, putting them at a competitive disadvantage to foreign competitors from countries where no carbon price exists.’55 To offset those competitive effects, and to entice ‘other countries to strengthen their climate efforts’, the idea of border adjustments has been floated.56 Commercially speaking, border adjustments are designed to level the playing field.57 CBAM, tabled in July 2021, is the European Commission’s attempt to draft legislation to that effect. Its rationale is ‘to make importers pay for the greenhouse gas . . . emissions embedded in the covered goods that they market in the EU.’58 On a related note, the only other example of a border carbon adjustment in existence is California’s rules on electricity imports.59

Commission, ‘EU Emissions Trading System (EU ETS)’, https://ec.europa.eu/clima/eu-action/euemissions-trading-system-eu-ets_en. 51 Marcu and Cecchetti (2022), p. 441. 52 Ibid. 53 Marceau (2016), p. 13. 54 Mehling et al. (2019), p. 441; Meyer and Tucker (2022), p. 112; Veel (2009), p. 749. 55 Samuel Kortum and David Weisbach, ‘Questioning the Promise of Carbon Tax Border Adjustments’ Kleinman Center for Energy Policy (21 July 2020), https://kleinmanenergy.upenn.edu/ podcast/questioning-the-promise-of-carbon-tax-border-adjustments/. 56 Ibid; Mehling et al. (2019), pp. 441–442, 481; Paul Krugman, ‘Wonking Out: Two Cheers for Carbon Tariffs’ New York Times (16 July 2021), https://www.nytimes.com/2021/07/16/opinion/ carbon-tariffs-climate-change.html. 57 Sato (2022), p. 391; Truby (2010), pp. 154–155. 58 Cándido García Molyneux and Paul Mertenskötter, ‘Guest Post: Will the EU CBAM Cover More Than What You Think? Complex Goods, System Boundaries, and Circumvention Under the Commission’s CBAM Proposal’ International Economic Law and Policy Blog (26 July 2021), https://ielp.worldtradelaw.net/2021/07/guest-post-will-the-eu-cbam-cover-more-than-what-youthink-complex-goods-system-boundaries-and-circu.html. 59 See Mehling et al. (2019), pp. 455–456.

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Because of its trade-restrictive effects, however, CBAM may be at odds with WTO rules. CBAM will apply to specific carbon-intensive sectors: cement, electricity, fertilizers, aluminium, iron and steel.60 The measure also includes some downstream products, such as tubes and pipes, with a view to forestalling circumvention.61 Let us take fertilizers as an example, the major exporters of which into the EU are Russia, Egypt, Belarus, Algeria, and Morocco.62 At the time of writing, ‘[n]one of these countries have carbon pricing in place, and thus they would all be vulnerable to a CBAM’.63 According to an UNCTAD study, the three countries most affected by CBAM overall will be Russia, China, and Turkey.64 Details of the application, ‘system boundaries’, are still to be fleshed out.65 WTO Members can challenge CBAM as such66 as well as the emerging administrative practice.67 In brief, CBAM works as follows: the authorized importer must declare the amount of carbon embedded in the covered imports and ‘For each tonne of embedded emissions of imported goods, the authorized importer must purchase one CBAM certificate’.68 Two adjustments will be made: first, a carbon prize paid in the country of origin will be deducted; secondly, emission allowances that have been allocated free of charge under the EU emissions trading system (ETS) will be considered.69 At the initial stage, CBAM charges will only apply to direct emissions (‘emissions from the production processes of goods’), not (yet) indirect emissions

60

Art. 2(1), in conjunction with Annex I, CBAM Proposal. Rec. 35 CBAM Proposal. 62 Andrei Marcu, Aaron Cosbey and Michael Mehling, ‘Border Carbon Adjustments in the EU: Sectoral Deep Dive’ European Roundtable on Climate Change and Sustainable Transition (18 March 2021), p. 39, https://ercst.org/border-carbon-adjustments-in-the-eu-sectoral-deep-dive/. 63 Ibid. 64 UNCTAD, ‘EU Should Consider Trade Impacts of New Climate Change Mechanism’ (14 July 2021), https://unctad.org/news/eu-should-consider-trade-impacts-new-climate-change-mechanism. 65 Arts 7(6), 35(6) CBAM Proposal. 66 Appellate Body Report, United States – Sunset Review of Anti-dumping Duties on Corrosion Resistant Carbon Steel Flat Products from Japan, WT/DS244/AB/R, adopted 9 January 2004, para. 82. 67 See Appellate Body Report, United States – Continued Existence and Application of Zeroing Methodology, WT/DS350/AB/R, adopted 19 February 2009, para. 181 re the use of zeroing methodology in US antidumping proceedings. For the difference between ‘as such’ and ‘as applied’ claims, see Appellate Body Report, United States – Sunset Reviews of Anti-dumping Measures on Oil Country Tubular Goods from Argentina, WT/DS268/AB/R, adopted 17 December 2004, para. 172. 68 Bixuan Wu, ‘Guest Post: Making the Rules of the Game with Prudence – Analysis of the EU’s CBAM Proposal’ International Economic Law and Policy Blog (19 July 2021), https://ielp. worldtradelaw.net/2021/07/guest-post-making-the-rules-of-the-game-with-prudence-analysis-ofthe-eus-cbam-proposal.html. Cf. Arts 6(2)(b)-(c), 22(1) CBAM Proposal. 69 Arts 6(2)(c), 9, 31 CBAM Proposal. 61

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(‘emissions from the . . . electricity . . . consumed during the production processes’).70 For the determination of the levy base, actual emissions and default values come into consideration. The default position is different for electricity as compared to the rest of the covered goods. Whereas for the former ‘Embedded emissions . . . shall be determined by reference to default values’, for the latter actual emissions are to be used by default.71 That said, for all products covered, the other method remains available—for electricity, should the authorized importer choose so, for the other goods, ‘When actual emissions cannot be adequately determined’.72 For complex goods, i.e. goods resulting from a multi-step production process, while emissions from the production of inputs is counted, it is limited to those emissions released within the system boundaries of the process. In other words, the emissions embedded in purchased inputs is not to be considered because they are released outside the system boundaries.73

3 Inconsistency with WTO Law 3.1

Border Adjustability

Maximum tariffs have been fixed at the WTO. Import charges ‘in excess of’ those bound tariffs infringe Article II:1(b) GATT. By contrast, pursuant to Article II:2 (a) GATT, a Member may levy on the importation of any product: a charge equivalent to an internal tax imposed consistently with the provisions of paragraph 2 of Article III in respect of the like domestic product or in respect of an article from which the imported product has been manufactured or produced in whole or in part . . .

The Appellate Body inferred that ‘Article II:2(a), subject to the conditions stated therein, exempts a charge from the coverage of Article II:1(b).’74 Article II:2(a) thus allows the ‘equalization of taxes on domestic and imported goods’.75 However, only ‘an internal tax . . . in respect of the like domestic product or in respect of an article from which the imported product has been manufactured’—a so-called indirect tax—is adjustable at the border.76 Conversely, because the EU has ‘low tariff

70

Arts 3(15)–(16), (28), 22(1) CBAM Proposal. Indirect emissions may be included after a transitional period, Art. 30 CBAM Proposal. 71 Art. 7(2)–(3) CBAM Proposal. 72 Art. 7(2) CBAM Proposal. 73 Wu (2021). 74 Appellate Body Report, India – Additional and Extra-additional Duties on Imports from the United States, WT/DS360/AB/R, adopted 17 November 2008, para. 153. 75 Veel (2009), p. 771. 76 See also Meyer and Tucker (2022), p. 115; Leal-Arcas (2021), p. 135.

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bindings, a finding that a tax is a direct tax will generally lead to a violation of [its] tariff commitments.’77 In the present case, CBAM complements the EU ETS.78 CBAM applies to the imported product whereas the ETS applies to the ‘like domestic product’. It follows that CBAM would be in conformity with WTO law if the following three conditions are met: First, CBAM is a charge upon importation. Secondly, the ETS amounts to an internal tax in respect of an article from which the imported product has been manufactured, in other words, is an indirect tax. Thirdly, CBAM is not in excess of the ETS for the same product.79 The second condition is most contentious, as it is not even clear if the ETS constitutes a tax; what is more, the pertinent ‘article’ here is the listed GHGs.

3.1.1

Charge Upon Importation

At first, it will be discussed whether CBAM is tantamount to a charge, next, whether an import charge or an internal charge. The obligation to purchase CBAM certificates amounts to a ‘pecuniary burden’ and creates a ‘liability to pay money’. It thus fulfils the criteria for a charge set out in Argentina – Hides and Leather.80 As to the second question, Dobson takes the view that ‘In line with the Note Ad III, charges on a good’s equivalent carbon tax liability would constitute an internal measure because they are applied at the border as an “adjustment” to equal internal taxes.’81 Case law from the GATT era seems to support this.82 First of all, the GATT Panel in US – Superfund stated that ‘Whether a sales tax is levied on a product for general revenue purposes or to encourage the rational use of environmental resources, is . . . not relevant for the determination of the eligibility of a tax for border tax adjustment.’83 That is, that the requirement to purchase emission allowances is intended to prevent carbon leakage speaks neither in favour of nor against border adjustability. Secondly, and more to the point, the GATT Panel in EEC – Animal Feed Proteins opined that ‘an obligation to purchase a certain quantity of

Timothy Meyer and Todd Tucker, ‘WTO Legal Issues Arising from Carbon Border Measures: An Introductory Primer’ (7 July 2021) SSRN (for the US) (emphasis added). The same is true of the EU, see WTO Tariff Download Facility, http://tariffdata.wto.org/TariffList.aspx. 78 Art. 1(2) CBAM Proposal. 79 Cf. Appellate Body Report, India – Additional Import Duties, para. 221. 80 Panel Report, Argentina – Measures Affecting the Export of Bovine Hides and Import of Finished Leather, WT/DS155/R and Corr.1, adopted 16 February 2001, para. 11.143. 81 Dobson (2021), p. 70 (emphasis added). See also Van den Bossche and Zdouc (2022), p. 390. 82 For the relevance of prior GATT panel reports, see Art. XVI:1 WTO Agreement; Appellate Body Report, Japan – Taxes on Alcoholic Beverages, WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/ R, adopted 1 November 1996, p. 14. 83 GATT Panel Report, United States – Taxes on Petroleum and Certain Imported Substances, L/6175 - 34S/136, adopted 17 June 1987, para. 5.2.4. 77

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skimmed milk powder . . . should be examined as internal measures under Article III and not as border measures under Article II.’84 The present author disagrees with the above assessment. The Appellate Body held in China – Auto Parts that ‘the charges falling within the scope of Article III are charges that are imposed on goods that have already been “imported”, and that the obligation to pay them is triggered by an “internal” factor, something that takes place within the customs territory.’85 The Appellate Body elaborated that a key indicator of whether a charge constitutes an ‘internal charge’ . . . is ‘whether the obligation to pay such charge accrues because of an internal factor (e.g., because the product was re-sold internally or because the product was used internally), in the sense that such “internal factor” occurs after the importation of the product of one Member into the territory of another Member.86

The Ad Note to Article III merely clarifies that ‘the time at which a charge is collected or paid is not decisive’ for the determination of the legal nature of the measure.87 According to the Proposal, CBAM will apply to selected products ‘upon their importation into the customs territory of the Union’.88 Hence, ‘the obligation to purchase CBAM certificates arises from the importation of goods and not by an internal event that occurs after importation’.89 CBAM, consequently, is a border measure, not the ETS ‘applied at the border’.90

3.1.2

Is the ETS An Indirect Tax?

No Tax As mentioned, only indirect taxes are adjustable at the border, not internal regulations.91 This raises the question of whether the ETS is an ‘internal tax’ in that sense. The European Court of Justice denied this:

GATT Panel Report, EEC – Measures on Animal Feed Proteins, L/4599 - 25S/49, adopted 14 March 1978, paras 4.17–4.18. 85 Appellate Body Report, China – Measures Affecting Imports of Automobile Parts, WT/DS339/ AB/R, WT/DS340/AB/R, WT/DS342/AB/R, adopted 12 January 2009, para. 161 (emphasis in original). 86 Ibid., para. 163 (emphasis in original). 87 Ibid., para. 162. 88 Art. 1(1) CBAM Proposal (emphasis added). 89 Sato (2022), p. 394. 90 Pro Reinhard Quick, ‘A Carbon Border Tax or A Climate Tariff?’ International Economic Law and Policy Blog (2 October 2019), https://ielp.worldtradelaw.net/2019/10/guest-post-a-carbonborder-tax-or-a-climate-tariff.html. 91 Working Party on Border Tax Adjustments, ‘Border Tax Adjustments’ L/3464 (2 December 1970), para. 14; Cecilia Bellora and Lionel Fontagné, Policy Department for External Relations, ‘Four Briefings on Trade-related Aspects of Carbon Border Adjustment Mechanisms’ (April 2020), p. 9. 84

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The domestic characterization of the ETS as an internal regulation is useful but not dispositive for WTO purposes.93 The label ‘emission allowance’ is secondary. That the requirement to purchase and surrender emission allowances is compulsory is not determinative either,94 because regulations may be compulsory, too. However, a finding of a tax would presuppose that the tax amount can be calculated by the taxpayer in advance.95 This is not possible here. The ETS involves a requirement to purchase emission allowances (unless allocated for free) the price of which is determined through auction and, therefore, fluctuates all the time.96

No Tax on Products Even if we assume that the ETS constitutes an internal tax, this alone would not make it eligible for border adjustment. In addition, the tax must be either ‘in respect of the like domestic product or in respect of an article from which the imported product has been manufactured’. Recognized examples are ‘specific excise duties, sales taxes and cascade taxes and the tax on value added.’97 The ETS is in respect of GHG emissions from covered activities,98 not ‘in respect of the . . . product’.99 As a corollary, only the second alternative is pertinent.

No Consumption Tax The next question to be answered is if the phrase ‘from which the imported product has been manufactured’ implies that the ‘article’ must be incorporated in the product. This is disputed. The WTO Committee on Trade and Environment drew the following conclusions from the GATT Panel ruling in US – Superfund: the panel considered that taxes on substances entering in the composition of the final product could be adjusted at the border. However, it is not clear, in this particular case, whether those

92 ECJ, Case C-366/10 Air Transport Association of America v. Secretary of State for Energy and Climate Change [2011] ECR I-13755, ECLI:EU:C:2011:864, para. 143. 93 Appellate Body Report, China – Auto Parts, para. 178. 94 In this sense, Mehling et al. (2019), p. 459. 95 Sato (2022), pp. 396–397; Quick (2019). 96 Art. 10 ETS Directive. 97 Working Party on Border Tax Adjustments (1970), para. 14. 98 Arts 2(1), 12(3), 2nd sentence, ETS Directive. 99 Sato (2022), p. 397.

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substances were still physically present in the final product, or whether they had been exhausted in the production process, and the panel made no distinction to that effect.100

Relying upon the French version (‘une marchandise qui a été incorporée dans l’article importé’),101 one view answers the question of incorporation in the affirmative.102 As per Article 33(3) VCLT, ‘The terms of the treaty are presumed to have the same meaning in each authentic text.’103 This view submits that ‘it is difficult to explain based on its text that an imported product is . . . produced “from” fuel’,104 and confines border adjustability to taxes on final products and raw materials. The Working Party on Border Tax Adjustments confirmed that ‘adjustment was not normally made for taxes occultes . . .’.105 The opposing view draws upon the SCM Agreement and counters that taxes occultes (consumption taxes on e.g. energy sources)106 are adjustable.107 The SCM Agreement provides that ‘Indirect tax rebate schemes can allow for exemption, remission or deferral of prior-stage cumulative indirect taxes levied on inputs that are consumed in the production of the exported product’.108 The Agreement further defines ‘inputs consumed in the production process’ as ‘inputs physically incorporated, energy, fuels and oil used in the production process and catalysts which are consumed in the course of their use to obtain the exported product.’109 It can be presumed that, being an integral part of the WTO Agreement,110 the same rules apply to both import and export border tax adjustments (BTAs) even though the SCM Agreement only covers export BTAs. It follows that the ‘article from which the imported product has been manufactured’ does not have to be ‘present physically in the final product’;111 it may be consumed in the production process. However, this does not mean that the ETS is adjustable at the border. While it can be inferred from the SCM Agreement that taxes on energy sources are adjustable, the ETS is not a consumption tax. For GHG emissions are not ‘consumed in the production’. GHG emissions are not an input in the production process, they are a by-product.112 This suggests that one has

Committee on Trade and Environment, ‘Taxes and Charges for Environmental Purposes: Border Tax Adjustment’ Note by the Secretariat, WT/CTE/W/47 (2 May 1997), para. 70. Cf. GATT Panel Report, US – Superfund, paras 2.5, 5.2.8. 101 Emphasis added. 102 Marceau (2016), p. 10. 103 The WTO Agreement has been authenticated ‘in the English, French and Spanish languages’. 104 Sato (2022), p. 398. 105 Working Party on Border Tax Adjustments (1970), para. 15(a). 106 Ibid., para. 15(a). 107 Bacchus (2022), p. 186; Dobson (2021), p. 71; Porterfield (2019), p. 24. 108 Para. I(1) Annex II to the SCM Agreement. 109 Fn. 61 Annex II to the SCM Agreement. 110 Art. II:2 WTO Agreement. 111 Bacchus (2022), p. 186. 112 Veel (2009), p. 774; Marceau (2016), p. 7. 100

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to distinguish between consumption taxes, on the one hand, and taxes on PPMs, on the other hand.113

Tax on PPMs Proponents of the adjustability of PPM taxes refer to the definition of ‘indirect taxes’ in the SCM Agreement (‘all taxes other than direct taxes and import charges’)114 and conclude e contrario that ‘Since a carbon tax is neither an income nor property tax it would most likely be qualified as an adjustable “indirect tax”.’115 This conclusion is borne out by paragraph (g) of Annex I to the Agreement, which lists as adjustable taxes ‘in respect of the production . . . of exported products’.116 For opponents, taxes on PPMs are not any different from ‘general environmental legislation, i.e. the cost incurred in complying with typical environmental laws’.117

3.1.3

Conclusions

In the author’s view, it would be too far-fetched to treat the requirement to surrender emission allowances as an indirect tax, despite it being compulsory.118 Consequently, the exemption for BTAs in Article II:2(a) does not apply and CBAM would infringe Article II:1(b) GATT.119 The question of whether CBAM is also inconsistent with Article III:2 GATT is, therefore, moot. Because Article III GATT only applies to internal measures,120 paragraph 4 thereof is likewise not pertinent here.121 It is true that the Appellate Body in EC – Bananas III applied Article III:4 GATT to import licensing requirements that affected ‘the internal sale, offering for sale, purchase, . . .’ of bananas.122 However, the reason why Article III:4 GATT applied in that case was that

113

Veel (2009), pp. 774–775. Fn. 58 to Annex I(e) to the SCM Agreement. 115 Bellora and Fontagné (2020), pp. 8–9. See also Dias et al. (2020), pp. 16–17; Boklan (2021), p. 137. 116 Para. (g) Annex I to the SCM Agreement. See Bellora and Fontagné (2020), pp. 8–9. 117 Quick (2019). 118 Pro Sato (2022), p. 397. Contra Mehling et al. (2019), p. 459. 119 Pro Quick (2019). 120 This can be inferred from the title of the provision as well as the references to ‘internal taxes or other internal charges’ and ‘internal sale, offering for sale, purchase, transportation, distribution or use’. 121 For the finding that CBAM is a border measure, see above Sect. 3.1.1. 122 Appellate Body Report, European Communities –Regime for the Importation, Sale and Distribution of Bananas, WT/DS27/AB/R, adopted 25 September 1997, para. 211. 114

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These rules go far beyond the mere import licence requirements needed to administer the tariff quota for third-country and non-traditional ACP bananas or Lomé Convention requirements for the importation of bananas. These rules are intended . . . to cross-subsidize distributors of EC (and ACP) bananas and to ensure that EC banana ripeners obtain a share of the quota rents.123

The Appellate Body expressly underscored that At issue in this appeal is not whether any import licensing requirement, as such, is within the scope of Article III:4, but whether the EC procedures and requirements for the distribution of import licences for imported bananas among eligible operators within the European Communities are within the scope of this provision.124

It does not follow from this that Article III:4 GATT extends to border measures like CBAM.125 In any event, things are different here: CBAM is no case of crosssubsidization; ‘Most revenues generated by CBAM will go to the EU budget’.126 Having said that, the MFN obligation in Article I:1 GATT, which prohibits discrimination among Members, may still be infringed. As stressed by the Appellate Body, ‘different aspects of the same measure may be found to be inconsistent with one or more’ WTO provisions.127

3.2

Article I:1 GATT

For purposes of Article I:1 GATT, it is immaterial whether the measure at issue is a border or an internal measure because the provision captures both.128 As a preliminary point, it should be noted that the fact that CBAM does not apply to all goods is innocuous since the question is if it applies to all ‘like’ goods. Furthermore, being linked to a good’s embedded emissions , CBAM is origin-neutral.129 That said, the EU decided to exclude from CBAM Iceland, Liechtenstein and Norway, which are parties to the Agreement on the European Economic Area, as well as Switzerland.130 In addition, there are two potential de facto infringements:131 CBAM treats goods differently based on, first, the ‘direct emissions released during the production of 123

Ibid. Ibid. (emphasis in original). 125 Contra Sato (2022), p. 399. 126 European Commission, Proposal for a Regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism, COM(2021) 564 final (14 July 2021) Explanatory Memorandum, p. 10. 127 Appellate Body Report, Brazil – Taxation, para. 5.53. 128 Trachtman (2017), p. 475. 129 Cf. Art. 22(1) CBAM Proposal. 130 Annex II to CBAM Proposal. 131 Trachtman (2017), p. 476. De facto discrimination is covered by Art. I:1 GATT, see Appellate Body Report, Canada – Certain Measures Affecting the Automotive Industry, WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, para. 78. 124

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goods’,132 and secondly, whether or not the country of origin has carbon pricing in place; non-pricing mechanisms are disregarded.133 The latter concerns Article 9(1) CBAM Proposal which reduces ‘the number of CBAM certificates to be surrendered in order for the carbon price paid in the country of origin for the declared embedded emissions to be taken into account.’ This ‘advantage’ is not accorded to the like good—with the same embedded emissions—originating in a country that does not employ carbon pricing to reduce GHG emissions but non-pricing mechanisms instead. As will be seen later, considering the climate efforts of other Members is required under the chapeau.134 Article 9 may not go far enough by limiting this consideration to pricing mechanisms.

3.2.1

Advantage

The term ‘advantage’ has been given a broad meaning in Article I:1 GATT (‘any’).135 A reduction of emission certificates to be purchased and surrendered— either because of a lower carbon footprint or because of a carbon price paid in the country of origin—entails ‘more favourable competitive opportunities’ and hence an advantage.136

3.2.2

Likeness

It is hotly debated whether otherwise identical goods that only differ in terms of embedded emissions (e.g. green vs dirty steel) are ‘like’.137 If they are not, they ‘may be treated differently’ (without finding discrimination).138 Likeness in a WTO sense is ‘about the nature and extent of a competitive relationship between and among products’;139 the Appellate Body thus took a market-based approach.140 Relevant factors are: ‘(i) the properties, nature and quality of the products; (ii) the end-uses of the products; (iii) consumers’ tastes and habits—more comprehensively termed consumers’ perceptions and behaviour—in respect of the products; and (iv) the tariff

132

Art. 22(1), in conjunction with Art. 3(16), CBAM Proposal. Meyer and Tucker (2022), p. 116. 134 See below Sect. 4.4.3. 135 Appellate Body Report, Canada – Autos, para. 79. 136 Cf. Panel Report, European Communities – Regime for the Importation, Sale and Distribution of Bananas (Ecuador), WT/DS27/R/ECU, adopted 25 September 1997, para. 7.239. 137 See e.g. Meyer and Tucker (2022), p. 116; Dobson (2021), p. 77. 138 Van den Bossche and Zdouc (2022), p. 392; Marceau (2016), p. 8. 139 Appellate Body Report, European Communities – Measures Affecting Asbestos and Asbestoscontaining Products, WT/DS135/AB/R, adopted 5 April 2001, para. 99. 140 Ibid., para. 103. 133

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classification of the products.’141 The scope of likeness, in other words, the ‘product scope’ covered, is broader or narrower depending on the WTO provision at issue.142

Processes and Production Methods In Philippines – Distilled Spirits, the Appellate Body found that ‘the differences in raw materials were insufficient to make [alcoholic] products not like . . .’143 That said, there is a distinction to be made between inputs consumed in the production process and PPMs.144 CBAM distinguishes goods based on the emissions released during their production. It is highly contested whether such non-product-related PPMs (that ‘leave no physical trace in the end product’)145 are relevant to the determination of likeness. In US – Tuna II (Article 21.5 – Mexico), the parties agreed that dolphin-safe tuna is like unsafe one.146 The prevailing view negates the relevance of non-productrelated PPMs for purposes of the likeness test and deduces this from Article XX (e) GATT.147 This provision provides a ground of justification for ‘products of prison labour’. Given that prison labour is a non-product-related PPM in WTO terms, it follows that regulatory distinctions on that basis are discriminatory. If not, there would be no need for justification. The opposing view counters that, even if denying discrimination (and allowing Members to distinguish between goods based on whether or not they have been made by prisoners), Article XX (e) GATT would still have meaning and effect, for instance, in relation to an infringement of Article XI GATT. The interpretive principle of effectiveness would thus be honoured.148

141 Ibid., para. 101 (for Art. III:4 GATT); Appellate Body Report, Canada – Certain Measures Concerning Periodicals, WT/DS31/AB/R, adopted 30 July 1997, p. 21 (for Art. III:2, 1st sentence, GATT). It is generally accepted that the same factors apply to the likeness test in Art. I:1 GATT, see Van den Bossche and Zdouc (2022), pp. 349–350. 142 Appellate Body Report, Japan – Alcoholic Beverages II, p. 21; Appellate Body Report, EC – Asbestos, para. 99. 143 Trachtman (2017), p. 474. Cf. Appellate Body Report, Philippines – Taxes on Distilled Spirits, WT/DS396/AB/R, WT/DS403/AB/R, adopted 20 January 2012, paras 174, 243. 144 See above Sect. 3.1.2. 145 Cooreman (2016), p. 230. 146 Panel Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products – Recourse to Article 21.5 of the DSU by Mexico, WT/DS381/RW, adopted 3 December 2015, para. 7.496. 147 Panel Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products, WT/DS381/AB/R, adopted 13 June 2012, para. 7.250; Panel Report, European Communities – Measures Prohibiting the Importation and Marketing of Seal Products, WT/DS400/AB/R, WT/DS401/AB/R, adopted 18 June 2014, para. 7.139; Mitchell and Merriman (2020), pp. 604–605. 148 Instead of all, see Appellate Body Report, United States – Standards for Reformulated and Conventional Gasoline, WT/DS2/AB/R, adopted 20 May 1996, p. 23.

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The strict orthodox view has been heavily criticized for ignoring the pollution caused by the manufacture of traded goods, especially when a global concern is at stake such as the climate and the planet’s atmosphere. In response, that view has somewhat mellowed over time. In a different context, the Appellate Body noted that ‘What constitutes a competitive relationship between products may require consideration of inputs and processes of production used to produce the product.’149 This raises the question of whether the notion of legitimate regulatory distinction is another relevant likeness factor. In US – COOL, the Appellate Body observed that ‘some technical regulations that have a de facto detrimental impact on imports may not be inconsistent with Article 2.1 when such impact stems exclusively from a legitimate regulatory distinction.’150 In the same vein, the investment chapters of the USMCA and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) provide that ‘whether treatment is accorded in “like circumstances” . . . depends on . . . whether the relevant treatment distinguishes between investors or investments on the basis of legitimate public welfare objectives.’151

Legitimate Regulatory Distinction PPMs ‘are the main contributors of greenhouse gases . . . emissions.’152 Yet, that the consideration of embedded emissions may be a legitimate regulatory distinction is immaterial at this stage according to the prevailing view.153 It is true that the Appellate Body ruled in Chile – Alcoholic Beverages that from the rejection of subjective intentions inhabiting the minds of individual legislators or regulators . . . . [i]t does not follow . . . that the statutory purposes or objectives – that is, the purpose or objectives of a Member’s legislature and government as a whole – to the extent that they are given objective expression in the statute itself, are not pertinent.154

However, the place to have regard to ‘statutory purposes or objectives’ is the exception clauses. As the Appellate Body noted in EC – Seal Products, the fact that, under the GATT 1994, a Member’s right to regulate is accommodated under Article XX, weighs heavily against an interpretation of Articles I:1 and III:4 that requires an

Appellate Body Report, Canada – Certain Measures Affecting the Renewable Energy Generation Sector, WT/DS412/AB/R, WT/DS426/AB/R, adopted 24 May 2013, para. 5.63. 150 Appellate Body Report, United States – Certain Country of Origin Labelling (COOL) Requirements, WT/DS384/AB/R, WT/DS386/AB/R, adopted 23 July 2012, para. 271. 151 Arts 14.4.4, 14.5.4 USMCA; fn. 14 to Art. 9.4 TPP. 152 Boklan (2021), p. 132. 153 For the opposing view in the literature, see ibid., p. 136; Beckford (2020), pp. 656 ff; Stéphanie Noël and Clémentine Baldon, ‘European Union & Certain Member States – Certain Measures Concerning Palm Oil & Oil Palm Crop-based Biofuels (Malaysia), WT/DS600’ Amicus Curia Written Submission of Veblen Institute for Economic Reforms (25 April 2022), paras 24–25, 92–93, https://www.veblen-institute.org/IMG/pdf/amicus_curiae_brief_ds600_final_25042022_1_.pdf. 154 Appellate Body Report, Chile – Taxes on Alcoholic Beverages, WT/DS87/AB/R, WT/DS110/ AB/R, adopted 12 January 2000, para. 62 (emphasis in original). 149

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examination of whether the detrimental impact of a measure on competitive opportunities for like imported products stems exclusively from a legitimate regulatory distinction.155

This is where the GATT Agreement differs from the Agreement on Technical Barriers to Trade (TBT Agreement) (and the investment chapters in the USMCA and CPTPP, for that matter), which does not have general exceptions à la Article XX GATT.156 Moreover, the argument that, for instance, green and dirty steel are in different markets along the lines of Canada – Renewable Energy157 does not hold water, as this would contradict the above case law on legitimate regulatory distinctions; besides, Canada – Renewable Energy was decided in the context of the SCM Agreement.158 The Appellate Body in US – Clove Cigarettes summarized the prevailing view as follows: ‘the regulatory concerns underlying a measure . . . may be relevant to an analysis of the “likeness” criteria . . . to the extent they have an impact on the competitive relationship between and among the products concerned.’159

Consumers’ Perceptions and Behaviour This leaves us with consumers’ perceptions and behaviour as the only criterion to consider embedded emissions.160 For, in all other respects, the respective goods will be identical. This presupposes that consumers are aware of the emissions embedded in covered goods. Dobson submits that, even if some consumers may be willing to pay more for climate-friendly products, ‘lifecycle emissions are not clearly visible in the end products and services’ and are ‘often not transparently available’ to most consumers.161 Furthermore, preference for low carbon goods in a general sense would not suffice, consumers’ environmental awareness would have to influence their purchasing behaviour.162 In EC – Asbestos, the Appellate Body observed that ‘consumers’ tastes and habits . . . are very likely to be shaped by the health risks associated with a product which is known to be highly carcinogenic.’163 Yet, in that case, the health risks arose from the toxicity of the product itself, not the production process.

Appellate Body Report, EC – Seal Products, para. 5.125. For the USMCA, see Art. 32.1. 157 Appellate Body Report, Canada – Renewable Energy, para. 5.178. 158 Dobson (2021), p. 82. 159 Appellate Body Report, United States – Measures Affecting the Production and Sale of Clove Cigarettes, WT/DS406/AB/R, adopted 24 April 2012, para. 119. 160 Van den Bossche and Zdouc (2022), p. 427; Dobson (2021), p. 80; Porterfield (2019), p. 30; Veel (2009), p. 780. 161 Dobson (2021), p. 81. 162 Cf. Mitchell and Merriman (2020), p. 568. 163 Appellate Body Report, EC – Asbestos, para. 122. 155 156

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In US – Clove Cigarettes, the Appellate Body pointed out that ‘if the products are highly substitutable for some consumers but not for others, this may also support a finding that the products are like.’164 Against this background, even though some consumer may prefer low carbon goods, the author agrees with Sato’s finding that ‘it is difficult to contend that EU consumers do not perceive and treat the products of higher emissions as “alternative[s]”, much less as competitors.’165

Conclusions In the final analysis, the emissions embedded in goods are immaterial to the determination of likeness in WTO law.166 As a consequence, Members making regulatory distinctions on that basis would discriminate in terms of Article I:1 GATT. Incidentally, the Appellate Body in US – Clove Cigarettes found the measure at issue was discriminatory in terms of Article 2.1 TBT because it excluded menthol cigarettes.167 This begs the question of whether other industry sectors should have been included in CBAM on the basis of their likeness. However, the present case is different from Clove Cigarettes, which was about different types (flavours) of one product (cigarettes). CBAM, by contrast, applies to entire product classes, identified by combined nomenclature codes.168

3.2.3

Unconditionally

Whereas ‘immediately’ is unproblematic, the requirement of ‘unconditionally’ requires some clarification. At this juncture, one has to distinguish between the two MFN challenges. While the advantage is always the lower financial burden imposed by CBAM, the conditions attached differ. In the first instance, the condition is the lower carbon footprint, in the second instance, the carbon price paid in the country of origin.

Lower Embedded Emissions Imports with lower embedded emissions—the condition—are subject to lower CBAM charges—the advantage. The (unadopted) GATT Panel ruling in US –

Appellate Body Report, US – Clove Cigarettes, para. 142. Sato (2022), p. 395. 166 Pro Sato (2022), p. 399; Dobson (2021), p. 82. 167 Appellate Body Report, US – Clove Cigarettes, para. 233. 168 See Annex I to CBAM Proposal. 164 165

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Tuna had found that ‘Article III deals only with regulation of products’.169 In line with this, the Panel in Indonesia – Autos observed that MFN treatment ‘cannot be made conditional on any criteria that is not related to the imported product itself.’170 These rulings must be deemed superseded now. The Appellate Body held in Brazil – Taxation that ‘measures that are on their face directed at producers’ are not excluded from the scope of Article III.171 The same holds true for Article I:1 GATT, as confirmed by the Panel in Canada – Autos: ‘subjecting an advantage granted in connection with the importation of a product to conditions not related to the imported product itself is [not] per se inconsistent with Article I:1’.172 It follows from this that PPM-based measures do not automatically infringe the WTO non-discrimination rules.173 In EC – Seal Products, the Appellate Body concluded that ‘Article I:1 permits regulatory distinctions to be drawn between like imported products, provided that such distinctions do not result in a detrimental impact on the competitive opportunities for like imported products from any Member.’174 This pronouncement is not helpful, as we have already established that the measure provides an ‘advantage’ (in the form of lower charges) depending on the emissions embedded in the imports, hence will have a detrimental impact on the competitive opportunities of those having to pay higher charges.175 The Panel in Canada – Autos further stated that inconsistency with Article I:1 GATT is given ‘not because [measures] involved the application of conditions that were not related to the imported product but because they involved conditions that entailed different treatment of imported products depending upon their origin.’176 The point of distinction here is the carbon footprint of imports. This is not a disguised origin-related criterion. Distinguishing between imports based on the emissions embedded therein is, therefore, not (de facto) discriminatory.

Discount for Carbon Price Paid in the Country of Origin The condition for the discount—the advantage—is the payment of a carbon price in the country of origin. In US – Tuna II (Article 21.5 – Mexico) (2015), the Panel clarified that

169

Trachtman (2017), p. 473. Panel Report, Indonesia – Certain Measures Affecting the Automobile Industry, WT/DS54/R, WT/DS55/R, WT/DS59/R, WT/DS64/R, adopted 23 July 1998, para. 14.143. 171 Appellate Body Report, Brazil – Taxation, paras 5.15–5.16. 172 Panel Report, Canada – Certain Measures Affecting the Automotive Industry, WT/DS139/R, WT/DS142/R, adopted 19 June 2000, para. 10.29. 173 Trachtman (2017), p. 473. 174 Appellate Body Report, EC – Seal Products, para. 5.88. 175 See above Sect. 3.2.1. 176 Panel Report, Canada – Autos, para. 10.25. 170

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Where a condition attached to an advantage is found to detrimentally modify the competitive opportunities of imported like products, the fact . . . that the disadvantaged Member could modify its practices so as to conform to the condition in question in no way changes the fact that the condition has upset the competitive equality that Article I:1 protects.177

Let us assume that, as a result of a regulatory climate measure in country A, the carbon footprint of a covered import is lowered. Consequently, the number of CBAM certificates to be surrendered would be lower, too, given that ‘Embedded emissions . . . shall be determined based on the actual emissions’.178 However, and this is the salient point, the importer of a good originating in a country with carbon pricing would need to surrender a lower number of CBAM certificates (thanks to the discount commensurate with Article 9 CBAM Proposal) than if the identical good with the identical carbon footprint originated in country A.

3.2.4

Conclusions

Regulatory distinctions based on the carbon footprint of imports are not at variance with Article I:1 GATT. However, deducting the carbon price paid in the country of origin, while disregarding other (non-pricing) reduction measures, amounts to an MFN discrimination:179 ‘Two firms that pay equivalent carbon costs – one via an explicit carbon pricing mechanism and the second an implicit price via regulation – are thus treated differently.’180 Finally, a de jure MFN discrimination arises from the exclusion of certain third countries.181

3.3

TBT Agreement

In principle, the GATT Agreement and the TBT Agreement apply in parallel.182 The Appellate Body observed in EC – Asbestos that ‘the TBT Agreement imposes obligations on Members that seem to be different from, and additional to, the obligations imposed on Members under the GATT 1994.’183 However, for the TBT Agreement to apply here, CBAM must qualify as a technical regulation within

Panel Report, US – Tuna II (Article 21.5 – Mexico), para. 7.450. Art. 7(2), 1st sentence, (3) CBAM Proposal. 179 Pro Dias et al. (2020), pp. 18–19; Sato (2022), p. 399. 180 Meyer and Tucker (2022), pp. 116–117, 119. 181 Espa (2022), p. 212. See below Sect. 4.4.3. 182 Cf. Rec. 2 Preamble to the TBT Agreement (‘Desiring to further the objectives of GATT 1994’). 183 Appellate Body Report, EC – Asbestos, para. 80 (emphasis in original). 177 178

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the meaning of Annex 1 to that Agreement. Since it constitutes mandatory legislation, it cannot be a standard.184

3.3.1

Technical Regulation

No Product Characteristics Whether CBAM is a technical regulation is questionable because it is not clear whether the definition of technical regulation captures non-product-related PPMs.185 A technical regulation ‘lays down product characteristics or their related processes and production methods’.186 The Appellate Body in EC – Seal Products clarified that We see no basis in the text of Annex 1.1 . . . to suggest that the identity of the hunter, the type of hunt, or the purpose of the hunt could be viewed as product characteristics. Nor do we see a basis to find that the market access conditions under the exceptions to the EU Seal Regime exhibit features setting out product characteristics.187

Following this, we find that CBAM does not lay down product characteristics either.

No Related Processes and Production Methods Regarding related PPMs, the Appellate Body noted that188 we understand the reference to ‘or their related processes and production methods’ to indicate that the subject matter of a technical regulation may consist of a process or production method that is related to product characteristics. In order to determine whether a measure lays down related PPMs, a panel thus will have to examine whether the processes and production methods prescribed by the measure have a sufficient nexus to the characteristics of a product in order to be considered related to those characteristics.189

It follows that a technical regulation only comprises product-related PPMs, which rules out CBAM. Importantly, CBAM does not decree specific PPMs that would have to be complied with when exporting to the EU.

See the definition of ‘standard’ in para. 2 Annex 1 to the TBT Agreement (‘with which compliance is not mandatory’). 185 Dobson (2021), p. 72. 186 Para. 1 Annex 1 to the TBT Agreement. 187 Appellate Body Report, EC – Seal Products, para. 5.45. 188 For ‘related PPMs’, see also Mitchell and Merriman (2020), pp. 611–612. 189 Appellate Body Report, EC – Seal Products, para. 5.12 (emphasis in original). 184

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Applicable Administrative Provisions Furthermore, the Appellate Body stated in EC – Seal Products that The administrative provisions under the EU Seal Regime also require that these products be certified by a recognized body as meeting the necessary criteria under each exception. Yet, when viewed together with the exceptions under the EU Seal Regime, we consider that this aspect of the measure is ancillary, and does not render the measure a ‘technical regulation’ within the meaning of Annex 1.1.190

The same holds true for the authorization, accreditation, registration and verification obligations in CBAM.191

3.3.2

Conclusions

In summary, CBAM is no technical regulation, because it neither lays down product characteristics nor related PPMs. The author, therefore, agrees with Will’s assessment that ‘an emissions-based ETS-BA is unlikely to fall under the TBT Agreement’.192

4 Justifications We have found infringements of Articles I:1 and II:1(b) GATT. Whether CBAM stands will depend upon whether the measure can be justified under an exception clause. Subparagraphs (b), (g) and even (a) of Article XX GATT as well as Article XXI GATT all come into consideration. As a preliminary point, it should be noted that ‘the aspects of a measure to be justified under the subparagraphs of Article XX are those that give rise to the finding of inconsistency under the GATT 1994.’193

4.1

Article XX(b) GATT

The legal analysis under the general exceptions ‘involves a two-tiered analysis in which a measure must first be provisionally justified under one of the subparagraphs of Article XX, before it is subsequently appraised under the chapeau of Article

190

Ibid., para. 5.57 (references omitted). See e.g. Arts 8, 10, 17–18 CBAM Proposal. 192 Will (2019), pp. 258, 278. 193 Appellate Body Report, EC – Seal Products, para. 5.185. 191

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XX.’194 The respondent bears the burden of proof for Article XX in the first instance.195

4.1.1

Protection of Human, Animal or Plant Life or Health

The list of justifiable grounds is closed under Article XX.196 For subparagraph (b) to be pertinent, the measure at issue must be (i) designed ‘to protect human, animal or plant life or health’ and (ii) ‘necessary’ to that effect.

CBAM’s Objectives CBAM’s objective is to make sure that the GHG reductions achieved by the ETS are not undermined by carbon leakage,197 which ‘occurs if, for reasons of costs related to climate policies, businesses in certain industry sectors or subsectors were to transfer production to other countries or imports from those countries would replace equivalent but less GHG emissions intensive products.’198 In short, ‘Emissions would . . . simply [be] shifted to other national locations.’199 It has been suggested that ‘leakage under unilateral climate action can be serious enough to outweigh the benefits of such action.’200 This is especially true of ‘Sectors with high energy intensity that are exposed to international trade, such as cement, steel, and aluminium’.201 The problem is exacerbated ‘when a country combines ambitious carbon pricing policies with low restrictions on cross-border trade.’202 A recent UNCTAD report finds that ‘without synchronous implementation of a CBAM, the European Union would experience substantial carbon leakage and export declines.’203 The explanation is that, first, climate change mitigation is a global public good—‘as all states benefit from any particular state’s efforts to lower its greenhouse

Ibid., para. 5.169. See also Appellate Body Report, US – Gasoline, p. 22; Appellate Body Report, US – Shrimp, paras 119–120. 195 Appellate Body Report, Indonesia – Importation of Horticultural Products, Animals and Animal Products, WT/DS477/AB/R, WT/DS478/AB/R, adopted 22 November 2017, para. 5.51. 196 Will (2019), p. 194. 197 Art. 1(1), (3), Recs 8–9, 11–12, 16 CBAM Proposal. See also Mehling et al. (2019), p. 440; Meyer and Tucker (2022), p. 110. 198 Rec. 8 CBAM Proposal. See also Galiffa and Bercero (2022), pp. 196–197; Bacchus (2022), p. 183; Evans et al. (2021), p. 307; Truby (2010), pp. 158, 182; Veel (2009), p. 752, fn. 6. 199 Marceau (2016), p. 3. 200 Mehling et al. (2019), p. 444. 201 Ibid., p. 445; Evans et al. (2021), p. 307. 202 Galiffa and Bercero (2022), p. 197. 203 UNCTAD, ‘A European Union Carbon Border Adjustment Mechanism: Implications for Developing Countries’, UNCTAD/OSG/INF/2021/2 (14 July 2021), p. 23, https://unctad.org/webflyer/ european-union-carbon-border-adjustment-mechanism-implications-developing-countries. 194

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gas emissions’204—and secondly, ‘free riding on efforts of others is an established risk when managing the global commons.’205 By ‘forc[ing] foreign producers to internalize the externality of CO2 emissions’,206 CBAM addresses this freeriding problem and is thus one component of the EU’s strategy to combat climate change.207 The Appellate Body recognized in Brazil – Retreaded Tyres that ‘certain complex public health or environmental problems may be tackled only with a comprehensive policy comprising a multiplicity of interacting measures.’208 It bears emphasizing that carbon pricing is one of the measures recommended by the Intergovernmental Panel on Climate Change (IPCC),209 and the High-level Commission on Carbon Prices posits that ‘A well-designed carbon price is an indispensable part of a strategy for reducing emissions in an efficient way.’210 At this juncture, it should also be mentioned that there can be indirect leakage, too, should fuel prices fall again:211 In global energy markets, the pressure exercised on fossil fuel prices in those regions that have introduced carbon constraints will stimulate demand elsewhere for the same fuels, shifting emissions across regions and weakening the aggregate mitigation effect of domestic climate action.212

That said, indirect emissions are not included in the initial rollout of the measure.213 Wu and Leonelli criticize CBAM for not charging imports, even though their carbon content may be high, when the carbon price paid in the exporting country is the same as what the CBAM charge would be.214 This misses the point. The EU does 204

Veel (2009), p. 753 fn. 11; Barrett (2007), p. 74. Mehling et al. (2019), p. 441. 206 Veel (2009), p. 753. 207 Rec. 13 CBAM Proposal. For the European Green Deal and the ‘Fit for 55’ legislative package, see European Commission, ‘Delivering the European Green Deal’, https://ec.europa.eu/clima/euaction/european-green-deal/delivering-european-green-deal_en. 208 Appellate Body Report, Brazil – Measures Affecting Imports of Retreaded Tyres, WT/DS332/ AB/R, adopted 17 December 2007, para. 151. 209 Hans-Otto Pörtner et al., Climate Change 2022: Impacts, Adaption and Vulnerability (2022), https://www.ipcc.ch/report/ar6/wg2/. See also Joeri Rogelj et al., ‘Mitigation Pathways Compatible with 1.5°C in the Context of Sustainable Development’ in Valerie Masson-Delmotte et al. (eds), Global Warming of 1.5°C: An IPCC Special Report on the Impacts of Global Warming of 1.5°C Above Pre-industrial Levels and Related Global Greenhouse Gas Emission Pathways, in the Context of Strengthening the Global Response to the Threat of Climate Change, Sustainable Development, and Efforts to Eradicate Poverty (2018), pp. 93, 95. 210 High-level Commission on Carbon Prices (2017), p. 1. 211 Mehling et al. (2019), p. 447. 212 Ibid. 213 Art. 30 CBAM Proposal. 214 Art. 9(1) CBAM Proposal. See Bixuan Wu, ‘Guest Post: To Penalize Low Carbon Price or High Carbon Intensity? A Comparison of the EU’s CBAM and the US Clean Competition Act’ International Economic Law and Policy Blog (1 July 2022), https://ielp.worldtradelaw.net/2022/0 7/guest-post-to-penalize-low-carbon-price-or-high-carbon-intensity-a-comparison-of-the-euscbam-and-th.html; Giulia Claudia Leonelli, ‘Guest Post: Full Carbon Pricing, Average Carbon 205

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not need to ‘penalize’ such imports because the exporting country already did. Otherwise, it would be a case of double taxation.215 It has been pointed out that ‘Empirical ex post analyses have confirmed the existence of leakage . . .’216 There is reason to believe that ‘carbon leakage may increase as carbon pricing increases.’217 This being the case, ‘carbon leakage weakens political support for decarbonization efforts’.218 In order to prevent carbon leakage from occurring, CBAM seeks to ensure a level playing field for domestic producers of covered goods.219 This second objective is immaterial from a WTO perspective, however; for competitiveness concerns are not deserving of protection under Article XX(b).220 Veel counters that ‘the comparative advantage flowing from a more permissive regime for greenhouse gas emissions is different from other forms of comparative advantage, as it results in the negative externality of increased global warming.’221 Be that as it may, ‘Carbon leakage and competitiveness concerns appear inseparable in practical terms.’222 The concomitant presence of competitiveness considerations does not harm the defence under Article XX GATT as long as the pursued policy objective can be subsumed thereunder. In this regard, it is worth calling to mind that Article XX(b) GATT does not cover environmental measures as such, only environmental measures necessary for public health. Some free trade agreements make this explicit.223 As a consequence, a respondent ‘has to establish the existence not just of risks to “the environment” generally, but specifically of risks to animal or plant life or health.’224 Furthermore, ‘A risk may be evaluated either in quantitative or qualitative terms.’225

Intensity and the Global Steel and Aluminium Arrangement: In Conversation with Bixuan Xu and Aaron Cosbey’ (3 July 2022), https://ielp.worldtradelaw.net/2022/07/guest-post-full-carbonpricing-average-carbon-intensity-and-the-global-steel-and-aluminium-arrangeme.html. 215 Espa (2022), p. 211. 216 Mehling et al. (2019), p. 445. 217 Bacchus (2022), p. 185. 218 Meyer and Tucker (2022), p. 110; Bacchus (2022), p. 185; Veel (2009), p. 753. 219 Rec. 29 CBAM Proposal. See also EU Commission, ‘Staff Working Document: Impact Assessment Report, Accompanying the Document Proposal for a Regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism’, SWD(2021) 643 final Part 1/2 (14 July 2021), p. 14 (Impact Assessment Report). 220 Mehling et al. (2019), p. 465. Veel (2009), pp. 751, 755, lists the political buy-in required for the adoption of climate measures as a separate reason but this is related to the competitiveness concerns. 221 Veel (2009), p. 752. 222 Marceau (2016), p. 35. 223 See e.g. Art. 28.3(1), 2nd sentence, CETA; Art. 29.1(2) TPP; Art. 32.1(3) USMCA; fn. 5 to Art. 17.12(1) RCEP. 224 Panel Report, Brazil – Measures Affecting Imports of Retreaded Tyres, WT/DS332/R, adopted 17 December 2007, para. 7.46. 225 Appellate Body Report, EC – Asbestos, para. 167.

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It is important to bear in mind here that the objective of preventing carbon leakage is closely linked to the objective of reducing GHG emissions. The Panel in Brazil – Taxation found that ‘the reduction of CO2 emissions is one of the policies covered by subparagraph (b) of Article XX, given that it can fall within the range of policies that protect human life or health.’226 Climate mitigation measures ‘protect human beings from the negative consequences of climate change (floods, rising sea levels, etc.)’227 and are, therefore, ‘public health measures’.228

Extraterritoriality Generally speaking, ‘Products can have carbon content in two ways. They can be produced using carbon, or their consumption may emit carbon.’229 In this connection, Mitchell and Merriman note that ‘under the UNFCCC, the Kyoto Protocol, and the Paris Agreement, GHG emissions are based on production, rather than on consumption. As such, emissions are “territorially-bounded”; their calculation is linked to the jurisdiction in which the emissions are produced.’230 CBAM, by aiming at GHG emissions in other jurisdictions, has thus extraterritorial effects.231 It is disputed if measures that are designed to protect public health abroad are covered by Article XX(b) GATT. However, this is not an issue here because climate change ‘has no jurisdictional limitation.’232 ‘GHGs mix in the atmosphere’,233 so emissions in other parts of the world will affect the climate just like domestic ones. The climate cannot be effectively protected unless all major polluting states take action. On one end of the spectrum, some go so far as to assert an erga omnes obligation to protect under international human rights law.234 In the context of Article XX(g) GATT, Sato raises the point that ‘if only depletion within the jurisdiction is allowed to be targeted, then as the CBAM is concerned, measures

226 Panel Report, Brazil – Certain Measures Concerning Taxation and Charges, WT/DS472/R, WT/DS497/R, adopted 11 January 2019, para. 7.880. 227 Dias et al. (2020), pp. 19–20; Will (2019), pp. 201–202. 228 Horn and Mavroidis (2011), p. 1913. See also Rec. 1 CBAM Proposal. 229 Trachtman (2017), p. 483. 230 Mitchell and Merriman (2020), p. 603. 231 Sato (2022), p. 388. See also Sifonios and Ziegler (2020), p. 125. 232 Boklan (2021), p. 139. 233 Bellora and Fontagné (2020), p. 11. 234 In the affirmative, Sciaccaluga (2020), pp. 97–104. See also Human Rights Committee, ‘Decision Adopted by the Committee Under Article 5(4) of the Optional Protocol, Concerning Communication No 2285/2013’, CCPR/C/120/D/2285/2013 (26 October 2017), para. 6.5; Human Rights Committee, ‘General Comment No 36 (2018) on Article 6 of the International Covenant on Civil and Political Rights, on the Right to Life’, CCPR/C/GC/36 (30 October 2018), para. 22. For an extraterritorial obligation of states to protect human rights in general, see De Schutter (2019), pp. 188–200; Joseph and Dipnall (2018), p. 127.

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against depletion will be inefficient for the conservation of the entire resource.’235 That is, by addressing GHG emissions elsewhere, CBAM simultaneously protects ‘human, animal or plant life or health’ within the EU. Hence, there is ‘a sufficient nexus’ to the territorial sovereignty of the respondent,236 which is considered sufficient by the Appellate Body.237 In addition, the Panel in US – Tuna II (Mexico) found ‘the objective of contributing to the protection of dolphins by ensuring that the [respondent’s] market is not used to encourage fishing methods that adversely affect dolphins to be legitimate.’238 The Appellate Body confirmed this finding.239 Likewise, the respondent cannot be expected to contribute to climate change by ‘encouraging’ PPMs that adversely affect the climate.240

4.1.2

Necessity

Next, CBAM must be ‘necessary’. The Appellate Body summarized the necessity test as follows: a necessity analysis involves a process of ‘weighing and balancing’ a series of factors, including the importance of the objective, the contribution of the measure to that objective, and the trade-restrictiveness of the measure . . . [I]n most cases, a comparison between the challenged measure and possible alternatives should then be undertaken.241

Importance of the Policy Objective Pursued There is a correlation between the importance of the policy objective pursued, on the one hand, and the necessity of the measure chosen to achieve that objective, on the other hand: ‘The more vital or important those common interests or values are, the easier it would be to accept as “necessary” a measure . . .’242 The Appellate Body stressed that ‘the preservation of human life and health . . . is both vital and important

235

Sato (2022), p. 401. Vidigal and Venzke (2022), p. 204; Trachtman (2017), p. 481; Marceau (2016), p. 18. 237 Appellate Body Report, US – Shrimp, para. 133; Appellate Body Report, EC – Seal Products, fn. 1191 to para. 5.173. 238 Panel Report, US – Tuna II (Mexico), para. 7.440. 239 Appellate Body Report, US – Tuna II (Mexico), para. 407(d). 240 Cf. Bäumler (2020), p. 496. 241 Appellate Body Report, EC – Seal Products, para. 5.169 (references omitted). 242 Appellate Body Report, Korea – Measures Affecting Imports of Fresh, Chilled and Frozen Beef, WT/DS161/AB/R, WT/DS169/AB/R, adopted 10 January 2001, para. 162; Appellate Body Report, EC – Asbestos, para. 172. 236

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in the highest degree.’243 As a corollary, ‘a measure referring to health protection could be more restrictive and still be considered necessary.’244 In the Paris Agreement, the Parties recognized that ‘Holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels . . . would significantly reduce the risks and impacts of climate change . . .’245 It is worth recalling that the Paris Agreement is a universal agreement, its membership exceeding even that of the WTO.246 All WTO Members except for Yemen have ratified the Paris Agreement. O’Connor points out that, strictly speaking, the ‘Paris [Agreement] itself does not seek to limit carbon but rather temperature’.247 This is too narrowly considered. The Paris Parties also agreed to ‘Increas[e] the ability to adapt to the adverse impacts of climate change and foster climate resilience and low greenhouse gas emissions development . . .’248 And ‘In order to achieve the long-term temperature goal’, they further ‘aim to reach global peaking of greenhouse gas emissions as soon as possible . . . and to undertake rapid reductions thereafter’.249 The UN Framework Convention on Climate Change (UNFCCC) states that ‘stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system . . . should be achieved within a time frame sufficient . . . to ensure that food production is not threatened . . .’250 Moreover, several international legal instruments can be interpreted as calling corporations to reduce their GHG emissions, such as the OECD Guidelines for Multinational Enterprises251 and the Sustainable Development Goals.252 Albeit soft law instruments, they do impact the reading of exception clauses as the use of Agenda 21 by the Appellate Body in US – Shrimp evidences.253 In sum, climate change has global repercussions, so combatting it through reducing GHG emissions is of utmost importance.254

Appellate Body Report, EC – Asbestos, para. 172. Will (2019), p. 208. 245 Art. 2(1)(a). 246 See above Sect. 2.1. 247 O’Connor (2019). Contra Kortum and Weisbach (2020). 248 Art. 2(1)(b) Paris Agreement. 249 Art. 4(1) Paris Agreement. 250 Art. 2 UN Framework Convention on Climate Change (adopted 9 May 1992, entered into force 21 March 1994) 1771 UNTS 107 (UNFCCC). 251 Part I.VI, para. 69. 252 Target 12.6 (‘Encourage companies, especially large and transnational companies, to adopt sustainable practices . . .’). 253 Appellate Body Report, US – Shrimp, paras 130–131. 254 See e.g. UN Secretary-General, ‘Making Peace with Nature Is the Defining Task of the 21st Century’ UN Climate Change News (2 December 2020), https://unfccc.int/news/un-secretarygeneral-making-peace-with-nature-is-the-defining-task-of-the-21st-century. 243 244

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Contribution to the Achievement of the Stated Objective There is a second correlation: ‘The greater the contribution, the more easily a measure might be considered to be “necessary”.’255 It suffices that the measure at issue ‘is apt to produce a material contribution to the achievement of its objective. This demonstration could consist of quantitative projections in the future, or qualitative reasoning based on a set of hypotheses that are tested and supported by sufficient evidence.’256 It follows that it does not harm CBAM’s defence that its exact contribution is not ascertainable yet. That said, ‘the panel will need to reach a conclusion not only concerning whether the measures do, or will, contribute to the [respondent’s] objective, but also the degree to which they will contribute to that objective.’257 Minimizing carbon leakage increases the effectiveness of the ETS in reducing GHG emissions.258 As per the European Parliament, ‘net imports of goods and services in the EU represent more than 20% of the Union’s domestic CO2 emissions’.259 It may be the case that higher costs do not always result in carbon leakage,260 nonetheless, the aforementioned UNCTAD study confirmed that ‘the introduction of carbon pricing coupled with a CBAM helps reduce CO2 emissions, inside and outside the European Union.’261 The study also observed that ‘the reduction represents only a small percentage of global CO2 emissions.’262 Does this mean that CBAM’s contribution will be less than ‘material’? It is settled that ‘A contribution exists when there is a genuine relationship of ends and means between the objective pursued and the measure at issue.’263 At this juncture, the primary objective of the measure at issue should be called to mind, namely the prevention of carbon leakage. Against leakage, border carbon adjustments provide effective protection.264 As the High-level Commission on Carbon Prices noted, ‘Concerns over carbon leakage . . . can also be tackled by improving policy coordination across countries and introducing so-called border carbon adjustments.’265 UNCTAD estimates that ‘With a $44 per tonne carbon tax, leakage is cut

Appellate Body Report, Korea – Various Measures on Beef, para. 163. Appellate Body Report, Brazil – Retreaded Tyres, para. 151. 257 Mitchell and Merriman (2020), p. 587 (emphasis in original). 258 OECD, Climate Policy Leadership in an Interconnected World: What Role for Border Carbon Adjustments? (2020), p. 4, para. 159. 259 European Parliament, Resolution Towards a WTO-compatible EU Carbon Border Adjustment Mechanism, 2020/2043(INI) (10 March 2021), para. 6, https://www.europarl.europa.eu/doceo/ document/TA-9-2021-0071_EN.pdf. 260 Sato (2022), pp. 387–388. 261 UNCTAD, ‘A European Union Carbon Border Adjustment Mechanism’ (2021), p. 3. 262 Ibid. 263 Appellate Body Report, Brazil – Retreaded Tyres, para. 210. 264 Mehling et al. (2019), pp. 446, 473, 481. 265 High-level Commission on Carbon Prices (2017), p. 41. 255 256

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by more than half, from 13.3 to 5.2 per cent, suggesting that the CBAM can be an effective instrument for substantially reducing carbon leakage.’266 What is more, the Appellate Body has indicated some leniency with respect to climate measures: In the short-term, it may prove difficult to isolate the contribution to public health or environmental objectives of one specific measure from those attributable to the other measures that are part of the same comprehensive policy. Moreover, the results obtained from certain actions – for instance, measures adopted in order to attenuate global warming and climate change . . . . – can only be evaluated with the benefit of time.267

Finally, the trade-restrictiveness of the measure will have to be factored in as well.268

Trade-restrictiveness of CBAM The third correlation of the necessity test goes as follows: ‘The less restrictive the effects of the measure, the more likely it is to be characterized as “necessary”.’269 That is, a panel would need to ‘assess the degree of the measures’ trade restrictiveness.’270 With respect to Article 2.2 TBT (‘more trade-restrictive than necessary’), the Appellate Body held that ‘the demonstration of a limiting effect on competitive opportunities in qualitative terms might suffice in the particular circumstances of a given case.’271 CBAM makes imports ‘with a high carbon content’ more expensive.272 It is thus less trade-restrictive ‘than import bans or quotas imposed on climate-intensive goods’.273 UNCTAD finds that ‘a CBAM results in declines in exports in developing countries in favour of developed countries, which tend to have less carbon intensive production processes.’274 But overall, ‘the European Union CBAM may have . . . relatively small effects . . . on most trade flows.’275 Should an import ban on ozonedepleting substances be acceptable under the Montreal Protocol on Substances That

UNCTAD, ‘A European Union Carbon Border Adjustment Mechanism’ (2021), p. 23. Appellate Body Report, Brazil – Retreaded Tyres, para. 151. See also Appellate Body Report, US – Gasoline, p. 21. 268 Appellate Body Report, EC – Seal Products, para. 5.214. 269 Appellate Body Report, China – Measures Affecting Trading Rights and Distribution Services for Certain Publications and Audiovisual Entertainment Products, WT/DS363/AB/R, adopted 19 January 2010, para. 310. See also Appellate Body Report, Korea – Various Measures on Beef, para. 163. 270 Mitchell and Merriman (2020), p. 585 (emphasis in original). 271 Appellate Body Report, United States – Certain Country of Origin Labelling (COOL) Requirements – Recourse to Article 21.5 of the DSU by Canada and Mexico, WT/DS384/AB/R, WT/DS386/AB/R (29 May 2015), para. 5.208. 272 Cf. Kortum and Weisbach (2020). 273 Will (2019), p. 212; Pauwelyn (2013), p. 505. 274 UNCTAD, ‘A European Union Carbon Border Adjustment Mechanism’ (2021), p. 3. 275 Ibid., p. 24. 266 267

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Deplete the Ozone Layer,276 it is difficult to see how a charge on the carbon content of imports would not. Both instruments protect the same environmental commons.

Alternative Measures We have come to the preliminary conclusion that CBAM is necessary. Next, ‘this result must be confirmed by comparing the measure with possible alternatives, which may be less trade restrictive while providing an equivalent contribution to the achievement of the objective.’277 It bears emphasizing that, in order to be considered an alternative, the proposed measure must address the problem identified by the EU, namely carbon leakage. What is not sought is an alternative to the ETS. As a second preliminary point, consultations with trading partners are not an alternative ‘because consultations are by definition a process, the results of which are uncertain and therefore not capable of comparison with the measures at issue in this case.’278 However, whether the EU has engaged in consultations may be relevant to the chapeau analysis.279 Several alternatives are being discussed in the literature. It should be recalled here that it is for the complaining party to ‘identify any alternative measures that, in its view, the responding party should have taken.’280 Those alternative measures must achieve the same level of leakage protection as CBAM would.281 The question is not whether CBAM is the best policy instrument to prevent carbon leakage. Mindful that the Paris Agreement calls for a country’s ‘highest possible ambition’,282 under WTO law, every Member is free to set their own level of climate protection.283 Will notes that the ‘comparison between the effectiveness of the two measures has a stronger impact on the necessity test than the material contribution.’284 And if it was the trade-restrictiveness of the measure relative to the importance of the objective, one might add, the ‘right to determine the level of protection’285—which is ‘the

276

Art. 4(1)-(1sept) Montreal Protocol on Substances That Deplete the Ozone Layer (adopted 16 September 1987, entered into force 1 January 1989) 1522 UNTS 3. 277 Appellate Body Report, Brazil – Retreaded Tyres, para. 178; Appellate Body Report, China – Publications and Audiovisual Products, para. 242. 278 Appellate Body Report, United States – Measures Affecting the Cross-border Supply of Gambling and Betting Services, WT/DS285/AB/R, adopted 20 April 2005, para. 317. 279 See below Sect. 4.4.2. 280 Appellate Body Report, EC – Seal Products, para. 5.169; Appellate Body Report, Brazil – Retreaded Tyres, para. 156; Appellate Body Report, US – Gambling, paras 309–311. 281 Appellate Body Report, US – Gambling, para. 308; Will (2019), p. 215. 282 Art. 4(3) Paris Agreement. 283 Appellate Body Report, Brazil – Retreaded Tyres, paras 170, 210; Appellate Body Report, EC – Asbestos, paras 168, 174; Appellate Body Report, EC – Seal Products, para. 5.200. 284 Will (2019), p. 211. 285 Cf. Appellate Body Report, EC – Asbestos, para. 168.

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fundamental principle’286—would be futile, as this would impute a strict proportionality test. CBAM will progressively replace free ETS allowances.287 The free allocation of emission allowances and CBAM are thus alternative measures to prevent carbon leakage. Some commentators regard the free allocation as more efficient because it levels the playing field for exports as well. The downside is that it ‘dampens the incentive to invest in greener production’ (by ‘not imposing a carbon cost at all on certain production’).288 In other words, the free allocation of emission allowances constitutes a lower level of climate protection.289 Importantly, for a measure to be a reasonably available alternative, it must be WTO-consistent.290 This is disputed as far as free-of-charge emission allowances are concerned.291 The US Commerce Department, for instance, considers them to be a countervailable subsidy.292 The same holds true for the compensation scheme for indirect emission costs, the efficiency of which seems doubtful in any case.293 Bacchus puts forward a carbon tax as an alternative.294 But this is rather an alternative to the ETS than CBAM. Another alternative proposed is ‘to charge the difference between average per unit carbon costs paid abroad and domestically, and allow the importer to provide evidence for rebate eligibility.’295 It is questionable, however, if this measure would be less trade-restrictive than CBAM.296 CBAM charges vary according to embedded emissions.297 Another way would be ‘to levy uniform charges’, irrespective of embedded emissions.298 This, in turn, would mute market signals to reduce the carbon intensity of production.299

Appellate Body Report, Brazil – Retreaded Tyres, para. 210. Art. 1(3), Recs 10–11 CBAM Proposal. 288 Evans et al. (2021), pp. 307, 314–315; Mehling et al. (2019), p. 446; Galiffa and Bercero (2022), p. 197; European Commission, ‘Carbon Border Adjustment Mechanism: Questions and Answers’, Press Release QANDA/21/3661 (14 July 2021), https://ec.europa.eu/commission/presscorner/ detail/en/qanda_21_3661; Bellora and Fontagné (2020), p. 11. 289 OECD (2020), p. 4, paras 160–161. 290 Appellate Body Report, US – Gambling, paras 307, 311. 291 Mehling et al. (2019), p. 466; Rubini and Jegou (2012), pp. 325 ff. 292 See Jesse Kreier, ‘Countervailing the EU’s Emissions Trading Scheme, Part 2’ International Economic Law and Policy Blog (17 December 2020), https://ielp.worldtradelaw.net/2020/12/ countervailing-the-eus-emissions-trading-scheme-part-2-.html. 293 Antonella Ferrara and Ludovica Giua, ‘The Effect of EU ETS Indirect Cost Compensation on Firms Outcomes’ (2020), https://publications.jrc.ec.europa.eu/repository/handle/JRC119837. 294 Bacchus (2021). 295 Kleimann in Kreier (2020). 296 For the compliance costs of a trace-back system, see Appellate Body Report, US – COOL, para. 490. 297 Art. 22(1) CBAM Proposal. 298 Veel (2009), p. 775 fn. 94. 299 Ibid. 286 287

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Some voices in the literature plead for carbon pricing on the domestic consumption of carbon-intensive goods, instead of their production, in order to prevent carbon leakage.300 This could be done by ‘including imports into the EU under the EU ETS’:301 Under this option, the number of EU ETS allowances would have been increased and imports would have competed with EU products for these allowances. In this way, the total number of EU ETS allowances would have capped the total carbon consumed in the EU (instead of total carbon produced in the EU under the current EU ETS) thus taking away any benefit from moving production abroad.302

From an environmental perspective, the advantage of this approach is that ‘it would also cap the amount of carbon imported into the EU’.303 As a consequence, this would change the level of climate protection desired by the EU, and depending on the cap set, could be even more trade-restrictive than CBAM. CBAM uses GHG emissions embedded in goods as its benchmark.304 Another way to quantify emissions would be per capita.305 This would advantage Members, usually developing countries, with a big population. It is doubtful, however, whether this change in methodology is equally effective in avoiding carbon leakage and reducing GHG emissions because it would not compel countries with a big or growing population to use more climate-friendly PPMs. As Charnovitz points out, ‘adding more capita to the planet will tend to worsen climate change.’306 The Appellate Body clarified in Thailand – Cigarettes (Philippines) that ‘what must be shown to be “necessary” is the treatment giving rise to the finding of less favourable treatment.’307 That is, ‘the rationale for product differentiation needs to be based on Article XX GATT’.308 In the present case, we found an MFN infringement because the CBAM Proposal considers a ‘carbon price paid in the country of

300

Karsten Neuhoff et al., Inclusion of Consumption of Carbon-intensive Materials in Emissions Trading: An Option for Carbon Pricing Post-2020 (May 2016), p. 12, https://climatestrategies.org/ wp-content/uploads/2016/10/CS-Inclusion-of-Consumption-Report.pdf. 301 Victor Crochet, ‘CBAM Enters with a BANG: The European Commission Puts Forth Its Carbon Border Adjustment Mechanism Proposal’ International Economic Law and Policy Blog (14 July 2021), https://ielp.worldtradelaw.net/2021/07/cbam-enters-with-a-bang-the-european-commissionputs-forth-its-carbon-border-adjustment-mechanism-pr.html. 302 Ibid. 303 Ibid. 304 Art. 22(1) CBAM Proposal. 305 Cf. Simon Lester, ‘Per Capita Emissions vs Manufacturing Emissions: Why Not Do Both?’ International Economic Law and Policy Blog (25 July 2021), https://ielp.worldtradelaw.net/2021/0 7/per-capita-emissions-vs-manufacturing-emissions-why-not-do-both.html. 306 Steve Charnovitz in ibid. 307 Appellate Body Report, Thailand – Customs and Fiscal Measures on Cigarettes from the Philippines, WT/DS371/AB/R, adopted 15 July 2011, para. 177. 308 Will (2019), p. 221.

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origin’ but no other (non-pricing) measures to reduce GHG emissions.309 So, an alternative would be to consider those measures as well.310 First of all, whether this approach would be WTO-consistent is itself highly questionable.311 Secondly, while there is an implicit price for complying with regulatory measures,312 how these measures translate into a carbon price (tax-based or emission allowances) that would have brought about the same amount of GHG reductions is not straightforward. In the first instance, this would presuppose a quantification of the emission reductions resulting from such measures. This is possible (for example, the emission reductions resulting from upgrading production facilities may be calculated) but complex.313 In a second step, those emission reductions would need to be compared with the emissions reductions resulting from carbon pricing. Thirdly, costs for complying with particular regulatory measures would have to be determined so that the respective cost burdens can be compared. As to the final point, Marceau notes that ‘economic analysis cannot fully project the costs of a regulation or a standard without making simplifying assumptions.’314 According to the Appellate Body, an ‘undue burden’ on the respondent, ‘such as prohibitive costs or substantial technical difficulties’, is a factor to be taken into account.315 It can be inferred that the same would apply to the difficulties of putting a price tag on regulatory measures. Extending Article 9(1) CBAM Proposal to regulatory measures would, therefore, not be a ‘reasonably available’ alternative.

Conclusions Given the paramount importance of climate protection—and the prevention of carbon leakage is a component thereof—CBAM is necessary to achieve the EU’s desired level of climate protection.316 The shift from a production-based to a consumption-based model might be a viable option, but more data and analysis would be required in that regard. Furthermore, it should be stressed that the affirmation of necessity is contingent upon the risk of carbon leakage. As that risk declines, because other Members introduce carbon pricing and companies face 309

Art. 9(1) CBAM Proposal. Sato (2022), pp. 402–403, discusses this under the chapeau but at the same time admits that it is a design question. 311 Aaron Cosbey, ‘Guest Post: Response to Bixuan Wu on EU’s CBAM’ International Economic Law and Policy Blog (3 July 2022), https://ielp.worldtradelaw.net/2022/07/guest-post-response-tobixuan-wu-on-eus-cbam.html. 312 See above Sect. 3.2.4. 313 Meyer and Tucker (2022), p. 117. 314 Marceau (2016), p. 13. 315 Appellate Body Report, US – Gambling, para. 308; confirmed for GATT in Appellate Body Report, Brazil – Retreaded Tyres, para. 156. 316 See also Trachtman (2017), pp. 479–480. 310

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similar carbon costs wherever they manufacture, CBAM will eventually become obsolete.317 The Vice-President of the European Commission Timmermans confirmed that CBAM will be a temporary measure.318 Next, we will examine subparagraph (g) of Article XX GATT, which does not have a necessity test. Its ‘relating to’ standard constitutes a lower threshold, so it is easier for a respondent to justify a climate measure thereunder.319

4.2

Article XX(g) GATT

The Appellate Body in China – Rare Earths summarized the content of this exception clause as follows: Article XX(g) permits the adoption or enforcement of trade measures that have ‘a close and genuine relationship of ends and means’ to the conservation of exhaustible natural resources, when such trade measures are brought into operation, adopted, or applied and ‘work together with restrictions on domestic production or consumption, which operate so as to conserve an exhaustible natural resource’.320

4.2.1

Conservation of an Exhaustible Natural Resource

The Appellate Body clarified in China – Raw Materials that ‘The word “conservation” . . . means “the preservation of the environment, especially of natural resources”.’321 Exhaustible resources are ‘finite’.322 That is, for a resource to be ‘exhaustible’, it must be ‘susceptible of depletion’.323 What is susceptible of depletion may change over time depending on pollution levels. The expression ‘exhaustible natural resources’ must, therefore, be interpreted in a dynamic manner ‘in the light of contemporary concerns of the community of nations about the protection and

317

Mehling et al. (2019), p. 447. Camilla Hodgson, ‘EU Rebuffs US Concerns Over Carbon Border Tax Threat’ Financial Times (31 March 2021), https://www.ft.com/content/d31ec6c9-453a-4705-b47b-1c9e46de817a, cited in Oharenko (2021). See also European Commission, ‘Green Paper on Greenhouse Gas Emissions Trading Within the European Union’, COM(2000) 87 final (8 March 2000), p. 7, https://op.europa. eu/en/publication-detail/-/publication/41ab9f93-b438-41a6-b330-bb0491f6f2fd/language-en. 319 Dobson (2021), p. 91; Will (2019), pp. 215, 219. 320 Appellate Body Report, China – Measures Related to the Exportation of Rare Earths, Tungsten and Molybdenum, WT/DS431/AB/R, WT/DS432/AB/R, WT/DS433/AB/R, adopted 29 August 2014, para. 5.94 (references omitted). 321 Appellate Body Report, China – Measures Related to the Exportation of Various Raw Materials, WT/DS394/AB/R, WT/DS395/AB/R, WT/DS398/AB/R, adopted 22 February 2012, para. 355; confirmed in Appellate Body Report, China – Rare Earths, para. 5.89. 322 Appellate Body Report, US – Shrimp, para. 128. 323 Ibid. 318

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conservation of the environment.’324 The UNFCCC affirms that ‘change in the Earth’s climate and its adverse effects are a common concern of humankind’.325 Also, the Appellate Body observed that ‘measures to conserve exhaustible natural resources, whether living or non-living, may fall within Article XX(g).’326 In US – Gasoline, the Appellate Body deemed ‘clean air’ to be an exhaustible natural resource.327 Arguably, this is analogous to ‘an atmosphere with low GHG density . . ., as it has value, is natural, and could be depleted.’328 As highlighted by Will, ‘Certain effects of global warming (tipping points) cannot be turned back.’329 What is more, ‘climate change itself is associated with the depletion of other natural resources such as biodiversity and reliable water supplies.’330 That CBAM’s primary objective is the prevention of carbon leakage does not run counter to this analysis. By making the ETS more effective, CBAM also contributes to the reduction of GHG emissions.331

4.2.2

Relating to

Under this heading, the respondent must show that there is ‘a close and genuine relationship of ends and means.’332 The means must be ‘reasonably related to the ends.’333 This is given because, as seen, CBAM even makes a contribution to climate protection.334 The Appellate Body held in China – Rare Earths that ‘consideration of the predictable effects of a measure may be relevant’.335 That said, ‘there is no requirement to apply an “empirical effects test” under Article XX(g).’336 Veel submits that ‘Carbon tariffs bear a direct relation to the reduction of CO2 emissions, as they (i) raise the cost for foreign polluters of emitting CO2, thereby encouraging them to reduce their CO2 emissions, and (ii) prevent the “leakage” of CO2 emissions . . .’337 Apropos a provision ‘designed to influence countries to adopt

Ibid., paras 129–130; Appellate Body Report, China – Rare Earths, para. 5.89. Rec. 1 Preamble to UNFCCC. 326 Appellate Body Report, US – Shrimp, para. 131 (emphasis in original). 327 Appellate Body Report, US – Gasoline, p. 19. 328 Sato (2022), p. 400; Dias et al. (2020), p. 19; Will (2019), p. 205; Dobson (2021), p. 91; Boklan (2021), p. 140; Meyer and Tucker (2022), p. 118; Trachtman (2017), p. 479; Veel (2009), p. 776. 329 Will (2019), p. 205. 330 Mehling et al. (2019), p. 467; Will (2019), p. 205; Marceau (2016), p. 17. 331 See above Sect. 4.1.2. 332 Appellate Body Report, China – Rare Earths, paras 5.90, 5.94; Appellate Body Report, US – Shrimp, para. 136. 333 Appellate Body Report, US – Shrimp, para. 141. 334 Pro Sato (2022), p. 401. For the parallel definition of contribution, see above Sect. 4.1.2. 335 Appellate Body Report, China – Rare Earths, para. 5.100. 336 Ibid., para. 5.98. 337 Veel (2009), p. 777. 324 325

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national regulatory programs requiring the use of TEDs by their shrimp fishermen’, the Appellate Body found that ‘This requirement is . . . directly connected with the policy of conservation of sea turtles.’338 It is worth recalling that the measure at issue does not constitute a ‘blanket prohibition of the importation’ of carbon-intensive goods.339 Moreover, its scope is limited to specific ‘carbon-intensive, leakage-exposed sectors’ (but may be extended in the future),340 ‘strengthen[ing] the link between the measure and its environmental objective.’341 To conclude, and along the lines of the Appellate Body ruling in US – Gasoline, CBAM ‘cannot be regarded as merely incidentally or inadvertently aimed at the conservation of’ a safe climate.342

4.2.3

Made Effective in Conjunction with Restrictions on Domestic Production or Consumption

Article XX(g) GATT requires that ‘restrictions be imposed not only on international trade but also on domestic consumption or production.’343 The Appellate Body deduced from this clause ‘a requirement of even-handedness in the imposition of restrictions, in the name of conservation, upon the production or consumption of exhaustible natural resources.’344 Furthermore, the Appellate Body clarified that ‘the phrase “made effective in conjunction with” in Article XX(g) of the GATT 1994 [does not] require a separate showing that the purpose of the challenged measure must be to make effective restrictions on domestic production or consumption.’345 Instead, ‘Article XX(g) permits trade measures relating to the conservation of exhaustible natural resources if such trade measures work together with restrictions on domestic production or consumption, which operate so as to conserve an exhaustible natural resource.’346 Domestic manufacturers of like goods are subject to the ETS in the EU, which involves an obligation to surrender emission allowances ‘equal to the total emissions’, too.347 Hence, ‘CBAM is “made effective in conjunction with restrictions on domestic production”’.348

Appellate Body Report, US – Shrimp, paras 138, 140. For the relevance of this, see ibid., para. 141. 340 Arts 2, in conjunction with Annex I, 30 CBAM Proposal. In particular, more downstream products might be included, see Impact Assessment Report, p. 25. 341 Mehling et al. (2019), p. 465. 342 Will (2019), pp. 206, 217–218. Cf. Appellate Body Report, US – Gasoline, p. 19. 343 Appellate Body Report, China – Rare Earths, para. 5.124. 344 Appellate Body Report, US – Gasoline, p. 21; Appellate Body Report, US – Shrimp, para. 143 (emphasis in original). 345 Appellate Body Report, China – Raw Materials, para. 361. 346 Ibid., paras 356, 360. 347 Art. 12(3) ETS Directive. 348 Sato (2022), p. 399. 338 339

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There is one discrepancy, however, regarding producers of electrical energy. Whereas the ETS applies to the ‘Combustion of fuels in installations with a total rated thermal input exceeding 20 MW’,349 CBAM applies to imported electricity in general. This does not necessarily mean that importers of electricity would have to purchase emission certificates where domestic producers would not. For importers (e.g. of green energy) can always show that no CO2 was emitted during electricity production, so no CBAM emissions would have to be acquired. The difference concerns installations with a total rated thermal input below 20 MW, which are exempt from the ETS but not CBAM (provided they export). Some commentators take the position that ‘a BCA cannot be applied to industry sectors or products that on the EU domestic side are not subject to the EU ETS’.350 The Appellate Body, by contrast, noted that ‘There is . . . no textual basis for requiring identical treatment of domestic and imported products.’351 It is not clear if this also means that there is no requirement for identical product coverage. In China – Rare Earths, the Appellate Body elaborated that ‘to comply with the “made effective” element of the second clause of Article XX(g), a Member must impose “real” restrictions on domestic production or consumption’ but does not require that ‘the burden of conservation be evenly distributed’.352 The benchmark is if the ‘burden on foreign consumers or producers’ is ‘significantly more onerous’.353 It follows that ‘even if the relevant legislation were to discriminate against imports in some of its details compared to domestic products, the legislation or the measure as a whole could still be found to meet this test.’354 What matters is that the ETS imposes real GHG constraints on domestic producers through its emissions cap.355

4.3

Article XX(a) GATT

In light of the EC – Seal Products ruling, where the Appellate Body accepted the legitimacy of ‘measures protecting public morals primarily concerned with situations outside the regulating state’,356 Article XX(a) GATT comes into consideration,

349

Annex I to the ETS Directive. Dias et al. (2020), p. 21 fn. 28. 351 Appellate Body Report, US – Gasoline, p. 21 (emphasis added). 352 Appellate Body Report, China – Rare Earths, paras 5.132, 5.134, 5.136, 5.165. 353 Ibid., para. 5.134. 354 Mehling et al. (2019), p. 467. 355 European Commission, ‘Emissions Cap and Allowances’, https://ec.europa.eu/clima/eu-action/ eu-emissions-trading-system-eu-ets/emissions-cap-and-allowances_en. 356 Dobson (2021), p. 94. Cf. Appellate Body Report, EC – Seal Products, paras 5.173, 5.198–5.200, 5.289–5.290. 350

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too.357 In that case, the Appellate Body confirmed the justifiability in principle of measures with effects on PPMs in other Members. However, with the requirements of subparagraph (g) being satisfied, the invocation of subparagraph (a) would not add anything to the EU’s defence. A panel would most likely exercise judicial economy. Therefore, we shall omit to discuss subparagraph (a) here.

4.4

Chapeau

It is consistent case law that the chapeau is concerned with the application of the measure at issue, 'as distinguished from' its design.358 Yet, its purport is controversial. On top of that, it may not always be a simple task to distinguish between design, on the one hand, and application, on the other hand. What seems clear is that procedural aspects of the measure are scrutinized under the chapeau.

4.4.1

Elements of the Chapeau

This uncertainty surrounding the exegesis of the chapeau is a problem for WTO law, given that it is probably ‘the most important provision in the entire GATT agreement.’359 One foundational question is whether the chapeau embodies one or several tests. This issue arises because ‘discrimination’ resurfaces in the chapeau, having already established an MFN infringement. Because the chapeau is an objective standard, this doubling of the discrimination analysis cannot be explained by the distinction between discriminatory effect and discriminatory intent.360 Likewise, it would not make sense to design exceptions with a view to justifying discrimination, and then apply the same discrimination standards to negate the exceptions.361 From that premise the Appellate Body drew the wrong conclusion: to wit, ‘The provisions of the chapeau cannot logically refer to the same standard(s) by which a violation of a substantive rule has been determined to have occurred.’362 This did not prevent the Appellate Body from observing that ‘the circumstances that bring about the discrimination that is to be examined under the chapeau [can] be the same as those that led to the finding of a violation of a substantive provision of the GATT

357

Will (2019), pp. 195–199. Appellate Body Report, US – Gasoline, p. 22; Appellate Body Report, US – Shrimp, para. 115. For the chapeau in general, see Riffel (2018), pp. 141 ff. 359 Pauwelyn (2013), p. 501. 360 Contra Leal-Arcas (2021), p. 143. 361 Pauwelyn (2013), p. 501. 362 Appellate Body Report, EC – Seal Products, para. 5.298; Appellate Body Report, US – Gasoline, p. 23. See also Appellate Body Report, US – Shrimp, para. 150. Pro Dias et al. (2020), p. 21, relying on effet utile. 358

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1994.’363 In EC – Seal Products, the Appellate Body held that ‘the causes of the “discrimination” found to exist under Article I:1 of the GATT 1994 are the same as those to be examined under the chapeau.’364 This conflates the above distinction between design and application. A provisionally justified measure would not founder on the chapeau for being discriminatory alone, it must be applied in an arbitrary manner. The adjective attribute ‘unjustifiable’ is not helpful, as it is precisely the issue whether the found discrimination can be justified.365 Therefore, correctly understood, the question under the chapeau must be whether the discrimination is arbitrary.366 This is borne out by the pronouncement of the Appellate Body in US – Shrimp that ‘The chapeau of Article XX is, in fact, but one expression of the principle of good faith.’367 Arbitrariness can be negated if the discrimination ‘is explained by a rationale that bears . . . [a] relationship to the objective of a measure provisionally justified under one of the paragraphs of Article XX’.368 Already in US – Gasoline did the Appellate Body rule that the respective elements of the chapeau may . . . be read side-by-side; they impart meaning to one another . . . [T]he kinds of considerations pertinent in deciding whether the application of a particular measure amounts to ‘arbitrary or unjustifiable discrimination’, may also be taken into account in determining the presence of a ‘disguised restriction’ on international trade.369

Cognizant of the chapeau’s good faith function, the Appellate Body clarified in Brazil – Retreaded Tyres that ‘the analysis of whether the application of a measure results in arbitrary or unjustifiable discrimination should focus on the cause of the discrimination, or the rationale put forward to explain its existence.’370 That is, arbitrariness is given when there is no rational reason for the state conduct. This should be the test, as it accommodates measures with multiple purposes.

4.4.2

Relevance of an Internationally Agreed Solution

One of the many things disputed about the chapeau is whether it entails an obligation to negotiate a multilateral solution first before taking unilateral action. The WTO has endorsed Principle 12 of the Rio Declaration on Environment and Development, which states that

Appellate Body Report, EC – Seal Products, para. 5.298. Ibid., para. 5.318. 365 Riffel (2018), p. 150. 366 Bartels (2015), p. 110; Riffel (2018), pp. 148–149. 367 Appellate Body Report, US – Shrimp, para. 158. 368 Appellate Body Report, Brazil – Retreaded Tyres, para. 232. 369 Appellate Body Report, US – Gasoline, p. 25. 370 Appellate Body Report, Brazil – Retreaded Tyres, para. 226. 363 364

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Unilateral actions to deal with environmental challenges outside the jurisdiction of the importing country should be avoided. Environmental measures addressing transboundary or global environmental problems should, as far as possible, be based on an international consensus.371

No obligation to conclude an international agreement can be deduced from this.372 There is no doubt that, in the context of climate change, coordinated action would be preferable to unilateral one for more than one reason.373 Most economists argue that carbon pricing is an effective policy instrument to reduce GHG emissions, and thus reach the Paris climate target, ‘with carbon border adjustment a second-best to a global carbon tax.’374 Things being as they are, a global carbon tax seems a long way off, however.

Obligation to Cooperate An obligation to cooperate in the climate sphere might arise from international human rights law375 as well as international climate law. As to the latter, the UNFCCC reaffirms the chapeau in weaker language (‘should’).376 The Kyoto Protocol stipulates that the parties ‘shall strive to implement policies and measures . . . in such a way as to minimize adverse effects, including the adverse effects of climate change, effects on international trade, and social, environmental and economic impacts on other Parties . . .’377 The Paris Agreement does not prescribe the means by which to reach the climate target, nor does it preclude border carbon adjustments. The Conference of the Parties simply ‘recognizes the important role of providing incentives for emission reduction activities, including tools such as domestic policies and carbon pricing’.378 Time is pressing.379 Sustainability Development Goal 13 urges countries to take ‘action to combat climate change and its impacts’. The High-level Commission on Carbon Prices underscores that ‘Tackling climate change is an urgent and

371 WTO Committee on Trade and Environment, ‘Report’, WT/CTE/1 (12 November 1996), para. 171. 372 Appellate Body Report, US – Shrimp (Article 21.5 – Malaysia), paras 123–124. 373 Mehling et al. (2019), p. 481; Truby (2010), p. 151. 374 Galiffa and Bercero (2022), p. 200; Kortum and Weisbach (2020); Rob Howse, ‘How to Begin to Think About the WTO Compatibility of the European Union CBAM’ International Economic Law and Policy Blog (14 July 2021), https://ielp.worldtradelaw.net/2021/07/how-to-begin-tothink-about-the-wto-compatibility-of-the-european-union-cbam.html; Elliott et al. (2010), p. 465. See also Bacchus (2022), pp. 176–178, 180. 375 Mayer (2021), p. 451. 376 Art. 3(5), 2nd sentence, UNFCCC. 377 Art. 2(3) Kyoto Protocol. 378 Conference of the Parties, ‘Adoption of the Paris Agreement’, Decision 1/CP.21, para. 136. 379 Mehling et al. (2019), p. 481.

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fundamental challenge.’380 In addition, the IPCC Working Group II concluded that ‘Near-term actions that limit global warming to close to 1.5°C would substantially reduce projected losses and damages related to climate change in human systems and ecosystems, compared to higher warming levels, but cannot eliminate them all’.381 Given the seriousness of the situation, Members cannot be expected to wait for a global solution to materialize before they are allowed to take climate action.382 In sum, while it encourages international cooperation,383 international climate law sanctions unilateral action. At this juncture, it should be noted that the EU is a party to the UNFCCC, the Kyoto Protocol, and the Paris Agreement.384 The implications of this for the chapeau analysis are not clear. While some point out that acceding to the Paris Agreement may not be sufficient to satisfy the chapeau, because border carbon adjustments were not considered under that Agreement,385 others are of the view that those international climate agreements ‘may provide a broad factual basis for argument that unilateral action is neither arbitrary nor unjustifiable.’386 This does not yet answer the question if negotiations are a requirement under the chapeau.387 The issue in US – Shrimp was that the respondent ‘negotiated seriously with some, but not with other Members . . .’388 This seems to suggest that an obligation to negotiate arises if the respondent negotiated with some Members; only then will it also have to do so with others. The Appellate Body in EC – Seal Products appears to have drawn the same conclusion.389

Good Faith Attempts of the EU Be this as it may, during the drafting of CBAM, the EU has consulted with other WTO Members.390 Furthermore, Recital 54 to the CBAM Proposal stipulates that The Commission should strive to engage in an even handed manner . . . with the third countries whose trade to the EU is affected by this Regulation, to explore possibilities for

380

High-level Commission on Carbon Prices (2017), p. 1. IPCC Working Group II, Sixth Assessment Report: Headline Statements from the Summary for Policymakers (28 February 2022), B.3, 3rd sentence. 382 Cf. Krugman (2021). 383 See e.g. Arts 6, 7(6)–(7), 8(4) Paris Agreement. 384 United Nations Climate Change, ‘European Union’, https://unfccc.int/node/61063. 385 Will (2019), pp. 213–214; Mehling et al. (2019), p. 479. 386 Trachtman (2017), p. 481. 387 In favour, Van den Bossche and Zdouc (2022), p. 652; Pauwelyn (2013), p. 504. Against, Trebilcock et al. (2013), pp. 678–679. 388 Appellate Body Report, US – Shrimp, para. 172. 389 Appellate Body Report, EC – Seal Products, para. 5.305. 390 European Commission, ‘Carbon Border Adjustment Mechanism’. 381

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dialogue and cooperation with regard to the implementation of specific elements of the Mechanism set out [in] this Regulation and related implementing acts.

The ETS Directive mirrors that.391 The CBAM Proposal also provides that ‘The Union may conclude agreements with third countries with a view to take account of carbon pricing mechanisms in these countries . . .’392 These negotiations must be open to all interested WTO Members. Although not expressly on the mutual recognition of carbon reduction mechanisms, the steel and aluminium sectoral arrangement between the EU and the US could be mentioned here. It is envisaged to lead to ‘a global arrangement to address carbon intensity and global overcapacity’.393 In the final analysis, the question if good faith negotiations are mandatory under the chapeau can be left open. For the EU has been negotiating and has enshrined in legal text its willingness for future negotiations.394

4.4.3

Arbitrary Discrimination

The key question concerning discrimination under the chapeau is whether the measure at issue needs to be applied in the same manner to all Members or whether the respondent may differentiate between polluters. At this point, it is worth recalling that the measure must be applied in the same way to goods from ‘countries where the same conditions prevail’. This means, by implication, that the measure must be flexible enough so as to take account of different conditions in exporting countries. In US – Shrimp (Article 21.5 – Malaysia), the Appellate Body took this to mean ‘conditioning market access on the adoption of a programme comparable in effectiveness’.395 The Appellate Body took issue with the ‘rigid and unbending requirement that countries applying for certification . . . adopt a comprehensive regulatory program that is essentially the same as the [respondent’s] program . . .’396 It follows that the uniform application of a measure could not be justified simply on grounds of administrative efficiency or cost-saving. A rationale is provided by the WTO: If that was accepted, then any country could ban imports of a product from another country merely because the exporting country has different environmental, health and social policies from its own. This would create a virtually open-ended route for any country to apply trade restrictions

391

Art. 25 ETS Directive. Art. 2(12) CBAM Proposal. 393 US Trade Representative, ‘Joint US-EU Statement on Trade in Steel and Aluminum’ (31 October 2021), https://ustr.gov/about-us/policy-offices/press-office/press-releases/2021/october/joint-us-eustatement-trade-steel-and-aluminum. 394 Rec. 53 CBAM Proposal. 395 Appellate Body Report, US – Shrimp (Article 21.5 – Malaysia), para. 144 (emphasis in original). 396 Appellate Body Report, US – Shrimp, para. 177 (emphasis added). 392

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unilaterally — and to do so not just to enforce its own laws domestically, but to impose its own standards on other countries.397

That said, ‘Article XX of the GATT 1994 does not require a Member to anticipate and provide explicitly for the specific conditions prevailing and evolving in every individual Member.’398 According to the legal text, ‘non-discrimination is not an absolute requirement’, for ‘it is permissible to treat countries differently, so long as the discrimination is not arbitrary, is justifiable, and is based on salient differences.’399 In US – Tuna II (Article 21.5 – Mexico), the Appellate Body elaborated that ‘[o]ne of the most important factors’ in the assessment of arbitrary or unjustifiable discrimination is the question of whether the discrimination can be reconciled with, or is rationally related to, the policy objective with respect to which the measure has been provisionally justified under one of the subparagraphs of Article XX.400

This is reminiscent of the ‘relating to’ standard in subparagraph (g) and purports that, if there is discrimination, it must be related to the objective of preventing carbon leakage. The Appellate Body clarified in EC – Seal Products that ‘the relationship of the discrimination to the objective of a measure is . . . not the sole test, that is relevant to the assessment of arbitrary or unjustifiable discrimination.’401 Another test was set out by the Appellate Body in US – Shrimp: discrimination results not only when countries in which the same conditions prevail are differently treated, but also when the application of the measure at issue does not allow for any inquiry into the appropriateness of the regulatory program for the conditions prevailing in those exporting countries.402

This expands the possibilities of exporting countries, confronted with PPM-related market access conditions, to challenge those. It is questionable whether ‘regulatory program’ in the present context concerns the whole gamut of carbon constraints or is limited to leakage prevention measures. The distinction between ‘measure at issue’ and ‘regulatory program’ suggests to inquire into the comprehensive policy of which leakage prevention forms part. Given the Members’ commitments under the Paris Agreement, a climate measure cannot be considered arbitrary a priori. In the wake of the Glasgow Climate Pact, ‘Over 90% of world GDP is now covered by net zero commitments.’403 Conversely, WTO, ‘The Environment’. Appellate Body Report, US – Shrimp (Article 21.5 – Malaysia), para. 149 (emphasis in original). 399 Trachtman (2017), p. 482. For the identical formulation in international investment law, see Radi (2020), p. 198. 400 Appellate Body Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products – Recourse to Article 21.5 of the DSU by Mexico, WT/DS381/AB/ RW, adopted 3 December 2015, para. 7.316. 401 Appellate Body Report, EC – Seal Products, para. 5.321 (emphasis added). 402 Appellate Body Report, US – Shrimp, para. 165. 403 Glasgow Climate Pact, COP26 Achievements at a Glance, p. 5, https://ukcop26.org/theconference/cop26-outcomes/. 397 398

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even though the EU may be fulfilling its international climate obligations, this does not mean that a climate measure could not be applied in an arbitrary manner.404 Sato objects to CBAM because, under the measure, import charges are levied ‘even when there is no risk of carbon leakage.’405 This would mean that, in some instances, CBAM is applied in a manner that is not related to its policy objective. Sato’s argument is that even imports with lower embedded emissions than those of like domestic goods would be charged.406 This is correct. The salient point, however, is that they would be charged less than the like domestic goods with the higher carbon footprint. As seen, a declarant can always choose to be charged on the basis of actual emissions.407 To take an example, if the declarant can prove that no GHGs were emitted during the production, no CBAM certificates will need to be surrendered at all.408 Imports, like domestic goods, pay a cost equivalent to their GHG emissions. The relationship to the objective of the measure is thus given.

Scope of CBAM CBAM will apply to specific carbon-intensive sectors that are (i) subject to the EU’s ETS and (ii) ‘at high risk of carbon leakage’.409 Some criticize the limited product scope of CBAM, notably with respect to ‘assembled products and downstream products’, as going against its GHG reduction objective.410 This line of argument is not convincing. First, the EU used objective criteria to determine which product categories are subject to CBAM. Secondly, regard must be given to the fact that a border carbon adjustment constitutes a new policy instrument that has never been trialled on such a scale. Because regulators need to gain some experience, it makes sense to experiment with a more limited coverage.411 Besides, the selection of ‘cement, aluminium, steel, and electricity . . . avoids the administrative cost and trans-shipment risk associated with inclusion of goods with more complex supply chains.’412 As to downstream products, they will possibly be included.413

404

Contra Saunders (2021), pp. 152–155. Sato (2022), pp. 387, 390, 403. 406 Ibid., pp. 388, 390. 407 See above Sect. 2.2. 408 Art. 22(1) CBAM Proposal. 409 Art. 2(1), in conjunction with Annex I, Recs 28–29, 34, 37 CBAM Proposal; European Commission, ‘Carbon Border Adjustment Mechanism’. 410 Sato (2022), p. 389. Cf. Appellate Body Report, Brazil – Retreaded Tyres, para. 227. 411 Mehling et al. (2019), p. 474. 412 Ibid., pp. 447–448. 413 Ashish Sinha, ‘Carbon Border Adjustment Mechanism (CBAM) Update and Its Impact on the EU Cross-border Imports’ Ernst & Young (4 Mar 2022), https://www.ey.com/en_ch/tax/greentaxes/carbon-border-adjustment-mechanism. 405

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That said, the found discrepancy within one covered product category (CBAM applies to electricity imports in general; the ETS exempts installations with a total rated thermal input below 20 MW)414 cannot be explained on grounds of ‘complexity and administrative burden’.415 Since it is possible that installations with such a small input export, too,416 this discrimination cannot be reconciled with a legitimate policy objective and hence is deemed arbitrary. The rationale for the exclusion of certain third countries417 is that ‘their production has already been subject to the EU ETS, whereby it applies to third countries or territories, or to a carbon pricing system fully linked with the EU ETS.’418 In other words, in those countries, the same relevant conditions prevail in terms of the chapeau.

Non-Tradability of CBAM Certificates One of the criticisms levelled against CBAM is that CBAM certificates, unlike ETS allowances,419 are not tradeable.420 The EU justifies this difference in treatment with ‘the need to preserve the effectiveness of the CBAM’:421 As it is not possible to impose a cap on the number of CBAM certificates available to importers, if importers had the possibility to carry forward and trade CBAM certificates, this could result in situations where the price for CBAM certificates would no longer reflect the evolution of the price in the EU ETS . . . It could also result in different prices for operators of different countries.422

This explanation is rationally related to CBAM’s policy objective. It is a consequence of CBAM not having a cap like the ETS, as this would entail ‘quantitative limits to import’.423 In addition, CBAM provides the possibility to sell back to the competent authority unused emission certificates for up ‘to one third of the total CBAM certificates purchased . . . during the previous calendar year.’424 The limitation to one third is justified by the EU as being necessary to allow ‘a reasonable

414

See above Sect. 4.2.3. Cf. Rec. 29 CBAM Proposal. 416 Cf. Appellate Body Report, EC – Bananas III, para. 136. 417 See above Sect. 3.2. 418 Rec. 14 CBAM Proposal. See also Galiffa and Bercero (2022), p. 198; Espa (2022), pp. 210, 212. 419 Art. 12(1) ETS Directive. 420 Sato (2022), p. 403; Crochet (2021). 421 Rec. 20 CBAM Proposal. 422 Rec. 22 CBAM Proposal. 423 Rec. 19 CBAM Proposal. 424 Art. 23 CBAM Proposal. 415

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margin for importers to leverage their costs over the period of validity of the certificates whilst preserving the overall price transmission effect’.425

Additional Compliance Costs CBAM imposes certain administrative burdens upon declarants (e.g. the need for authorization,426 reporting duties,427 the costs associated with verification428) and foreign operators (e.g. the costs of registration429). In particular, ‘declarants (and ultimately producers) need to identify all emissions associated with imports by obtaining necessary information from their suppliers.’430 Some commentators see a stand-alone violation of the chapeau therein.431 This author disagrees. Only because there are compliance costs, this alone does not make a measure unlawful. Domestic operators, too, are subject to registration, reporting and verification obligations under the ETS Directive.432 Every measure comes with a certain compliance burden, and be it only to familiarize oneself with the measure. As pointed out by the Appellate Body in US – Gasoline, ‘There are . . . established techniques for checking, verification, assessment and enforcement of data relating to imported goods, techniques which in many contexts are accepted as adequate to permit international trade – trade between territorial sovereigns – to go on and grow.’433 This is normal part of international trade. We can conclude that the occurrence of such compliance costs does not put the application of a measure in breach of the chapeau. What is more, the administrative duties as set out in CBAM do not seem excessive. Nowadays, better technology exists to record and verify GHG emissions, such as blockchain systems.434 How to charge GHGs without determining the amount of GHGs emitted first?435 How to prevent fraud if not through verifying the amount reported? These things are prerequisite for the smooth operation of CBAM. The GATS Agreement makes it plain that higher compliance costs are immaterial if they are due to ‘inherent competitive disadvantages which result from the foreign character’ of a product.436

425

Rec. 22 CBAM Proposal. Arts 4–5, 17, 25(1) CBAM Proposal. 427 Arts 5(5); 6 (annual declaration); 33(1), 35 (quarterly reports) CBAM Proposal. 428 Art. 8 CBAM Proposal. 429 Art. 10 CBAM Proposal. 430 Sato (2022), p. 389. 431 Ibid., pp. 396, 402–403. See also Meyer and Tucker (2022), p. 117. 432 Arts 4–6, 14–15 ETS Directive. 433 Appellate Body Report, US – Gasoline, p. 27. 434 Dias et al. (2020), p. 23; Mehling et al. (2019), pp. 436, 477. 435 Trachtman (2017), p. 483. 436 Fn. 10 to Art. XVII:1 GATS. 426

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One word on reporting duties for declarants is in order: Those reporting duties include indirect emissions, i.e. energy inputs,437 even though no CBAM certificates will need to be surrendered for indirect emissions at this stage.438 There is no difference to the ETS, however, which also captures indirect emissions by including combustion as a covered activity.439 In short, what is required under the chapeau is due process, not cost neutrality.440 Processes have to be ‘transparent’ and ‘predictable’; the interests of foreign traders must be heard.441 As mentioned above, the due process requirement extends to the coming-about of the measure,442 including its promulgation.443 CBAM establishes notification obligations for authorities;444 decisions have to be substantiated;445 the right to appeal negative decisions is guaranteed.446 Furthermore, CBAM provides for a transitional period so as to give trading partners some lead time to adjust.447

Minimum Purchase Requirement and Validity Period Declarants are required to purchase and surrender CBAM certificates on an annual basis.448 The same is true of domestic operators under the ETS Directive (with an earlier surrender date).449 But a declarant must purchase CBAM certificates so that the number of certificates held ‘at the end of each quarter corresponds to at least 80 per cent of the embedded emissions . . . in all goods it has imported since the beginning of the calendar year.’450 In other words, CBAM establishes a minimum purchase requirement per quarter.451 This difference between the CBAM Proposal and the ETS Directive matters, as the Panel in Argentina – Hides and Leather explains

437

Art. 35(2)(c) CBAM Proposal. CBAM certificates will need to be surrendered for ‘embedded emissions’, Art. 22(1) CBAM Proposal. The definition of ‘embedded emissions’ in Art. 3(16) CBAM Proposal only includes direct emissions. 439 Arts 2(1), in conjunction with Annex I, 3(t) ETS Directive. Cf. Rec. 17 CBAM Proposal. 440 Appellate Body Report, US – Shrimp, para. 181. 441 Ibid., para. 180. 442 See above Sect. 4.4.2. 443 Panel Report, European Communities – Measures Affecting Asbestos and Products Containing Asbestos, WT/DS135/R, adopted 5 April 2001, para. 8.233. 444 Arts 10(3), 16(3), 19(3), 22(3), 26(4), 33(2), 35(5) CBAM Proposal. 445 Arts 17(3), 26(4), 35(5)(b) CBAM Proposal. 446 Arts 19(4), 22(4), 26(4)(f), 35(5)(f) CBAM Proposal. 447 Rec. 50 CBAM Proposal. See also Galiffa and Bercero (2022), p. 199. 448 Arts 20(1), 22(1) CBAM Proposal. 449 Art. 12(3), 2nd sentence, ETS Directive. 450 Art. 22(2), 2nd sentence, CBAM Proposal. 451 Rec. 44 CBAM Proposal. 438

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First, in situations where taxable persons have disposable working capital to finance the pre-payment of the IVA or IG, they are forced, on account of the pre-payment requirement, to forego interest on that working capital in the interval between the tax pre-payment and its crediting. Alternatively, in situations where taxable persons do not have disposable working capital to finance the pre-payment of the IVA or IG, they need to raise the necessary capital and pay interest on it in the interval between the tax pre-payment and its crediting.452

The minimum purchase requirement only applies to goods that have been imported. The purpose of this inventory threshold is ‘to prevent importers from withholding purchases until the surrender deadline approaches or a time when the CBAM certificate price is relatively low.’453 EU operators, by contrast, can bulk-purchase emission allowances when the price is low. ETS allowances are valid indefinitely,454 whereas CBAM certificates are only valid for two years.455 As a matter of principle, the better treatment resulting from the later surrender date under CBAM (31 May, as opposed to 30 April under the ETS) cannot offset the competitive disadvantages resulting from the inventory threshold and the limited validity of CBAM certificates.456 That excess certificates can be resold to the authorities cannot remedy this.457 In any event, as seen, this entitlement is ‘limited to one third of the total CBAM certificates purchased . . . during the previous calendar year.’458 In the final analysis, those two aspects of CBAM—the inventory threshold and the limited validity of certificates—violate the chapeau.459

Special and Differential Treatment for Developing and Least-Developed Countries Whether special and differential treatment for developing and least-developed countries could be reconciled with the chapeau is an open question. Some even argue that the chapeau mandates special and differential treatment on the basis that different conditions prevail in developing and least-developed countries.460 In US – Shrimp, the Appellate Body criticized the respondent for not ‘taking into consideration

Panel Report, Argentina – Hides and Leather, para. 11.187. Wu (2021). 454 Art. 13 ETS Directive. 455 Art. 24, Rec. 44, 1st sentence, CBAM Proposal. 456 Cf. Panel Report, United States – Standards for Reformulated and Conventional Gasoline, WT/DS2/R, adopted 20 May 1996, para. 6.14; GATT Panel Report, United States – Section 337 of the Tariff Act of 1930, L/6439 - 36S/345, adopted 7 November 1989, para. 5.14; GATT Panel Report, United States – Denial of Most-favoured-nation Treatment as to Non-rubber Footwear from Brazil, DS18/R - 39S/128, adopted 19 June 1992, para. 6.10. 457 Art. 23 CBAM Proposal. 458 See above Sect. 4.4.3. 459 Pro Sato (2022), pp. 396, 403. 460 Veel (2009), p. 792; Mehling et al. (2019), pp. 469, 474–475; Marceau (2016), p. 19. See also Sifonios and Ziegler (2020), pp. 131–132. 452 453

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different conditions which may occur in the territories of those other Members.’461 Kreier raises the question of whether ‘developing countries that are complying with their (lower) Paris targets [should] still be required to pay the carbon border adjustment’.462 In terms of burden of proof, the Appellate Body clarified that ‘If a respondent considers that the conditions prevailing in different countries are not “the same” in relevant respects, it bears the burden of proving that claim.’463 For instance, relevant conditions may be different in least-developed countries that lack the capacity to run a comparable carbon pricing scheme. Principle 11 of the Rio Declaration on Environment and Development underscores that ‘Standards applied by some countries may be inappropriate and of unwarranted economic and social cost to other countries, in particular developing countries.’464 International climate law, in general, is guided by the ‘principle of common but differentiated responsibilities’.465 This principle purports that ‘the climate is the responsibility of all countries, but that industrialized countries have contributed more to the causes of climate change than lesser developed countries, and that industrialized countries therefore bear more responsibility in implementing measures to tackle climate change.’466 Notably, Article 3(2) UNFCCC stresses that The specific needs and special circumstances of developing country Parties, especially those that are particularly vulnerable to the adverse effects of climate change, and of those Parties, especially developing country Parties, that would have to bear a disproportionate or abnormal burden under the Convention, should be given full consideration.

The Appellate Body clarified in US – Seal Products that ‘“conditions” relating to the particular policy objective under the applicable subparagraph are relevant for the analysis under the chapeau.’467 Relevant special circumstances here are, for example, being a developing small island country, a developing country with low-lying coastal areas, or a least-developed country.468 Different nationally determined contributions under the Paris Agreement (which concern economy-wide, not sectorspecific, emissions)469 also imply ‘different implicit carbon prices’ in the respective Parties.470

Appellate Body Report, US – Shrimp, para. 164. Kreier (2020). See also Sifonios and Ziegler (2020), p. 132. 463 Appellate Body Report, EC – Seal Products, para. 5.301. 464 UN Conference on Environment and Development, ‘Rio Declaration on Environment and Development’ (14 June 1992), UN Doc. A/CONF.151/26/Rev.1 (vol I), 3. 465 Art. 3(1) UNFCCC; Arts 2(2), 4(3) Paris Agreement. 466 Dias et al. (2020), p. 23 fn. 35. See also Vidigal and Venzke (2022), p. 205; Sifonios and Ziegler (2020), p. 132; Mehling et al. (2019), pp. 472, 475. 467 Appellate Body Report, EC – Seal Products, para. 5.300. 468 Art. 4(8)–(9) UNFCC; Arts 4(6), 13(3) Paris Agreement. See also Leal-Arcas (2021), p. 144. 469 Cf. Art. 4 Paris Agreement. 470 Kortum and Weisbach (2020). 461 462

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WTO law is receptive to this.471 The Enabling Clause allows Members to ‘accord differential and more favourable treatment to developing countries, without according such treatment to other contracting parties.’472 Moreover, ‘Particular account shall be taken of the serious difficulty of the least-developed countries in making . . . contributions in view of their special economic situation and their development, financial and trade needs.’473 Specifically, the Doha Declaration calls ‘to give particular attention to: the effect of environmental measures on market access, especially in relation to developing countries, in particular the leastdeveloped among them . . .’474 The Achilles heel of the WTO principle of special and differential treatment is that it is not specific enough; how to heed it is largely left to the Members. So how does CBAM factor in the fact that Members are at different stages of their economic development? The CBAM Proposal does not provide for special and differential treatment for developing and least-developed countries. Instead, the EU promises less developed countries technical assistance.475 Furthermore, the European Parliament proposes to provide ‘financial support . . . to support climate mitigation and adaptation in least developed countries’.476 The reasoning is that, first, ‘Exempting countries can also risk that flows of carbon-intensive goods shift to and through such countries’,477 and secondly, ‘Exempting some developing countries . . . will result in discrimination among countries that is unrelated to the climate objectives of the border measure.’478 Will disagrees with the second reason: ‘If a state’s lower ability to pay correlates with its lower climate impact, exemptions will relate to climate protection and climaterelated concerns of the positive list of Article XX GATT.’479 The first reason is compelling, however, given CBAM’s objective (of preventing carbon leakage) and the risk of circumvention.480 Besides, ‘exemptions from the application of border measures would discourage investment in green technologies’, hence have counterproductive effects.481 471

Cf. Recs 1–2 Preamble to the WTO Agreement. See also Vidigal and Venzke (2022), pp. 205–206; Marceau (2016), p. 19. 472 Para. 1 GATT Decision on Differential and More Favourable Treatment, Reciprocity and Fuller Participation of Developing Countries, L/4903 (28 November 1979) (Enabling Clause). 473 Para. 8 Enabling Clause. 474 Para. 32(i) Ministerial Declaration, WT/MIN(01)/DEC/1 (14 November 2001). 475 Rec. 55 CBAM Proposal; European Commission, ‘Carbon Border Adjustment Mechanism’. 476 Art. 24a(2) Amendments Adopted by the European Parliament on the Proposal for a Regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism, COM(2021) 564 (22 June 2022), https://www.europarl.europa.eu/doceo/document/TA-92022-0248_EN.html. 477 Mehling et al. (2019), p. 474; Truby (2010), p. 159. 478 Meyer and Tucker (2022), p. 119. 479 Will (2019), p. 222. 480 See also Art. 27 CBAM Proposal. 481 Galiffa and Bercero (2022), p. 200; Impact Assessment Report, p. 30.

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Default Values The number of CBAM certificates to be surrendered ‘corresponds to the embedded emissions’.482 It is, therefore, key to quantify embedded emissions. To that end, CBAM relies upon default values in certain constellations. Default values are ‘calculated or drawn from secondary data representing embedded emissions in goods’.483 The use of default values is problematic in light of the chapeau requirements, in particular, because the values will be ‘increased by a mark-up’ for goods other than electricity.484 There is no ‘common international standard for the calculation of the carbon content of goods’.485 The Working Party on Border Tax Adjustments accepted for composite goods that ‘in principle it was administratively sensible and sufficiently accurate to rebate by average rates for a given class of goods.’486 In addition, the Appellate Body confirmed in US – Gasoline that statutory baselines could be applied when ‘a baseline could not be established because of an absence of data.’487 Even though default values apply, declarants can always prove the actual GHG emissions embedded in the imported goods.488 It makes sense to impose that burden on declarants because they can retrieve that data from their suppliers. Since the use of actual emissions is optional, ‘the overall group of . . . imports [of a covered good] only stands to be treated more favorably than the group average of EU . . . producers [of that good].’489 For, in a particular case, either the default value will be advantageous to the declarant490 or information on actual emissions can be provided.

482

Art. 22(1) CBAM Proposal. Art. 3(21) CBAM Proposal. 484 Bacchus (2021); Wu (2021). See Point 4.1 Annex III to CBAM Proposal. 485 Mehling et al. (2019), p. 477. 486 Working Party on Border Tax Adjustments (1970), para. 16. 487 Appellate Body Report, US – Gasoline, p. 27. The Appellate Body, p. 28, concluded that the respondent had ‘to explore adequately means, including in particular cooperation with the governments of [complainants], of mitigating the administrative problems relied on as justification by the [respondent] for rejecting individual baselines for foreign refiners; and to count the costs for foreign refiners that would result from the imposition of statutory baselines.’ For the requirement of good faith negotiations, see above Sect. 4.4.2. 488 See above Sect. 2.2. 489 Bellora and Fontagné (2020), p. 10 (emphasis in original). 490 Note that for goods other than electricity ‘the default values shall be based on the average emission intensity of the 10 per cent worst performing EU installations for that type of goods’, Art. 7.2, 2nd sentence, in conjunction with Point 4.1 Annex III, CBAM Proposal (emphasis added). 483

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Price of CBAM Certificates According to the European Commission, ‘CBAM certificates mirror the ETS price’.491 Plus, under the ETS, ‘the cap on emissions is set for the EU as a whole.’492 Taken together, and given that the financial burdens under both the ETS and CBAM are contingent upon embedded emissions, this should lead to a declarant paying an equal amount for the same quantity of carbon emitted as an EU operator.493 The WTO compatibility of this is borne out by the US – Tuna II (Mexico) case the measure in which was upheld although it ‘addressed the same externality (risks of harm caused to dolphins) in different ways, on the basis of differences in the magnitude of these externalities (respective importance of the risks of harming dolphins in different areas of the ocean).’494 Nonetheless, the price of an ETS allowance and a CBAM certificate will not be identical at any given time. As for the ETS, ‘the price of allowances is determined through auctions’.495 As for CBAM, the price of CBAM certificates shall be ‘the average price of the closing prices of EU ETS allowances . . . for each calendar week.’496 That is, whereas domestic operators pay daily spot prices, declarants pay ‘weekly average prices’.497 This raises the question of whether the chapeau requires an identical price.498 If yes, this would counteract subparagraph (g), which does not even presuppose an ‘even distribution’.499 The EU justifies the discrepancy on the basis of administrative feasibility,500 for ‘daily prices risk becoming obsolete upon publication.’501 Crochet already finds fault with the fact the EU pegs ‘CBAM certificate prices to the EU ETS price’ because this ‘imposes a price for carbon emissions onto imports from other countries that is inherently linked to the EU’s own carbon emission levels and decarbonisation commitments.’502 As a result, ‘imports from trading partners who share similar climate ambitions and work towards them through their own ETS will still need to pay CBAM certificates to make up for the difference between the price paid in the country of origin and the CBAM price.’503 Crochet and Wu deduce from this that ‘the objective of the measure is not avoiding carbon leakage to European Commission, ‘Carbon Border Adjustment Mechanism’. European Commission, ‘Emissions Cap and Allowances’. 493 Art. 22(1) CBAM Proposal; Art. 12(3), 2nd sentence, ETS Directive. 494 Sifonios and Ziegler (2020), p. 123. 495 Rec. 21 CBAM Proposal. 496 Art. 21(1) CBAM Proposal. 497 Rec. 21 CBAM Proposal; Meyer and Tucker (2022), p. 117. 498 Cf. Crochet (2021). 499 See above Sect. 4.2.3. 500 Rec. 21 CBAM Proposal. 501 Rec. 43 CBAM Proposal. 502 Crochet (2021). 503 Ibid. 491 492

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countries which do not share the EU’s level of climate ambitions but, rather, that foreign producers do not pay less for their carbon emissions than EU producers.’504 The counterargument is, of course, that one (the prevention of carbon leakage) cannot be achieved without the other (imports being adjusted to the level of the domestic carbon price).505 It is important to remember that CBAM is complementary to the ETS.506 Yet, Sato concurs with Crochet and Wu, adding that ‘the price determined by the balance between the total emissions cap and demand in the EU market is hardly the proximity of the costs that should have been incurred by foreign producers.’507 In a nutshell, the issue is whether CBAM has been properly calibrated. This can be inferred from the US – Tuna II (Article 21.5 II – Mexico) ruling, where the Appellate Body held that because ‘the . . . Measure is “tailored to”, and “commensurate with”, the different risks to dolphins caused by different fishing methods in different parts of the ocean’, this also demonstrates that the discrimination under the measure ‘can[not] be said to be applied in a manner that constitutes a means of “arbitrary or unjustifiable discrimination” within the meaning of Article XX’.508

In casu, the risk is carbon leakage. Howse submits that ‘the EU can set a carbon price that is based on its own climate and other policies, as long as this price is applied in an even handed way to the imports of its trading partners.’509 From the fundamental WTO principle to determine its own level of (climate) protection,510 it follows that the EU ‘is free to either decide (i) the level of a carbon tax or (ii) the number of ETS allowances emitted in a given year.’511 This principle also informs the reading of the chapeau; anything else would make a mockery of it. In conclusion, it suffices under the chapeau, too, that even-handedness is given; price identity is not required. Here, the CBAM price ‘reflect[s] closely the EU ETS price’.512 Because ‘the publication of CBAM prices on a weekly basis would accurately reflect the pricing trend of EU ETS allowances’,513 the disadvantage for declarants is thus limited.

504

Ibid.; Wu (2022). Cosbey (2022). See above Sect. 4.1.1. 506 See above Sect. 3.1. 507 Sato (2022), p. 393. 508 Appellate Body Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products, Recourse to Article 21.5 of the DSU by the United States / Second Recourse to Article 21.5 of the DSU by Mexico, WT/DS381/AB/RW/USA, WT/DS381/AB/RW2, adopted 11 January 2019, para. 6.281 (references omitted). See also Sifonios and Ziegler (2020), p. 127. 509 Robert Howse in Crochet (2021). 510 See above Sect. 4.1.2. 511 Howse in Crochet (2021). 512 Rec. 21 CBAM Proposal. 513 Rec. 43 CBAM Proposal. 505

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Equivalent Climate Action Elsewhere: Pricing vs Regulatory Measures Importantly, CBAM does not tell exporting countries how to reduce GHG emissions. Bellora and Fontagné argue that ‘Taxing the average or actual carbon content of imports from, say, China, does not require any policy change in China. It merely implies that that part of China’s production which is sold in the EU will need to pay the EU’s carbon price.’514 However, the measure puts other countries under pressure to adopt a carbon pricing mechanism. Exporting countries are still left a choice, but that choice comes with a price tag. The stronger the trade dependence on the EU market, the stronger the inducement will be to introduce carbon pricing.515 It should be noted that this issue is different from the question of whether domestic producers of like goods pay an equivalent price. It is correct that the chapeau can be read as requiring the recognition of measures ‘comparable in effectiveness’.516 CBAM does so for carbon pricing in the country of origin.517 One of the key questions under the chapeau is if the EU is legally obliged to also take account of non-pricing reduction measures.518 The answer depends on how narrowly the expression ‘same conditions’ within the chapeau is to be interpreted. If it is interpreted narrowly, only carbon pricing mechanisms in other Members are relevant conditions. If it is interpreted more broadly, the presence of non-pricing mechanisms in exporting countries might entail that the same conditions prevail, with the consequence that such mechanisms would need to be taken into account as well.519 The first thing to note is that EU producers are subject to regulatory measures in addition to the ETS. That is to say, they, too, have compliance burdens resulting from non-pricing mechanisms. One just think of ‘emission performance standards for cars and vans’.520 Factoring in non-pricing mechanisms would thus ‘also mean increasing the CBAM import charge by the amount of the regulatory carbon costs imposed on EU firms’.521 Whether this would be in conformity with WTO law is another question altogether.522

514

Bellora and Fontagné (2020), p. 11. Cf. Cooreman (2016), p. 247. 516 Appellate Body Report, US – Shrimp (Article 21.5 – Malaysia), para. 144; Van den Bossche and Zdouc (2022), p. 650; Will (2019), p. 228. 517 Art. 9(1) CBAM Proposal. 518 Answering this in the affirmative, Sato (2022), p. 402; Trachtman (2017), pp. 481–482; Pauwelyn (2013), pp. 502–503. 519 Cf. Will (2019), p. 221. 520 European Commission, ‘CO2 Emission Performance Standards for Cars and Vans’, https://ec. europa.eu/clima/eu-action/european-green-deal/delivering-european-green-deal/co2-emission-per formance-standards-cars-and-vans_en. 521 Cosbey (2022). 522 See above Sect. 4.1.2. 515

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Secondly, as seen, under CBAM declarants may surrender allowances based on actual emissions.523 If those have decreased as a result of non-pricing mechanisms, declarants will surrender fewer allowances.524 In that sense, non-pricing mechanisms are considered.525 However, what is not considered under CBAM is the costs of complying with regulatory measures in the country of origin, due to it being so burdensome to determine those costs. Meyer and Tucker contend that CBAM conditions favorable market access on adopting the same kind of domestic decarbonization measures as the EU has adopted, rather than the effectiveness of a nation’s domestic decarbonization measures. That favorable market access comes in the form of credit for an explicit carbon price paid in the home market, but no credit for potentially equally effective implicit prices paid to comply with regulations.526

This author takes a different stance. First, economists agree that regulatory measures are less effective than price incentives, that is, market-based measures.527 Secondly, because of the conceptual and technical difficulties in comparing the effectiveness of non-pricing mechanisms with carbon pricing,528 the former are not equivalent in terms of the chapeau. We rejected the consideration of non-pricing mechanisms under Article 9 CBAM Proposal as an alternative measure for reasons of feasibility.529 This is also a valid consideration under the chapeau.530 It would be non-sensical to answer the question of necessity in the affirmative, because alternatives are not reasonably available, but then negate justification under the chapeau because the respondent does not rely on those alternatives already rejected. This argument cannot be refuted by referring to the cumulative nature of the exceptions’ requirements. Those cumulative requirements appraise different aspects of the measure at issue; an opposing approach would address the same counterargument twice—under necessity and the chapeau. Two cumulative requirements must not cancel each other out; but this would be the case if one disregarded feasibility under the chapeau.

523

Art. 7(2)–(3) CBAM Proposal. Art. 22(1) CBAM Proposal. 525 Galiffa and Bercero (2022), pp. 198–199; Cosbey (2022). 526 Meyer and Tucker (2022), p. 119. 527 Bacchus (2022), pp. 178, 180; Galiffa and Bercero (2022), p. 200. 528 Leal-Arcas (2021), p. 143; Impact Assessment Report, p. 26. 529 See above Sect. 4.1.2. 530 Veel (2009), p. 789; David Kleimann, ‘The Worst of Two Worlds: Why the US Blueprint for a Transatlantic Climate Club Authored by Todd Tucker & Tim Meyer Must Be Binned Immediately’ International Economic Law and Policy Blog (1 December 2021), https://ielp.worldtradelaw. net/2021/12/guest-post-the-worst-of-two-worlds-why-the-us-blueprint-for-a-transatlantic-climateclub-authored-by.html. 524

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Conclusions

CBAM is not perfect. It does not have to be in order to pass muster. This would be an unrealistic expectation and even threaten the legitimacy, and by extension the existence, of the WTO.531 It suffices that the measure is not applied in an arbitrary manner. Most of CBAM’s ‘specific features’532 can be rationally related to its primary objective of preventing carbon leakage and its secondary objective of reducing GHG emissions. By and large, CBAM meets the requirements of the chapeau.533 Some changes would be required, first, regarding the minimum purchase requirement. Either the inventory threshold is scrapped, and with it the limited validity period, or alternatively, domestic operators will need to be subjected to the same threshold and validity period. Secondly, the exemption for small installations will need to be removed from the ETS. Because of interconnected electricity grids and the difficulty of assigning electricity imports to a particular installation, it would not be feasible to incorporate such an exemption into CBAM.

4.5

Article XXI(b)(iii) GATT

Because the chapeau restricts their regulatory autonomy, Members are tempted to invoke the security exception in Article XXI GATT, which does not have a chapeaulike clause. In the present case, subparagraph (b)(iii) might be pertinent. For the EU to be able to rely upon that provision, an ‘other emergency in international relations’ is a prerequisite.

4.5.1

Climate Crisis as An ‘Other Emergency in International Relations’

It is settled now that the security exception is justiciable in principle.534 It has to be, otherwise Members would justify their protectionist measures on that basis, undermining ‘the security and predictability of the multilateral trading system’.535 The Panel in Saudi Arabia – IPRs defined ‘emergency in international relations’ as

531

See also Sifonios and Ziegler (2020), p. 130. Rec. 20 CBAM Proposal. 533 Joachim Englisch and Tatiana Falcão, ‘EU Carbon Border Adjustments for Imported Products and WTO Law’ SSRN (23 September 2021), pp. 72–76, https://papers.ssrn.com/sol3/papers.cfm? abstract_id=3863038; Porterfield (2019), p. 39. 534 Panel Report, Russia – Measures Concerning Traffic in Transit, WT/DS512/R, adopted 26 April 2019, paras 7.77, 7.79, 7.82, 7.101, 7.103. 535 Ibid., para. 7.79. See already GATT Panel Report, US – Export Restrictions (Czechoslovakia), BISD II/28, adopted 8 June 1949, p. 3. 532

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referring to ‘“a situation . . . of heightened tension or crisis” . . . related to . . . “defence or military interests, or maintenance of law and public order interests”’.536 The climate has become a national and international security concern. The Hague District Court in Milieudefensie v. Royal Dutch Shell observed that ‘climate change due to CO2 emissions will lead to serious and irreversible consequences . . .’537 This is in line with the findings of the IPCC Working Group II, according to which ‘Global warming, reaching 1.5°C in the near-term, would cause unavoidable increases in multiple climate hazards and present multiple risks to ecosystems and humans’.538 In particular, ‘Climate change creates security risks, such as climate migration and political instability around the world, as well as direct threats to military forces and capabilities.’539 Meyer and Tucker, therefore, submit that ‘the threat posed by climate change is “emergency in international relations”.’540 On this point, the present author agrees.

4.5.2

Protection of Essential Security Interests

The second requirement is that the respondent ‘considers’ the measure at issue ‘necessary for the protection of its essential security interests’. It is questionable here whether carbon leakage ‘refer[s] to those interests relating to the quintessential functions of the state’ and thus concerns ‘essential security interests’ within the meaning of Article XXI(b) GATT.541 What speaks in favour is that carbon leakage is one obstacle to more ambitious climate efforts. Kreier goes so far as to postulate that ‘unilateral action becomes impossible without addressing the problems of carbon leakage and the related political impossibility of taking such action without addressing the competitive implications’.542 While Article XXI GATT is justiciable, as mentioned above, not all elements thereof are. The EU could still argue that it considers CBAM necessary for its essential security interests. The Panel in Russia – Traffic in Transit confirmed that ‘it is left, in general, to every Member to define what it considers to be its essential security interests.’543 Even though this aspect of the exception clause is largely selfjudging, and consequently enlarges the Members’ scope of discretion to adopt climate measures, including market access conditions, the Panel cautioned that ‘the measures at issue meet a minimum requirement of plausibility in relation to

536 Panel Report, Saudi Arabia – Measures Concerning the Protection of Intellectual Property Rights, WT/DS567/R, unadopted, para. 7.257. 537 Milieudefensie v. Shell, para. 4.4.7. 538 IPCC Working Group II (2022), B.3, 1st sentence. 539 Meyer and Tucker (2022), p. 120. 540 Ibid. 541 Cf. Panel Report, Russia – Traffic in Transit, para. 7.130. 542 Kreier (2020). 543 Panel Report, Russia – Traffic in Transit, para. 7.131.

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the proffered essential security interests, i.e. that they are not implausible as measures protective of these interests.’544 This plausibility test is a low threshold, however, that climate measures—in light of the gravity and acuteness of the climate crisis as established in several international instruments (of which the Glasgow Climate Pact is the most recent example)545—would meet.

5 Conclusions The article described the different evolutionary steps that WTO case law underwent from Indonesia – Autos, proscribing market access conditions per se, to US – Tuna II (Mexico), allowing a Member to condition market access so as not to incentivize harmful PPMs. It could be illustrated that, over time, WTO adjudicatory bodies showed more deference to domestic regulators, thus providing the necessary leeway to design and apply border carbon adjustments in a WTO-compliant way. Hence, properly construed, there is no need ‘to revise or ignore trade law’, as posited by some.546 This author agrees with the analysis of Sato that CBAM amounts to ‘entry fees for the EU market’.547 Where the author disagrees is that, since US – Tuna II (Mexico), it is clear that the conditioning of market access through border carbon adjustments is in conformity with WTO law so as to ensure that the EU market ‘is not used to encourage’ production in a manner that adversely affects the global climate. There is urgency to act on the part of governments, as the window of opportunity ‘to achieve the temperature stabilization goals in the Paris Agreement rapidly closes’.548 The US – Tuna II (Mexico) ruling opened the door for the conditioning of market access in a substantial sense. That said, the article also demonstrated that the chapeau, as interpreted by the predominant view, provides many pitfalls.549 The non-discrimination obligations compel Members to treat like products the same, whereas the chapeau compels Members to treat similarly situated countries the same. The combination makes it difficult to make regulatory distinctions. Therefore, the scrutiny under the chapeau should be reduced to an arbitrariness test. Regulators must be allowed to experiment with new regulatory approaches, with a view to tackling such a pressing issue as

544

Ibid., para. 7.138. United Nations Climate Change, ‘The Glasgow Climate Pact – Key Outcomes from COP26’ (2022), https://unfccc.int/process-and-meetings/the-paris-agreement/the-glasgow-climate-pactkey-outcomes-from-cop26. 546 Krugman (2021). Pro Vidigal and Venzke (2022), pp. 204, 207; Espa (2022), pp. 211–212; Boklan (2021), p. 148. 547 Sato (2022), p. 392. 548 Mehling et al. (2019), p. 435. 549 Cf. Leal-Arcas (2021), pp. 144–145. 545

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climate change. Not designed with climate protection in mind, the security exception is merely a stopgap; what is more, its standard of review is highly deferential. Against this background, the better way forward in the context of climate change mitigation might be a WTO climate waiver, as proposed by Bacchus and Quick.550 The article did not address the legality of climate clubs, where ‘like-minded states . . . enter into agreements for mutual recognition of one another’s carbon regime and . . . apply import BTAs only to products coming from states for which no mutual recognition agreement exists.’551 The Paris Agreement facilitates ‘voluntary cooperation . . . to allow for higher ambition in . . . mitigation and adaptation actions’.552 From the perspective of the chapeau, the legality of climate clubs will hinge upon whether they are closed ones or open to every interested Member.553

References Bacchus J (2022) Trade links: new rules for a new world. CUP Barrett S (2007) Why cooperate? The incentive to supply global public goods. OUP Bartels L (2015) The chapeau of the general exceptions in the WTO GATT and GATS agreements: a reconstruction. Am J Int Law 109:95–125 Bäumler J (2020) Nachhaltiges Wirtschaften in globalen Lieferketten: gesetzliche Sorgfaltspflichten von Unternehmen im Lichte des WTO-Rechts. Archiv des Völkerrechts 58: 464–501 Beckford D (2020) National treatment in the WTO: abandoning regulatory purpose or reinvigorating it? Trade Law Dev 12:656–682 Boklan D (2021) Combating climate change under the WTO: exploring the relevance of process and production methods. In: Bahri A, Zhou W, Boklan D (eds) Rethinking, repackaging, and rescuing world trade law in the post-pandemic era. Hart, pp 131–148 Cooreman B (2016) Addressing environmental concerns through trade: a case for extraterritoriality? Int Comp Law Q 65:229–248 De Schutter O (2019) International human rights law: cases, materials, commentary, 3rd edn. CUP Dias A, Seeuws S, Nosowicz A (2020) EU border carbon adjustment and the WTO: hand in hand towards tackling climate change. Global Trade Customs J 15:15–23 Dobson N (2021) Extraterritoriality and climate change jurisdiction: exploring EU climate protection under international law. Hart Elliott J et al (2010) Trade and carbon taxes. Am Econ Rev 100:465–469 Espa I (2022) Reconciling the climate/industrial interplay of CBAMs: what role for the WTO? Am J Int Law Unbound 116:208–212 Evans S et al (2021) Border carbon adjustments and industrial competitiveness in a European green deal. Climate Policy 21:307–317

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Bacchus (2022), p. 199; Quick (2019). Trachtman (2017), p. 476. For climate clubs in general, see Mehling et al. (2022), pp. 213 ff; Galiffa and Bercero (2022), pp. 199–201; Leal-Arcas (2021). For a green steel club, see Todd Tucker and Timothy Meyer, ‘A Green Steel Deal: Toward Pro-jobs, Pro-climate Transatlantic Cooperation on Carbon Border Measures’ (June 2021) Roosevelt Institute Working Papers. Critical, Lester (2022), pp. 122–123; Kleimann (2021). 552 Art. 6(1) Paris Agreement. 553 Vidigal and Venzke (2022), p. 207. 551

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Galiffa C, Bercero I (2022) How WTO-consistent tools can ensure the decarbonization of emissionintensive industrial sectors. Am J Int Law Unbound 116:196–201 Horn H, Mavroidis P (2011) To b(ta) or not to b(ta)? On the legality and desirability of border tax adjustments from a trade perspective. World Econ 34:1911–1937 Joseph S, Dipnall S (2018) Scope of application. In: Moeckli D, Shah S, Sivakumaran S (eds) International human rights law, 3rd edn. OUP, pp 110–131 Leal-Arcas R (2021) Climate clubs for a sustainable future: the role of international trade and investment law. Wolters Kluwer Lester S (2022) How the United States can lead the effort to reduce carbon emissions. World Trade Rev 21:121–126 Marceau G (2016) The interface between the trade rules and climate change actions. In: Park DY (ed) Legal issues on climate change and international trade law. Springer, pp 3–39 Marcu A, Cecchetti F (2022) The trading of carbon. In: Hafner M, Luciani G (eds) The Palgrave handbook of international energy economics. Springer, pp 439–469 Mayer B (2021) Climate change mitigation as an obligation under human rights treaties? Am J Int Law 115:409–451 Mehling M et al (2019) Designing border carbon adjustments for enhanced climate action. Am J Int Law 113:433–481 Mehling M et al (2022) The form and substance of international cooperation on border carbon adjustments. Am J Int Law Unbound 116:213–218 Meyer T, Tucker T (2022) A pragmatic approach to carbon border measures. World Trade Rev 21: 109–120 Mitchell A, Merriman D (2020) Indonesia’s WTO challenge to the European Union’s renewable energy directive: palm oil and indirect land-use change. Trade Law Dev 12:548–624 Pauwelyn J (2013) Carbon leakage measures and border tax adjustments under WTO law. In: Research handbook on environment, health and the WTO. Edward Elgar, pp 448–506 Porterfield M (2019) Border adjustments for carbon taxes, PPMs, and the WTO. Univ Pa J Int Law 41:1–41 Radi Y (2020) Rules and practices of international investment law and arbitration. CUP Riffel C (2018) The chapeau: stringent threshold or good faith requirement. Leg Issues Econ Integr 45:141–176 Rubini L, Jegou I (2012) Who’ll stop the rain? Allocating emissions allowances for free: environmental policy, economics, and WTO subsidy law. Transnatl Environ Law 1:325–354 Ruggie JG, Rees C, Davis R (2021) Ten years after: from UN guiding principles to multi-fiduciary obligations. Bus Hum Rights J 6:179–197 Sato SY (2022) EU’s carbon border adjustment mechanism: will it achieve its objective(s)? J World Trade 56:383–404 Saunders I (2021) Navigating the backlash: re-integrating WTO and public international law? Aust Year Book Int Law 38:134–156 Sciaccaluga G (2020) International law and the protection of ‘climate refugees’. Springer Sifonios D, Ziegler A (2020) ‘Tuna-dolphin forever’? The development of the PPM debate related to trade and environment in the WTO. Indian J Int Econ Law 12:106–133 Trachtman J (2017) WTO law constraints on border tax adjustment and tax credit mechanisms to reduce the competitive effects of carbon taxes. Natl Tax J 70:469–493 Trebilcock M, Howse R, Eliason A (2013) The regulation of international trade, 4th edn. Routledge Truby J (2010) Towards overcoming the conflict between environmental tax leakage and border tax adjustment concessions for developing countries. Vermont J Environ Law 12:149–183

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Van den Bossche P, Zdouc W (2022) The law and policy of the world trade organization: text, cases and materials, 5th edn. CUP Veel PE (2009) Carbon tariffs and the WTO: an evaluation of feasible policies. J Int Econ Law 12: 749–800 Vidigal G, Venzke I (2022) Of false conflicts and real challenges: trade agreements, climate clubs, and border adjustments. Am J Int Law Unbound 116:202–207 Will U (2019) Climate border adjustments and WTO law: extending the EU emissions trading system to imported goods and services. Brill

Christian Riffel PhD (2014), Bern, is Associate Professor of International Economic Law at the University of Canterbury, Aotearoa New Zealand. He is Associate Editor of the New Zealand Yearbook of International Law and contributor to the Encyclopedia of Public International Law. In addition, he is Co-Chair of the International Economic Law Interest Group of the Australian and New Zealand Society of International Law and a member of the International Law Association Committee on Rule of Law and International Investment Law. Chris is listed as arbitrator for EU trade agreements and also serves as Honorary Consul of Germany in the South Island of New Zealand.

Removing Barriers to Climate Change Litigation: The Progressive Erosion of Central Banks’ Immunity Astrid Iversen

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Central Banks: Their Mandates and Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Price Stability and the Case for Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Expanding the Role of Central Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Accountability and Legal Protection of Central Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Sovereign Immunity and Central Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Commercial Exemption and Central Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Special Immunity Protection for Central Banks’ Property . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Evolving Standards of Central Banks’ Legal Protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Swedish Supreme Court Case No. Ö 3828-20 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Backlash Against Immunity for Central Banks’ Property? . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

150 153 153 154 156 158 158 159 164 166 166 170 172 172

Abstract This article discusses sovereign immunity rules and the future of climate change litigations in foreign courts against central banks and sovereign wealth funds managed by central banks. It argues that expansions of central banks’ responsibilities and activities in financial markets over the past decades, including that of managing sovereign wealth funds, increase the risk of climate lawsuits against

Thanks to the participants at the seminar on central banks and control mechanisms arranged by the Inland Norway University of Applied Sciences, along with the Private Law Department and PluriCourts of the University of Oslo, held in Oslo on 10th June 2022. Thanks also to Ivar Alvik and Beate Sjåfjell who enabled me to present an early draft of the paper in their respective research groups at the University of Oslo in spring 2022. Thanks are also owed to Mads Andenas, Yuliya Chernykh and Stian Øyby Johansen for their helpful discussions and comments. All errors are mine. A. Iversen (✉) Inland Norway University of Applied Sciences, Lillehammer, Norway e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 149–174, https://doi.org/10.1007/8165_2022_98, Published online: 24 December 2022

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central banks, and in particular, the risk of their assets being exempted from absolute immunity from enforcement measures. While the doctrine of sovereign immunity has evolved from an absolute to a restrictive approach across a number of jurisdictions, central banks, and in particular, their assets, have continued to enjoy close to absolute protection under international and domestic law. The article discusses whether this may be changing: Taking a Swedish Supreme Court judgment from 2021 as a starting point, it argues that there is no clear rule in international customary law providing absolute immunity for central banks’ assets that are unrelated to its exercise of monetary policy. Far-reaching immunity is not only unreasonable when taking into consideration the original justification for central banks’ immunity but it may also prompt a backlash against the immunity protecting the property related to the core functions of central banks, namely the monetary policy mandates. Equally important, this may weaken states’ commitments to comply with international and domestic environmental obligations.

1 Introduction Central banks are the highest monetary authority of a state. Its mandate is given by the legislator and it typically enjoys a certain independence from the government. The legal form of and the actual function performed by central banks vary across jurisdictions and change over time. Central banks’ core mandate is typically to manage short-term interest rates and ensure price stability, which is referred to as its monetary policy mandate.1 In recent years, we have seen a rapid increase in climate litigation around the world, and states are now under an increased risk of being sued for violating national and international climate and environmental obligations.2 The UNEP Global Climate Litigation Report: 2020 Status Review reported that, in 2017, there were 884 cases brought in 24 countries. More recently, as of 1 July 2020, climate change cases had been filed in 38 countries, and the total number of cases had nearly doubled, amounting to at least 1550. Governments are the most frequent defendants in climate change cases.3 In general, cases against governments assert that either broad policies or specific decisions are inconsistent with national or international

1

Lastra (2006), ch 2. The report considers ‘climate change litigation’ to include cases that raise material issues of law or fact relating to climate change mitigation, adaptation or the science of climate change. The cases are brought before a range of administrative, judicial and other adjudicatory bodies. See Burger and Metzger (2020), p. 6. 3 Ibid, p. 13. 2

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obligations (constitutional, legislative or policy commitments) to reduce greenhouse gas emissions. The risk of climate-related litigation is also relevant for central banks. The increase in climate-related lawsuits has thus coincided with central banks taking on tasks beyond their monetary policy in a narrow sense. Increasingly, central banks have become responsible for financial stability, including banking regulations. Moreover, today, many central banks are investing more money in the financial market than in previous decades. Since the outbreak of the global financial crisis in 2007, there has been an unprecedented increase in central banks’ purchasing of financial assets, spurred on recently in response to the COVID-19 pandemic.4 Moreover, some central banks have been given the responsibility of managing their government’s sovereign wealth fund (SWF), which necessitates that they invest and hold assets in foreign jurisdictions.5 There are several potential scenarios in which a central bank can become involved in a climate-related lawsuit. The first scenario is one in which central banks can be sued due to their lack of environmental consideration when purchasing financial assets in the markets (through so-called quantitative easing programmes) and managing Sovereign Wealth Funds’ investment portfolios. Second, a decision to invest in a concrete asset may not have not sufficiently taken such considerations into account. As central banks’ responsibilities and activities in financial markets have expanded, there is an emerging demand that they should actively engage in issues related to the climate crisis. Yet, critics argue that, contrary to this, central banks’ stabilisation policies support non-sustainable sectors, rather than promoting a green transition. While several central banks have reviewed or are in the process of reviewing their approach to dealing with the climate crisis, lawsuits are being initiated due to a perceived lack of proper engagement with the issue. A third climate-related lawsuit scenario is related to central banks, or sovereign wealth funds managed by central banks, holding stocks in companies that have violated environmental obligations. Affected parties may bring a suit against a central bank and claim compensation for environmental damages. Then, in a fourth scenario, affected parties in a climate-related suit against a state or central bank may seek to use enforcement measures against the property of a central bank, potentially both in domestic and foreign jurisdictions. This article focuses mainly on the fourth scenario. More precisely, it examines the requirements for enforcement measures against central banks’ property in foreign courts. The threat and use of enforcement measures against central banks’ property are forceful legal tools that can be used to hold a central bank, or a state as such, accountable for national and international climate and environmental obligations. 4

Potter and Smets (2019); Fratto et al. (2021). There is no generally accepted definition of a sovereign wealth fund, but in a broad sense, it is a type of investment fund that the state owns or controls, which is typically financed by state revenues derived from the exploitation of natural resources, from surpluses of the state’s foreign exchange reserve or from income from privatisation of state property. See, for example, Ö 3828-20, Ascom Group SA and Terra Raf Trans Trading Ltd. v The Republic of Kazakhstan and The National Bank of Kazakhstan, para 31.

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At the same time, undue interference with central banks’ property can severely obstruct a central bank’s operations. A balance must be struck between central banks’ accountability and appropriate legal protection of their operations. Central bank operations can be safeguarded by sovereign immunity rules. Sovereign immunity is a principle in national and public international law that protects foreign states and their property from the jurisdiction of national courts on a procedural basis.6 The doctrine of sovereign immunity has evolved from an absolute to a restrictive approach across a number of jurisdictions, allowing courts, inter alia, to have jurisdiction over foreign states’ commercial activities, as well as apply enforcement measures against foreign states’ property used for commercial purposes.7 However, due to central banks’ essential role in the economy, their assets have typically continued to enjoy substantial protection under international and domestic immunity laws. Now, that may be changing. This article discusses sovereign immunity rules and the future of climate change-related litigations against foreign central banks in domestic courts. In particular, it asks whether the expansions of central banks’ responsibilities and activities in financial markets over the past decades increase the risk of central banks’ assets being exempted from absolute immunity from enforcement measures, and consequently, increase the risk of their property being sought/attached in climate-related lawsuits against central governments or central banks themselves. The article is organised as follows: Sect. 2 explains the role of an independent central bank in a state’s economy and how its mandates have been expanded in the past two decades. In light of this expansion, the section thereafter discusses the importance of balancing central banks’ need for independence with their need for accountability. The latter includes the need to hold central banks accountable for states’ national and international environmental obligations. Accountability can be achieved through legal proceedings, but these can significantly interfere with central banks’ independence and disturb the implementation of their mandates. Section 3 discusses how rules on sovereign immunity can provide legal protection for central banks. It explains how the transition from an absolute to a restrictive approach to sovereign immunity has made the protection of central banks more unpredictable, as central banks regularly operate in commercial markets. It also discusses how a number of jurisdictions have sought to compensate for this uncertainty by introducing special immunity regulation providing near-to-absolute immunity for central banks’ property. Section 4 thereafter discusses the future of immunity from enforcement measures for central banks’ property. The starting point is a recent Swedish Supreme Court judgment, which, based on the United Nations Convention on Sovereign Immunities of States and their Property, seeks to distinguish between

6 For a general discussion of rules on sovereign immunity, see Fox and Webb (2015). This article examines the extent to which SWF are covered by the sovereign immunity rules protecting central banks specifically, but also the extent to which ordinary immunity rules protects SWF from enforcement measures in foreign courts. 7 Immunity from enforcement measures is also referred to as immunity from execution.

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central banks’ property that deserves protection from the special central bank immunity rules, and other property that does not. The question is whether such a distinction can contribute to finding the right balance between legal protection of central banks and their independence, on the one hand, and accountability, on the other, as well as whether other jurisdictions are likely to follow a similar path. Section 5 concludes the article.

2 Central Banks: Their Mandates and Independence 2.1

Price Stability and the Case for Independence

Central banks have different tools to help them reach their goal of price stability. The main tool is to influence the money supply by adjusting the policy interest rate—the interest rate that commercial banks have to pay to have deposits at or borrow money from the central bank, which enables them to lend money to individuals and corporations.8 Increasing the policy rate will increase the cost of borrowing, slowing down the economy by making credit and investment more expensive. Decreasing the policy rate will on the other hand stimulate the economy by encouraging credit and investment. Central banks are given the task of managing interest rates for the following reason: Price instability, and in particular high inflation, has significant costs and no long-term welfare benefits. The costs include distortions in economic activity, the cost of repricing real assets according to a changing nominal price level and the cost of the effort people have to undertake to avoid losing the value of their financial claims. In more extreme situations, very high inflation can cause social demoralisation.9 Because price instability and high level of inflation is bad for society, everyone is better off if the political institutions maintain stable prices. Over the last three decades, central banking laws across numerous jurisdictions have granted independence or great operational autonomy to central banks, with an explicit price stability mandate.10 This development towards independent central banks is justified from a public policy standpoint and has been supported by a broad consensus among scholars and policymakers.11

8

Lastra (2006), pp. 44–46. Ibid, p. 44. The obvious example would be the interwar period in Germany. 10 Ibid. 11 Ibid. The literature uses empirical studies and creates a legal index (based on selected legal provisions and indicators) for the purpose of developing economic and statistical tests that show a negative correlation between central bank independence and inflation. See, overview of literature in Lastra (2006), p. 44, note 33. However, the support for independent central banks is not unanimous. Policymakers and scholars have raised debates about the need for better coordination with parliaments and governments in times of economic crisis. Debates about the accountability and legitimacy of central banking tools have also led to debates about central banks’ independence. Lately, 9

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Independent central banks are conceived as a means to achieve the goal of stable prices and avoid high levels of inflation (or deflation). The idea is that a politically autonomous but goal-constrained central bank can devote itself to maintaining price stability, without being subject to the political pressure that might otherwise induce inflationary policies.12 Before the advent of central bank independence, the Ministry of Finance instructed the Central Bank on what to do. In other words, the Central Bank could be asked by the Ministry of Finance to finance government deficits or use interest rate policy for a variety of government objectives.13 Independent central banks are seen as a pre-commitment by the political system to tie its hands, i.e., prevent it from taking destructive action when inflationary temptation appears. If the central bank is independent of the political cycle and committed to the (politically decided) goal of maintaining price stability in the long term, it will not be subject to political pressure, which has shorter term goals typically corresponding to election cycles. Central banks’ independence has also led to them being granted a separate legal personality from the state. In principle, this means that they are the subject of rights and obligations and can sue or be sued.14

2.2

Expanding the Role of Central Banks

Central banking has changed significantly over the past decade. Before the Global Financial Crisis, central banks’ main focus was typically on their price stability mandate, and they had a reasonably high level of independence. Particularly in the past two decades, we have seen that central banks have gained an expanding role and taken on tasks in addition to monetary policy in a narrow sense.15 There are several reasons for this development. First, central banks’ mandates and competencies are politically decided, mainly by the legislative branch in domestic administrative and constitutional law. However, this legislation often has an openended nature, and central banks can evolve and adapt as new needs arise. So, while central banks’ mandates are clearly defined in legislation, as independent institutions, they typically have wide technical discretion with regards to the means by

distributional effects of both conventional and unconventional monetary policy tools have created new debates about the need for increased political awareness and involvement in monetary policy design. The effect of monetary policies on inequality has been analysed by many researchers. For example, the empirical effects of monetary policies on inequality were investigated by Carpenter and Rodgers III (2004); Coibion et al. (2017); Bartscher et al. (2021). 12 There are also arguments in favour of central banks, as financial supervisors, having at least operational independence, but this relies on a slightly different justification. See, for example, Khan (2018). 13 Lastra (2006), p. 44. 14 Ibid, p. 41. 15 Khan (2018), p. 6.

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which they strive to achieve these goals.16 This flexibility has been used by central banks in many countries in response to recent financial and economic crises.17 In advanced economies, central banks have normally used interest rates as their tool for enacting monetary policies. In response to the Global Financial Crisis and the deep recession it caused in parts of the world, central banks in many advanced economies lowered their policy interest rates to near-zero levels. Despite this, economic growth remained weak, interest rates persisted at near-zero levels and some central banks started to use so-called ‘unconventional’ monetary policies to further stimulate economic activity. Unconventional monetary policies are tools other than changing an interest rate. These tools include negative interest rates, extended liquidity operations and asset purchases (quantitative easing). Some of these tools have been in central banks’ toolkits for a long time. However, what makes such policies particular unconventional is that their use has sometimes become the principal mechanism for achieving monetary policy goals, when the policy rate has been set to zero.18 These unconventional measures have again become increasingly prominent as central banks around the world respond to the severe economic consequences of the COVID-19 pandemic.19 This unconventional type of monetary policy extends a giant public safety net across the financial system and has made it increasingly clear that it is challenging to draw a clear line between financial and monetary policies, the former belonging to the competence of democratically elected politicians and the latter to the independent central banks.20 Second, central banks’ mandates have also explicitly been expanded by parliaments. Today, central banks are now typically responsible for both macro- and micro-prudential supervision in their work with financial stability, which, in particular, encompasses banking supervision and regulation. Micro-prudential responsibilities were dealt with by a separate state agency, but now these have been taken into most central banks’ mandates.21 Third, unconventional monetary policies are not the only way in which central banks are increasing their investments in financial markets. Some central banks have been given the responsibility of managing their governments’ SWF, requiring them to invest and hold assets in foreign jurisdictions.22

16

Lastra (2006), p. 41. Some claim that central banks over-stretched the limits of their monetary policy mandate. See for example Peter Gauweiler and Others v Deutscher Bundestag [2014] ECLI:EU:C:2015:400 and Heinrich Weiss and Others v European Central Bank [2018] ECLI:EU:2018:1000. Both cases concerned lawsuits against the European Central Bank before the European Court of Justice, where the claimants, unsuccessfully, alleged that the bank acted ultra vires when implementing asset purchase programmes. 18 Potter and Smets (2019). 19 Ibid. 20 See Tooze (2018), ch 18. 21 Andenas and Chiu (2013), pp. 415 ff. 22 Botswana, Chile, China, Japan, Kazakhstan and Norway are some examples. See Wuerth (2019). 17

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Last, as central banks’ responsibilities and activities in financial markets have expanded, the demand has been emerging for central banks to actively engage in issues related to the climate crisis. Critics argue that central banks’ stabilisation policies support non-sustainable sectors, and that they should be making changes to these that promote a green transition.23 While several central banks have reviewed or are under the process of reviewing their approach to dealing with the climate crisis, lawsuits are being initiated due to a perceived lack of proper engagement with the issue.24

2.3

Accountability and Legal Protection of Central Banks

Central banks’ broad mandates, the broad discretion they have to choose the means with which they execute monetary policies and the institutional independence that has become standard in the past decades require enhanced accountability.25 Central banks, both when deciding monetary policies and as financial supervisors and managers of SWF, need to be held accountable for the freedom they have been given to make important policy decisions, and accountable for the consequences of those decisions. Accountability mechanisms for central banks vary widely across jurisdictions. Central bankers must demonstrate to the government that their powers have been used appropriately. This typically entails transparency requirements and disclosure of information relating to central banks’ mandates, internal organisation, policies, operations, outcomes and relationship with the government. Disclosure can take the form of public minutes, reports to Parliament, parliamentary hearings and open letters explaining deviation from monetary policies. Accountability can also take a more judicial form. Allowing a central bank, its decision-makers, staff and possibly others to be taken to court for action taken (or not taken) against it, and for possible resulting damages, provides such a legal form of accountability.26 We have seen several attempts to pursue accountability through legal means in recent times. In the aftermath of the Global Financial Crisis, courts across several jurisdictions were asked to review whether central banks acted ultra vires when implementing unconventional monetary policies.27 In Belgium, in 2001, environmental campaigners initiated a lawsuit against the Belgian National Bank based on claims that its asset purchase programmes, which were upholding the monetary

23

See for example Kyriakopoulou (2019). Bloomberg (2021). 25 Khan (2018), p. 6. 26 Ibid, p. 10. 27 In a European context, the lawsuits against the ECB before the ECJ are well known, in particular Peter Gauweiler and Others v Deutscher Bundestag [2014] ECLI:EU:C:2015:400 and Heinrich Weiss and Others v European Central Bank [2018] ECLI:EU:2018:1000. 24

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policy decisions of the European Central Bank (ECB), and individual purchases, violated the domestic and international environmental obligations of the state.28 Since 2016, the ECB has bought corporate bonds as part of its efforts to support the economy and return inflation to its goal of below but close to 2%. As of 9 April 2021, Eurozone central banks held some 268 billion euros ($320 billion) of corporate assets, including many in non-sustainable energy companies.29 The environmental campaigners claimed the Belgian National Bank’s participation in this corporate bond-buying program to help boost the euro area’s economy was ‘fuelling the climate crisis’. More specifically, they argued that the ECB, when it made the decision to establish the program, failed to assess the climate impact of buying these corporate assets, despite its legal obligations to do so.30 While legal accountability may contribute to holding central banks accountable and ensuring they act within their mandates, as well as incentivising them to address their states’ environmental obligations, it may also disrupt their operations and the implementation of some of their mandates. Central banks are particularly vulnerable in this regard as they regularly have property in foreign jurisdictions. They routinely establish accounts with foreign banks—private as well as central banks. The Federal Reserve Bank of New York, Bank of England, Banque de France, Bundesbank, Bank of Japan and People’s Bank of China are among the banks that hold significant assets for other central banks.31 As indicated above, central banks may also invest in assets in foreign jurisdictions, and have indeed done so, and to an increasing extent, through various vehicles the past decades. Some make investments as a part of their monetary policy operations, and others invest through sovereign wealth funds, which some central banks are set to manage. Central banks’ assets located in a foreign country can make an attractive target for creditors seeking to satisfy a judgment against a central bank and also against a state more generally.32 It is important to keep in mind that the broader ‘mandate’ of the state is of a particular kind. Its public duties are often in areas prone to significant risk, including healthcare, infrastructure, defence and education, as well as central banking and financial supervision. Allowing for extensive liability for the state can risk paralysing its core functioning, as well as present a challenge to its independence: the risk of being sued and having its assets seized may stop it from executing its mandate appropriately. Being protected from suits and enforcement measures against their property can incentivise central banks to make policy decisions without undue influence.33 Sovereign immunity rules are among those that can contribute to safeguarding

28

Bloomberg (2021) Ibid. 30 Ibid. 31 Wuerth (2019), p. 267. 32 Wuerth (2019), p. 266. 33 Khan (2018), p. 10. 29

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central banks’ independence and ensuring that they can operate without undue interference. Yet, the extent to which central banks are exempted from sovereign immunity from suits and enforcement measures can contribute to increasing their environmental scrutiny, as well as that directed towards the state more generally. At the same time, exemption through sovereign immunity for central banks and their property may severely hinder central banks from ensuring financial and economic stability. Accountability is the counterbalance to independence, and thereby, also the counterbalance to a well-functioning central bank. Essentially, the right balance between the two must be struck.

3 Sovereign Immunity and Central Banks 3.1

Introduction

Sovereign immunity is a principle in both national and public international law.34 The immunity that one sovereign grants another in its own courts has traditionally been justified under the principle of state sovereignty. According to the principle of sovereignty in international law, no state is to be subject to the will of another state. This is connected to the principle of equality, under which all states are considered to enjoy the same rank.35 Sovereign immunity can be seen as a manifestation of these two principles, and they may explain why it is deemed inappropriate for a sovereign state to be sued in the national courts of another sovereign state. A more functional explanation of sovereign immunity is that states are equal subjects of governance with exclusive power over a defined territory, and the courts of one state should not be able to test the validity or legitimacy of another state’s exercise of authority within its own territory.36 Some legal scholars have also noted that state immunity in practice is probably based on “the expedient of gaining reciprocity and because judicial actions caused diplomatic antagonism”.37 While these justifications mainly concern immunity from jurisdiction, immunity from execution provisions is said to stem more directly from concerns about the disruption and political ramifications that can result from the seizure of a foreign state’s property.38 34

For a discussion of the rules on sovereign immunity, see Fox and Webb (2015). In Jurisdictional Immunities of the State (Germany v Italy: Greece Intervening) (Judgment) (2012) ICJ Rep 99, para 57, the ICJ stated that: “The Court considers that the rule of State immunity occupies an important place in international law and international relations. It derives from the principle of sovereign equality of States, which, as Art. 2, paragraph 1, of the Charter of the United Nations makes clear, is one of the fundamental principles of the international legal order”. 36 Alvik (2006), p. 16. 37 Wood (2007), p. 557. 38 Blackman and Mukhi (2010), p. 48. 35

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Rules on sovereign immunity can provide legal protection for central banks and their operations. This chapter explains how the progress from an absolute to a restrictive approach to sovereign immunity has made the protection of central banks more unpredictable (Sect. 3.2), as central banks regularly operate in commercial markets and the new doctrine exempts state activity of a commercial kind from immunity. It also shows how a number of countries have sought to compensate for this uncertainty by introducing special immunity regulations, which grant near-toabsolute immunity for central banks’ property (Sect. 3.3).

3.2 3.2.1

Commercial Exemption and Central Banks From an Absolute to a Restrictive Approach Towards Immunity

States have long tried to reconcile the public interest in avoiding judicial interference in the execution of the core activities of foreign states, and thereby interference in states’ relations, and the private interest of citizens who have been aggrieved by a foreign state.39 In the past decade, the international rules on sovereign immunity have evolved from a doctrine of absolute immunity to one of relative or restrictive immunity. Before the twentieth century, most countries had absolute immunity from the jurisdiction of foreign courts. At this time, it was prohibited for private citizens to bring claims against foreign sovereigns in domestic courts. Questions of enforcement measures were, therefore, irrelevant.40 The shift from an absolute to a restrictive approach to sovereign immunity arose as a consequence of states having become more involved in commercial activities. The extent to which the shift has taken place varies across jurisdictions. Nowadays, international law does not afford absolute immunity to states. While states remain free to grant immunity for commercial activities, they are no longer under a duty to do so, as international law has evolved in this matter. Today, most commercially significant jurisdictions subscribe to the doctrine of ‘restrictive’ sovereign immunity in their domestic laws. The argument for a more restrictive approach is that absolute immunity constitutes an unjust treatment of private contractors. The idea is that, when a “sovereign descends to the market place, they must accept the sanctions of the market place”.41 The essence of the restrictive doctrine is that states may only invoke immunity from

39

Harvard Law Review (2010). Wood (2007), p. 557. 41 Ibid, pp. 557 and 560–570; Fox and Webb (2015), pp. 399 ff. See, for example, Lord Dennings’ formulation in Trendtex Trading Corporation v Central Bank of Nigeria QB 529 (EWCA Civ) (1977), 132: “If a government department goes into the market place of the world and buys boots or cement—as a commercial transaction—that government department should be subject to all the rules of the marketplace.” 40

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jurisdiction where the act concerned is governmental in nature (acta iure imperii), rather than commercial (acta iure gestionis). A common test when considering whether an act is commercial is to see if the ‘nature’ of the activity is commercial, irrespective of whether the act may have a governmental ‘purpose’.42 The leading US case on restrictive immunity, Weltover, is a good illustration of how courts interpret what is meant by an act of a commercial nature. It defines it as an activity that, although performed by the sovereign, is of a type that a private party could also engage in.43 It is important to underline that although the objective behind the immunity rules remains the same, jurisdictions distinguish between governmental and commercial acts in different ways.44 With a more restrictive approach to immunity from jurisdiction, the issue of enforcement measures against state property has become relevant. In general, the doctrine on sovereign immunity from enforcement measures tends to have a higher threshold for granting exemptions from immunity than rules on sovereign immunity from jurisdiction. While no common state practice can be identified, most financially important jurisdictions and the majority of the Western world have developed an approach by which enforcement is permitted for property used or intended to be used for ‘commercial purposes’.45

3.2.2

Legal Sources

As mentioned above, rules on sovereign immunity are based on both national and public international law.46 In the case law of national courts, the transition to the restrictive doctrine of sovereign immunity was recognised by the French Cour de Cassation in 1969, by the US Supreme Court in 1976 and by the English Court of Appeal in 1977.47 The doctrine of restrictive state immunity was the basis for the 42

By the 1960s, German courts had adopted the nature of the acts test: BVerfGE 16, 27 (1963) (Empire of Iran case). The US FSIA §1603(d) expressly provides that “the commercial character of an activity shall be determined by reference to the nature of the course of conduct of particular transaction, or act, rather than by reference to its purpose”. This was also evident in the ruling of the Republic of Argentina v Weltover, Inc. 504 US 607 (1992). The UK SIA avoids any express reference to the purpose or nature of the transaction, but it follows from case law that the nature test is decisive. See, for example, Owners of Cargo Lately Laden on Board The Marble Islands v Owners of The I Congreso del Partido 1 AC 244 (1983). See, in general, Fox and Webb (2015), pp. 411–412; Wood (2007), pp. 560–561. 43 Republic of Argentina v Weltover, Inc 504 US 607 (1992). 44 The Continental European view is different from that of England due to historical developments. See Fox and Webb (2015), p. 402. 45 In addition to the “purpose” test, many jurisdictions, as well as the UNCSI, apply a nexus requirement between property seized and the relevant commercial activity. 46 See, in general, Fox and Webb (2015), pp. 2–3. 47 Alvik (2006), p. 19. The changes happened in the cases: Administration des chemins de fer du gouvernement iranien v Société Levant Express Transport Cass Civ 1ère, 25 February 1969, Bull

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European Convention on State Immunity adopted by the Council of Europe in 1972 and was laid down in US and UK law in the Foreign Sovereign Immunities Act (US FSIA) of 1976 and the State Immunities Act (UK SIA) of 1978, respectively. The lack of a multilateral instrument setting out the rules of state immunity is a longstanding obstacle to any uniform law. At the international level, there was no authoritative text for the doctrine of restrictive immunity before 2004 so the rules were instead derived from international custom, as evidenced in treaties, national legislation, court decisions and other state practices.48 In 1991, the International Law Commission (ILC) finalised its study of the law of state immunity based on all these sources, resulting in the Draft Articles on Jurisdictional Immunities of States and their Property. The ILC concluded that there was a “steady trend, with the exception of the People’s Republic of China, towards all States accepting a restrictive doctrine and framed its draft Articles on that basis”.49 In 2004, the UN General Assembly adopted the Convention on Jurisdictional Immunities of States and their Property (UNCSI), based on the 1991 ILC Draft Articles. The Convention has not yet entered into force, but central parts of it are considered to express current customary international law.50 Moreover, in its 2012 Jurisdictional Immunities judgment, the International Court of Justice (ICJ) for the first time treated the question of restrictive immunity under customary international law and indirectly recognised the commercial exemption from sovereign immunity.51 The judgment was based on customary international law because there was no treaty concerning sovereign immunity between the two parties, Germany and Italy. In the Jurisdictional Immunities judgment, the ICJ recognised a category of state acts for which immunity may not bar proceedings against foreign states. The Court referred to a distinction between state acts that can be categorised as being of a private law or commercial nature (acta iure gestionis) and acts that are of a governmental or authoritative nature (acta iure imperii).52 It explicitly refrained from discussing the subject of acta iure gestionis any further given that it was tasked to consider whether the acts of the German armed forces and other state organs— which were clearly acta iure imperii—were exempted from immunity on the ground that they constituted serious violations of international human rights law and international humanitarian law. Consequently, the ICJ’s judgment provides little guidance on the criteria to distinguish acts of a commercial or private law nature from acts performed in the exercise of sovereign or governmental authority. International

civ I no. 86 (France); Alfred Dunhill of London, Inc. v Republic of Cuba 425 US 682 (US) (1976); Trendtex Trading Corporation v Central Bank of Nigeria QB 529 (EWCA Civ) (UK) (1977). See Fox and Webb (2008), p. 3. See also Wood (2007), p. 560, operating with slightly different years. 48 Fox and Webb (2008), p. 3. 49 Ibid. 50 See Alvik (2006), p. 19. 51 Jurisdictional Immunities of the State (Germany v Italy: Greece Intervening) (Judgment) (2012) ICJ Rep 99. 52 Ibid, para 60.

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law is, therefore, still heavily reliant on state practice, including legislation and case law, in the area of sovereign immunity to distinguish acta iure imperii from acta iure gestionis.53

3.2.3

Immunity from Jurisdiction: Central Banking Acts of a Commercial Nature

In line with the content of the previous sections, and despite increasing agreement on a doctrine of restrictive immunity, it can be difficult to establish which state acts should be categorised as iure imperii and which others are designated iure gestionis.54 This is of concern for the activities of central banks. Central banks are regarded as being a core part of a state and essential for its functioning. However, central banks regularly operate in the market and execute tasks that can be perceived as similar to those of commercial actors. The commerciality exemption following from the restrictive doctrine of sovereign immunity leaves it somewhat unclear which parts of a central bank’s activities should be categorised as commercial and thereby not protected by immunity from jurisdiction. There are potentially even more of these than before, considering the expanding role of central banks in the past two decades, in particular, in financial markets. To illustrate this, it can be helpful to examine the possible categorisations of central banking activities on a generalised basis, without references to the rules in specific jurisdictions. First, central banks’ administrative affairs, such as being an employer and purchasing goods and services for its day-to-day operations (cleaning, security and canteen management) are activities that private entities also conduct. They are not activities of a governmental nature as such, and therefore, fall outside the scope of sovereign immunity protection. A second activity is a central bank’s decision of interest rate levels. On the one hand, decisions concerning interest rate levels at which other banks borrow from the central bank are something that private actors are not entitled to make. It inherently seems to be of a governmental nature. On the other hand, some central banks have been privately owned institutions and some still have private shareholders.55 It can be argued that these features make interest rate decisions more commercial in nature. Although they are clearly influenced by central banks’ interest rate levels, the fact that commercial banks decide their own interest rates can be an argument in favour of categorising central banks’ interest rate decisions as being of a commercial nature. 53

International courts would also, necessarily, continue to rely upon domestic law in their rulings concerning sovereign immunity. See, in general, Fox and Webb (2015), p. 402. 54 Ibid, p. 399. The Continental European view is different from that of England due to historical developments. See ibid, p. 402. See also Iversen (2023), ch 2. 55 For instance, the National Bank of Belgium, the Bank of Greece and the US Federal Reserve System allow some kind of participation by private investors in their ownership and/or governance system. See the discussion in Spolaore (2020).

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However, the better conclusion is likely to be that decisions concerning interest rates are of a governmental nature and hence immune from jurisdiction in foreign courts. Third, central banks’ decisions to purchase, sell or issue assets on the market are more complex to categorise. To reiterate how we approach this, it is normally not the purpose of the issuance or purchase of assets in the market that is decisive when considering sovereign immunity from jurisdiction, but rather the nature of the activity. With this in mind, as a starting point, it is of no importance if the central bank invests in assets as part of its monetary policy mandate or through an SWF. Investing in assets is typically of a clear commercial nature, as it is similar or at times equal to the work of corporations and private investors. Central banks’ issuance of debt is also an act similar to that carried out by corporations (corporate bonds). Whether the issuance is of a commercial or governmental nature can be influenced by the form of issuance, for instance, whether the financial asset is essentially a private law contract sold on the open market or one created by a governmental decree and resembling a concession contract. The former would arguably more easily be categorised as an activity of commercial nature, and the latter an activity of governmental nature. Fourth, central banks’ regulatory activity related to their financial stability mandate represents something only a governmental agency has the competence to implement. This is a strong argument, as was also the case for deciding interest rate levels, in favour of labelling relevant acts as being of a governmental nature. At the same time, and as some have argued, some of the financial stability tasks that central banks conduct are similar to those of private financial institutions. For example, private finance institutions, like central banks, can provide loans to corporations and other financial institutions, even in times of economic instability.56

3.2.4

Immunity from Enforcement Measures: Central Banks’ Property with a Commercial Purpose

As briefly mentioned in Sect. 3.2.1, a broad spectre of financially important jurisdictions permits enforcement over property used or intended to be used for commercial purposes. Article 19(c) of the UNCSI can be viewed as an expression of this approach. It states, somewhat backwards, that post-judgment measures of constraint against the property of a state may only be taken against property in use or intended for use by the state for “other than government non-commercial purposes”.57 In this 56

Harvard Law Review (2010), pp. 263–265. According to litra c), it is also a requirement that post-judgment measures of constraint “may only be taken against property that has a connection with the entity against which the proceeding was directed”. UNCSI Article 19 also provides that no post-judgment measures of constraint against the property of a state may be taken in connection with a proceeding before a court of another state unless and except to the extent that (a) the state has expressly consented to the taking of such measures, or (b) the state has allocated or earmarked property for the satisfaction of the claim that is the object of that proceeding. 57

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context, the question of immunity from enforcement measures for central banks’ property is confronted with similar challenges as discussed above. It is necessary to distinguish what property can be categorised as commercial or governmental under the restrictive approach. In particular, with central banks’ expanding role, it is clear that this can be a challenge. Central banks trade and store foreign currency, execute purchases and payments and invest in stocks and bonds, all in foreign jurisdictions. These are all activities with certain commercial aspects to them and can be also conducted by private parties. Whether they have a commercial purpose is often difficult to establish. In sum, exemptions from immunity from enforcement measures for central banks’ property have significant potential to disturb central banks’ operations. The extent to which central banks’ property is protected by the commercial exemption under the doctrine of restrictive immunity is uncertain. Several jurisdictions have taken the risks associated with this legal uncertainty seriously and drafted legislation specifically protecting central banks’ property.

3.3

Special Immunity Protection for Central Banks’ Property

The US FSIA and UK SIA, as well as the UNCSI, have specific language protecting central banks’ property that might otherwise fall within an exception from sovereign immunity, such as the commerciality exception. UNCSI Article 21(c) provides that “property of the central bank or other monetary authority of the State” shall not be considered as property specifically in use or intended for use by the state for anything other than government non-commercial purposes under Article 19(c). The UK SIA provides immunity from execution for state property, with an exception in section 13(4) for “property which is for the time being in use or intended for use for commercial purposeless”. However, section 14 (4) provides that the “[p]roperty of a State’s central bank or other monetary authority shall not be regarded for the purposes of subsection (4) of section 13 above as in use or intended for use for commercial purposes”. It follows from case law that immunity applies whether or not the central banks’ property is used for a commercial activity without any examination of the purpose for which the property is used.58 The US FSIA § 1611(b)(1) protects the property of a foreign central bank from enforcement measures if it is “held for its own account”. NML Capital Ltd. v Banco Central de La República Argentina is the leading case interpreting this phrase, which largely decides the scope of immunity provided by the provision. In this case, the Court concluded that funds held in an account in the name of a central bank were presumptively immune from attachment. A plaintiff can rebut that presumption by demonstrating with specificity that the funds are not being used for ‘central banking

58

See United Kingdom, High Court of Justice, AIC Ltd. v Federal Government of Nigeria, case nos. S/03/0056 and S/03/005, 13 June 2003, EWHC 1357 (QB), 129 ILR 571.

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functions’ as normally understood, irrespective of whether those functions are ‘commercial’.59 As these three examples reflect, the special rules protecting central banks’ property from enforcement measures also vary across jurisdictions. Wuerth describes these rules as falling along a continuum and systematises them by creating three categories: First, the most protective jurisdictions provide close-to-absolute immunity from enforcement measures for the property of foreign central banks (in the absence of an explicit waiver). Second, jurisdiction takes a middle ground in protecting central banks’ property as long as it is used for central banking functions or for governmental purposes, or it more generally limits enforcement measures against state-owned property. Third, some states provide no special protection for central banks’ property. These states also generally deny immunity from enforcement measures for property used for a commercial activity based on the nature of that activity, not its purpose. Wuerth places the US legislation in the middle group and UK and UNCSI in the category of near-to-absolute immunity from enforcement measures for the property of sovereign banks (unless there is an explicit waiver).60 Regardless of country-specific differences, Wuerth documents a trend in the past two decades towards more generous immunity from execution for property of foreign central banks.61 She proposes that major states, in particular financial centres, seek to attract or maintain investments by foreign central banks and so they tend to provide high protection for central banks’ assets. Wuerth notes that Argentina, Belgium, China, France, Japan and Russia have enacted recent legislation to expand the immunity from enforcement for central banks’ assets. Moreover, some of the expansions have had the explicit goal of attracting investment by foreign central banks.62 In other words, it seems that states have an interest in serving as a safe jurisdiction for central banks’ assets, to attract or maintain investment by foreign central banks. To that end, it is in their interest to expand the scope of their interests that are protected. As noted in Sect. 2.3, central banks’ independence and legal protection provided by, amongst other factors, sovereign immunity rules allow central banks to execute their functions. This level of protection must, however, be balanced against an appropriate level of accountability. The expansion of central banks’ tasks and the diversification of their holdings and investments is likely to create pressure to limit their immunity, especially for assets clearly used for purposes other than as foreign currency reserves.63

59

United States, Court of Appeals, NML Capital Ltd. v Banco Central de la República Argentina, 5 July 2011, 652. F.3d 172 (2d Cir. 2011), pp. 193–194. 60 Wuerth (2019), pp. 266 and 281. The legislations of the UK, USA and UNCSI have included a waiver exception of the immunity of central banks’ assets. 61 Ibid, p. 266. 62 Ibid. 63 Ibid, p. 284.

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Section 4 discusses the future of immunity from enforcement measures for central banks’ property. The starting point is a recent Swedish Supreme Court judgment, which interprets UNCSI. This distinguishes between central banks’ different types of property and argues that not all deserve protection from the special rules concerning central banks’ immunity (Sect. 4.1). The question is whether such a distinction can contribute to finding the right balance between legal protection of central banks and their independence, on the one hand, and accountability, on the other. A further consideration is whether other jurisdictions are likely to follow a similar path (Sect. 4.2).

4 Evolving Standards of Central Banks’ Legal Protection 4.1

Swedish Supreme Court Case No. Ö 3828-20

In 2021, the Swedish Supreme Court decided on a case concerning immunity from enforcement measures against central banks’ property. The case involved a discussion of whether the near-to-absolute immunity that central banks’ property is granted should cover property not associated with its more traditional functions. The issue is relevant for all jurisdictions where central banks have an expanding role and fundamentally addresses the debate on how we should balance central banks’ independence with their accountability. Moreover, while the Swedish Supreme Court applied Swedish law, the judgment is also relevant for determining the immunity protection provided for by the UNSCI and in customary international law.

4.1.1

Background to the Case

The case stemmed from a dispute between Ascom Group SA, AS, GS and Terra Raf Trans Traiding Ltd. (the investors) on the one side, and the Kazakhstan state and its National Bank on the other. The investors initiated arbitral proceedings administered by the Stockholm Chamber of Commerce pursuant to Article 26 of the Energy Charter Treaty. In December 2013, an arbitral award was issued according to which Kazakhstan was ordered to pay approximately USD 500 million plus interest and compensation for the costs of litigation for the investors. Following a request by the investors for enforcement of the award, the Swedish Enforcement Authority decided to attach financial instruments on a securities depository at the private bank (SEB), funds on a cash account at SEB and receivables linked to the instruments (the property). The securities consisted of shares in approximately 30 listed Swedish limited companies.

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The attachment decisions referred to the property as belonging to Kazakhstan.64 To be more precise, the attached assets form part of the National Fund, which can be characterised as an SWF.65 The Kazakhstan SWF was established in 2000 according to a presidential decree. The purpose of the fund is to ensure the stable economic development of the country, accumulate assets for future generations and reduce the domestic economy’s dependence on external factors unfavourable to the country.66 The National Bank manages the SWF according to an agreement with the state (the National Fund Agreement). The National Bank’s management is also described in the Kazakh National Bank Act.67 The investors proposed that the Supreme Court should not grant immunity for the assets. The Republic of Kazakhstan and the National Bank of Kazakhstan opposed this and claimed the assets were covered by immunity. The latter asserted that the property cannot be subject to attachment because (1) the property is subject to state immunity, and (2) the property does not belong to Kazakhstan in the sense required by statutory law for attachment because the instruments are not located in Sweden.68 The Supreme Court only considered the first question. The Court’s decision was based on Swedish law. While there are no relevant provisions in Swedish legislation on the immunity of a foreign state from enforcement, Swedish courts are obliged to respect immunity that follows from international customary law.69 The Court noted that, in line with case law of the ICJ,70 the UNCSI is relevant to the extent that is can shed light on the content of international customary law.71 For the rest of the case, the Court based its reasoning on the provisions of the UNSCI based on the assumption that these reflect customary law.72 The Court concluded that UNCSI Article 21(1)(c), which provides near-toabsolute immunity from enforcement measures, was irrelevant for the case at hand. The justification, which will be detailed in the next section, was that the purpose of the property was not related to the National Bank’s implementation of monetary policy. The Court was instead of the opinion that, whether the attached property was immune from enforcement measures had to be assessed according to the commercial exemption in UNCSI Article 19(c). The Court concluded that the 64

Ö 3828-20, Ascom Group SA and Terra Raf Trans Trading Ltd. v The Republic of Kazakhstan and The National Bank of Kazakhstan, para 3. 65 Ibid, para 30. 66 Ibid, para 34. 67 Ibid, ss 34–35. 68 Ibid, paras 4 and 7. 69 Ibid, para 14. 70 Jurisdictional Immunities of the State (Germany v Italy: Greece Intervening) (Judgment) (2012) ICJ Rep 99, para 66. 71 Sweden ratified the Convention in the Swedish Treaty Series 2009:32 and incorporated it into Swedish law in the Jurisdictional Immunities and Their Property Act (2009: 1514). As is the case for the Convention, the Act has not entered into force. 72 Ö 3828-20, Ascom Group SA and Terra Raf Trans Trading Ltd. v The Republic of Kazakhstan and The National Bank of Kazakhstan, paras 14, 16 and 24.

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National Bank, or more precisely the SWF’s holding of financial assets, in this case, had a commercial purpose. Consequently, no immunity from enforcement measures was granted for the relevant property based on Article 19(c) either. The case was sent back to the lower court to consider whether said property belonged to Kazakhstan and not the National Bank (the second question).

4.1.2

Scope of Protection Under UNSCI Article 21(1)(c)

When establishing the scope of Article 21(1)(c), the Court argued that it was necessary to account for the interests the provision aims to protect. This had two implications. Firstly, the special and absolute protection of a central bank should apply “not only to property in respect of which the bank is the owner under civil law, but also to property otherwise at the bank’s disposal”.73 Consequently, as a starting point, the property of an SWF managed by a central bank falls under the scope of Article 21(1)(c).74 Secondly, it is not self-evident that the absolute immunity provided by this rule should apply to all property owned by or at the disposal of a central bank.75 Again, the Court looked to the underlying interest sought to be protected by the provision and stated that: The reason why central bank property should be entitled to special protection must be deemed to be that a central bank conducts activities within the area of monetary policy in a broad sense. The great importance of monetary policy to a state’s central functions justifies what is in principle absolute immunity in respect of property used within this activity.76

The Court asserted that there was no clear support for the position that absolute immunity under customary law, as expressed in UNCSI Article 21(1)(c), also applies to property a central bank has at its disposal without any connection to the bank’s monetary policy task. In fact, it argued that it was ‘not justifiable’ to provide central banks with such a far-reaching entitlement to immunity. The Court concluded that the special level of protection to be enjoyed by central banks should “be limited to such property as has a clear connection with the central bank’s activities in the area of monetary policy”.77 Finding that the special rule of immunity provided by Article 21(1)(c) was deemed not to be applicable for the reason mentioned, the Court instead turned to the rules in UNCSI Article 19(c) to assess whether the attached property was protected from enforcement measures due to the ordinary commercial exemption.78

73

Ibid, para 22. Ibid, para 24. 75 Ibid, para 23. 76 Ibid. 77 Ibid, para 24. 78 Ibid. 74

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UNCSI Article 19(c) and States’ Purpose When Investing in Financial Assets

As discussed in Sect. 3.2.4, UNCSI Article 19(c) only permits enforcement measures against property used or intended to be used for commercial purposes. The challenge is, as the Court explained, that there may be several purposes behind a state’s investments in financial assets abroad: perhaps a general wish to secure and increase the state’s assets to meet society’s needs in the long term and to increase wellbeing in the country. Alternatively, it can be linked to macroeconomic considerations of the state, for example, that the immediate consumption of assets can lead to undesirable effects on the country’s economy. Moreover, the purpose of holding financial assets can be to counteract negative effects of external factors or other unforeseen circumstances. Last, investments can be made based on pure monetary policy considerations.79 According to the Court, the purpose for which a property is held is, as a rule, found in the ‘actual use’ of the property.80 This criterion, in itself, is only of limited help because there is often an absence of actual use of states’ holding of financial assets traded in the financial markets with which to form the basis for assessing the purpose behind the holding.81 The innovative contribution of the Swedish Supreme Court was its suggested guideline for assessing ‘the actual use’ of investments in financial assets of central banks and states more generally. The ‘actual use’ criterion is applied by looking at the investment strategy and factors described therein, such as the risk level and horizon of the investment and the yield requirements. The Court elaborated on its view by contrasting long-term with short-term investments. In short, long-term investments typically have the aim of increasing future returns, the use is unspecified and the tolerance for risk is relatively high. These types of investments are typically made in company shares, and the risk is similar to the risk of commercial actors.82 Short-term investments, on the other hand, are normally made by investors who require that resources can be made available at an earlier stage, on short notice, and these types of investments are associated with a lower risk. Examples of relevant assets are government bonds and bank deposits, where the risk taken is less similar to a commercial risk.83 If an initial assessment of the investment strategy indicates that actual use is commercial, the Court suggests an additional assessment. This considers whether there might be other factors that, irrespective of the commercial character, make it more natural to categorise the purpose as governmental, meaning immunity should be afforded (a double test):84

79

Ibid, para 26. Ibid, para 25. 81 Ibid. 82 Ibid, para 28. 83 Ibid. 84 Ibid, paras 28–29. 80

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In order for immunity to continue to apply to such property, it must therefore be required that, over and above motives which are basically of a commercial nature, there are qualified purposes of a sovereign nature85 that are expressed concretely and clearly in the state’s regulation of how the property is to be used.86

In other words, the Court argues that the central bank has to demonstrate a link between the assets and the sovereign activity for which the assets can be used. It underlines that the mere fact that a state will be able to use the value of the property for government activities in the future or that the savings are intended for future generations is not enough.87 Moreover, the Court notes that, even though a state’s saving in financial assets on the international capital market may, as with other government savings, per se serve a general macroeconomic function, this does not automatically mean that such savings can be regarded as a sovereign activity. According to the Court, it is necessary to establish “a more concrete link between, on the one hand, the form of saving and, on the other hand, the state’s monetary policy or other acts of a sovereign nature must be required”.88

4.2

Backlash Against Immunity for Central Banks’ Property?

The Swedish Court’s interpretation of the rules concerning immunity from enforcement measures against central banks’ property was courageous. Firstly, it interpreted UNCSI Article 21(1)(c) to provide that customary international law does not guarantee all central banks’ property protection, only that which has a connection to its monetary policy mandate. Secondly, the Court’s method for establishing whether financial assets held by a state has a commercial or governmental purpose under Article 19(c), is both innovative and practical. The judgment does, however, give rise to several questions. One question is whether the Swedish conclusion that only central banks’ property with a monetary policy purpose is immune from enforcement measures is an outlier or provides a meaningful interpretation of UNCSI Article 21 (1)(c) and/or customary international law. A second question is whether the reasoning behind the Swedish judgment might inspire courts and legislators in other countries that currently provide central banks with more generous protection so that a new balance between central banks’ accountability on the one hand, and legal protection and independence on the other hand, might emerge. With regards to the interpretation of UNCSI Article 21(1)(c), it should be noted that there were different views on the protection that ought to be given to central 85 The use of ‘nature’ in this context can be confusing. I do, however, interpret this to solely describe the ‘purpose’ of the property and not to the requirement related to sovereign immunity from jurisdiction under the restrictive doctrine. 86 Ö 3828-20, Ascom Group SA and Terra Raf Trans Trading Ltd. v The Republic of Kazakhstan and The National Bank of Kazakhstan, para 28. 87 Ibid. 88 Ibid, para 29.

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banks’ different types of property during the negotiations of the convention. On several occasions, it was discussed whether only central banks’ property with a monetary purpose should be immune from enforcement measures. The removal of specific references to this limitation may indicate that the final provision was meant to provide immunity from enforcement measures for all of central banks’ property ipso facto. However, the fact that the drafting history clearly shows a general lack of agreement weakens this argument that Article 21(1)(c) covers all central banks’ property ipso facto.89 This is also a point the Swedish Supreme Court makes in paragraph 21: Article 21 (1) (c) is intended to provide central banks and other monetary authorities with special protection from enforcement measures. However, the extent of this protection appears unclear in international customary law. This applies in particular in light of the fact that, during the negotiations that preceded the Convention, there were different views on the issue and that no clear state practice has subsequently been developed.

While the Court, throughout its judgment, interprets Article 21(1)(c) as if it is customary international law, it is also possible to question this assumption. If Article 21(1)(c), in conflict with the Swedish judgment, is interpreted to provide close-to-absolute immunity from enforcement measures for central banks’ property, it cannot correspond with customary international law. As mentioned in Sect. 3.3, several states allow for enforcement measures against parts of central banks’ properties. In sum, while the scope and legal status (customary international law or not) of Article 21(1)(c) remain unclear,90 the Swedish Court’s reasoning may correspond well with customary international law. The Swedish Court’s interpretation of Article 19(c) can be perceived as radical in the sense that it affected property formally owned or managed by a central bank. However, if one agrees that the property does not fall under special central bank immunity protection, the suggested assessment method of looking at the investment strategy to decide on the purpose of the property is less radical as an interpretation of customary international law. Even more so, it can contribute to clarifying how the purpose of holding financial assets can be established in a meaningful way. Of course, it remains to be seen whether other domestic and international courts will be persuaded by the arguments and follow suit.

For example, at the first reading of the draft articles, Germany, supported by Australia, Qatar and the five Nordic countries, opposed the proposition that all property of a central bank should be classified as not in use or intended for use for commercial purposes. Instead, they proposed that only property serving monetary purposes should be deemed inherently uncommercial, and therefore, immune. See O’Keefe et al. (2013), p. 337, referring to Preliminary Report Ogiso 119, para 239. 90 O’Keefe et al. propose another line of argument in favour of excluding central banks’ property related to commercial activities if it is held by independent central banks given the scope of immunity protection under Articles 19 and 21. The argument is that independent central banks engaging in ‘purely commercial conduct’ are not ‘states’ for the purposes of the UNCSI Article 2(1) (b)(iii). Yet, the Swedish Court did not make any reference to this latter provision in the reasoning for its judgment. Ibid, p. 343. 89

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5 Conclusion Regardless of whether the Swedish Court’s interpretation of UNCSI Article 21(1) (c) was correct or whether the provision expressed customary international law, there are two key reasons for courts in other jurisdictions to take the Swedish judgment seriously. First, central banks play an essential role in contributing to economic stability, which is a prerequisite for the welfare of individuals and commercial life alike. As such, there are good reasons to protect central banks’ independence using legal tools such as immunity from enforcement measures. The justification for legal protection from interference is strongest when it comes to implementing monetary policy. Yet, in a situation where central banks’ role has been expanded, including but not limited to the management of SWFs, one should be careful with arguing that all of its tasks deserve equal legal protection and independence. Independent central banks need to be held accountable to be perceived as legitimate. Shielding central banks from legal accountability in areas not closely related to monetary policy may contribute to a backlash against the need for independence for their core functions. To avoid such a backlash, it is reasonable to restrict immunity for property used for other purposes. Second, states are not taking sufficient measures to fight climate change and protect the environment. The expanding role of central banks means that their activities potentially have more of an impact than in the past on the climate. Moreover, central banks hold increasing property abroad with purposes that cannot necessarily be categorised as monetary policy-related in a narrow sense. Far-reaching immunity from jurisdiction and enforcement measures may weaken central banks’ commitments—and those of the state, more generally—to comply with international and domestic environmental obligations. Central banks are legal constructs and states can decide to integrate whatever vehicles into them they like, as well as provide them with the tasks the state deems fit. In extreme cases, it is possible to imagine that this can be misused as a way of avoiding legal accountability. The further away from monetary policy you get, the weaker the arguments are in favour of shielding central banks and their property by legal means. Limiting the rules concerning sovereign immunity from enforcement measures for central banks to only cover property with a monetary policy-related purpose can create an important incentive for states and central banks to abide by domestic and international environmental obligations.

References Alvik I (2006) Statsimmunitet etter norsk rett og folkeretten. In: Fauchald OK, Jakhelln H, Syse A (eds) Festskrift til Carl August Fleischer, dog fred er ej det bedste. Universitetsforlaget, Oslo Andenas M, Chiu IH (2013) The foundations and future of financial regulation: governance for responsibility. Routledge, Abingdon

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Bartscher AK, Kuhn M, Schularick M, Wachtel P (2021) Monetary policy and racial inequality. Federal Reserve Bank of New York Staff Report, New York City Blackman JI, Mukhi R (2010) The evolution of modern sovereign debt litigation: vultures, alter egos, and other legal fauna. Law Contemp Probl 73:47–61 Bloomberg (2021) Belgian Central Bank Sued by ClientEarth for “Fueling the Climate Crisis”, 13 April 2021. https://www.bloomberg.com/news/articles/2021-04-13/belgian-central-banksued-for-fueling-the-climate-crisis. Last accessed 24 June 2022 Burger M, Metzger D (2020) Global Climate Litigation Report: 2020 status review. UNEP Carpenter SB, Rodgers WM III (2004) The disparate labor market impacts of monetary policy. J Policy Anal Manag 23(4):813–830 Coibion O, Gorodnichenko Y, Kueng L, Silvia J (2017) Innocent bystanders? Monetary policy and inequality. J Monet Econ 88:70–89 Fox H, Webb P (2008) The law of state immunity (Oxford International Law Library), 2nd edn. Oxford University Press, Oxford Fox H, Webb P (2015) The law of state immunity (Oxford International Law Library), 3rd edn. Oxford University Press, Oxford Fratto C et al (2021) Unconventional monetary policies in emerging markets and frontiers. International Monetary Fund Harvard Law Review (2010) Too sovereign to be sued: immunity of central banks in times of financial crisis. Harv Law Rev 124(2):550–571 Iversen A (2023) Intercreditor equity in sovereign debt restructuring. Oxford University Press, Oxford Khan A (2018) Legal protection: liability and immunity arrangements of central banks and financial supervisors. International Monetary Fund, Washington, D.C. Kyriakopoulou D (2019) Central banks and climate change. OMFIF Special report, Official Monetary and Financial Institutions Forum Lastra RM (2006) Legal foundations of international monetary stability. Oxford University Press, Oxford O’Keefe R, Tams CJ, Tzanakopoulos A (2013) The United Nations Convention on jurisdictional immunities of states and their property: a commentary. Oxford University Press, Oxford Potter SM, Smets F (2019) Unconventional monetary policy tools: a cross-country analysis. Bank for International Settlements, Basel Spolaore P (2020) Ownership and governance of central banks: insights from the Italian experience. Eur Comp Financ Law Rev 17(6):619–656 Tooze A (2018) Crashed; how a decade of financial crises changed the world. Penguin Wood PR (2007) Conflict of laws and international finance, The law and practice of international finance series, vol 6, 1st edn. Sweet & Maxwell, London Wuerth I (2019) Immunity from execution of central bank assets. In: The Cambridge handbook of immunities and international law. Cambridge University Press, Cambridge

Astrid Iversen is an Associate Professor at Inland Norway University of Applied Sciences. She is currently on leave from this position to do research on Central Banks’ Expanding Role in Financial Markets in Times of Crisis, in a joint project between the University of Oslo and Inland Norway University of Applied Sciences. She holds a PhD (2020) from the University of Oslo on the topic of Sovereign Debt Restructuring.

The WTO Panel Report on US-Safeguard Measure on PV Products: A Decisive Victory for the Fight Against Climate Change? Xinyan Zhao

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The WTO Jurisprudence: US-Safeguard Measure on PV Products . . . . . . . . . . . . . . . . . . . . . . . . 2.1 The Road to Dispute . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The Panel’s Rulings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Impact of US-Safeguard Measure on PV Products on WTO Members’ National Strategies for Promoting the Use of Clean Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Diversifying the Supply Chains of PV Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Preventing Pollution Throughout the Life Cycle of PV Products . . . . . . . . . . . . . . . . . . . 4 A More Comprehensive Analytical Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract Using solar energy, a clean and renewable energy source, is significant to reducing global greenhouse gas emissions. Some disputes revolving around green incentive policies regarding clean energy resources were brought to the World Trade Organisation’s (WTO) dispute settlement system a few years ago. WTO panels faulted members’ green incentive policies in Canada-Renewable Energy and India-Solar Cells because the relevant procurement constituted a WTO-inconsistent domestic content requirement. Although these rulings ensure the functioning of a liberal market of green products, they have a side effect on the long-term enforcement of global climate policies. By closing the door on green incentive policies for domestic industries, WTO panels have indirectly supported the monopoly of the international market of green products by a few giant producers. This monopoly has significantly harmed the development of environmental industries in many countries and discouraged the relevant investment and innovation. These consequences might be underestimated or ignored by panels but have slowed down reducing greenhouse gas emissions. Given this, it is essential to know how X. Zhao (✉) University of Lausanne, Lausanne, Switzerland e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 175–204, https://doi.org/10.1007/8165_2022_88, Published online: 11 November 2022

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governments can promote clean and renewable energy in a manner consistent with WTO law. The US-Safeguard Measure on PV Products panel may have given a clear response that members should use safeguard measures to protect their environmental industries against unfair competition. Whereas many people hail the panel’s decision, it is noteworthy that safeguard measures have limitations to promote the sustainable development of clean energy. It is necessary to deeply analyse the value and impact of this new WTO panel report. This chapter aims to shed light on this aspect. It is structured as follows. Section 1 introduces the relevance of the WTO dispute settlement system to the development of clean energy and the combat of climate change and describes the structure of this chapter. Section 2 reviews the WTO jurisprudence. After that, Sect. 3 sets forth the positive and negative impacts of the US-Safeguard Measure on PV Products on WTO members’ national strategies for promoting the use of clean energy. Notably, this discussion focuses on the role of WTO panels in diversifying the supply chain of PV products and preventing pollution throughout the life cycle of PV products. Then, Sect. 4 suggests that a more comprehensive analytical framework that balances various sustainability elements is desirable for combatting climate change. Finally, this chapter ends up with a brief conclusion.

1 Introduction Combatting climate change is an important task for today’s global governance.1 Anthropogenic climate change has led to global warming and ocean acidification, which are significantly harmful to the planet’s flora and fauna.2 To mitigate and adapt to these adverse effects, people must change their lifestyles to slow down climate change. Among the possible solutions, using renewable and clean energy is an essential means.3 Scientific research has shown that replacing coal-based energy sources with clean energy sources such as wind and solar power will significantly reduce greenhouse gas (GHG) emissions that cause global warming.4 Currently, 193 United Nations (UN) member states are committed to using renewable and clean energy to reduce GHG emissions in key climate change conventions, including the UN 2030 Agenda for Sustainable Development (the 2030 Agenda), the United Nations Framework Convention on Climate Change (UNFCCC), and the Paris Agreement on Climate Change.5

1

Cottier and Payosova (2016), pp. 10–12. Delimatsis (2016), p. 1; Schefer and Arnaiz (2016), p. 49. 3 Cottier (2014), p. 40; Kulovesi (2014), pp. 342–343. 4 Algieri et al. (2011), p. 7275. 5 Shadikhodjaev (2015), pp. 479–480; Delimatsis (2016), p. 2; Young (2016), p. 332; Tamiotti and Ramos (2016), p. 505. 2

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At the same time, they are acutely aware of trade’s important role in the fight against climate change. Trade in goods, including energy and carbon-intensive products, is a major contributor to GHG emissions. 6 Governments, therefore, need to reduce these products’ carbon content or curb their imports. Many countries have now applied their own sustainable development policies to achieve these objectives.7 These policies can be divided into two categories. One is carbon tax mechanisms to reduce carbon emissions,8 such as the European Union’s (EU) Emissions Trading System (ETS) and the Carbon Border Adjustment Mechanism (CBAM). The other is green incentive policies to promote renewable and clean energy sources directly, such as the popular feed-in tariff (FIT) programmes.9 It is well known that the relevance of WTO rules and clean energy regulation is very close.10 On the one hand, the major energy-trading countries, including the Organisation of the Petroleum Exporting Countries (OPEC; except Iran, Iraq, Algeria, and Libya), are already WTO members.11 WTO agreements naturally govern their energy trade.12 On the other hand, WTO dispute settlement rules affect the implementation of energy-importing countries’ domestic regulatory measures to reduce GHG emissions.13 In the absence of a multilateral agreement on abatement among WTO members, these domestic regulatory measures are essential to reduce carbon emissions.14 Of course, due to their trade-restrictive nature, many trade disputes have arisen between exporting and importing countries revolving around these domestic regulatory measures.15 Over the past decade, the point of contention in such disputes has been the prevention of green protectionism,16 i.e., preventing importing countries from imposing tariff barriers on green products17 used to reduce GHG emissions18 and from creating unfair competition for imported green products

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IPCC, 2014: Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Edenhofer, O., R. Pichs-Madruga, Y. Sokona, E. Farahani, S. Kadner, K. Seyboth, A. Adler, I. Baum, S. Brunner, P. Eickemeier, B. Kriemann, J. Savolainen, S. Schlömer, C. von Stechow, T. Zwickel and J.C. Minx (eds.)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA, p. 753. 7 Cottier (2014), p. 40; Borlini and Montanaro (2018), pp. 84–85; See also Lewis (2014), pp. 14–15. 8 Vranes (2016), pp. 77–78; Trachtman (2016), p. 109. 9 Kent and Jha (2014), p. 248; Bigdeli (2016), p. 119. 10 Cottier (2014), p. 42. 11 Cottier (2014), p. 42. 12 Cottier (2014), p. 42. 13 Schefer and Arnaiz (2016), p. 49. 14 Shadikhodjaev (2015), p. 506. 15 Kent and Jha (2014), pp. 249–250; Hajdukiewicz and Pera (2020), p. 507. 16 Griffin (2013), p. 205. 17 Green products often refer to photovoltaic products, such as solar modules and cells. See Shi (2019), p. 49. 18 Espa and Holzer (2018), p. 416.

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through preferential policies for green products manufactured domestically (e.g., FIT programmes).19 For nearly a decade, WTO panels have refused to support FIT programmes, the major clean energy incentive policy. In both Canada-Renewable Energy and IndiaSolar Cells, panels ruled that FIT programmes violated WTO rules on the basis that they contained domestic content requirements.20 Instead, WTO panels had a relatively lenient attitude towards contingency measures imposed by importing countries on green products.21 The WTO panel even upheld for the first time an importing country’s contingency measures on imported green products in the latest US-Safeguard Measure on PV Products case.22 Some scholars have expressed their concerns about this ruling in some recent studies.23 For example, Fang argues that this panel report will encourage green protectionism and thus hinder the free trade of green products in international markets.24 In her view, trade restrictions on green products such as solar modules and cells will prevent countries from meeting commitments to reduce GHG emissions and slow down global warming.25 However, the implication of the US-Safeguard Measure on PV Products panel report on climate change is complex. This complexity is reflected in the fact that while the panel’s rulings will have a short-term negative impact on the PV industry, they will also have a long-term positive impact. On the one hand, the panel’s rulings will reduce the supply of green products on the international market in the short term.26 Intuitively, this consequence is, of course, detrimental to the fight against climate change. On the other hand, these rulings will also optimise the development model of the PV industry. The question is whether the long-term value of the panel report is sufficient to offset its negative impact on combatting climate change. If so, is this panel report a decisive victory in the fight against climate change? In this chapter, I will analyse these questions in depth. Section 2 of the chapter will review the WTO jurisprudence. Then, Sect. 3 will discuss the positive and negative impacts of the US safeguards on photovoltaic products on WTO members’ strategies to promote the use of clean energy. Notably, this part focuses on the role of WTO panels in diversifying the supply chain of PV products and preventing pollution throughout the life cycle of PV products. 19

Espa and Holzer (2018), p. 417. Charnovitz and Fischer (2015), p. 192; WTO Panel Report, Canada — Certain Measures Affecting the Renewable Energy Generation Sector, WT/DS412/R, adopted 24 May 2013, pp. 139–140; WTO Panel Report, India — Certain Measures Relating to Solar Cells and Solar Modules, WT/DS456/R, adopted 14 October 2016, p. 140. 21 Brewster et al. (2016), p. 348. 22 Fang (2022), p. 241; See also WTO Panel Report, United States - Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, p. 96. 23 Fang (2022), p. 240. 24 Fang (2022), p. 269. Many scholars believe that green protectionism undermines the fight against climate change. See Schefer and Arnaiz (2016), p. 72; Wu (2016), p. 279. 25 Fang (2022), p. 269. 26 Kent and Jha (2014), pp. 251–252; Wang et al. (2021), p. 6820. 20

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Section 4 suggests that a more comprehensive analytical framework that balances various sustainability elements is desirable for combatting climate change. Finally, this chapter ends with a brief conclusion.

2 The WTO Jurisprudence: US-Safeguard Measure on PV Products 2.1

The Road to Dispute

Article XIX of the General Agreement on Tariffs and Trade (GATT) and the Agreement on Safeguards (SG Agreement) allow WTO members to protect domestic producers of similar products by imposing safeguard measures on rapidly increasing imports in accordance with the corresponding requirements.27 In 2017, two US firms28 believed that the import of PV products into the US were causing them serious injury and requested the United States International Trade Commission (USITC) to impose a safeguard measure on imports of PV products from all sources.29 This move aimed to prevent China from circumventing US anti-dumping and countervailing measures by exporting solar components from other countries.30 After investigation, the USITC determined that the US could impose a safeguard measure on imports of PV products following WTO rules.31 According to the commission’s reports, the then-president of the US decided on 23 January 2018 to impose a safeguard measure on imports of PV products beginning on 7 February 2018,32 including but not limited to modules, laminates, panels, and buildingintegrated materials.33 The safeguard measure imposes two restrictions on imported PV products: one is a 2.5 GW tariff-rate quota on imports of solar cells not partially or fully assembled into other products; the other is ad valorem duties on imported modules. Both the tariff-rate quota and ad valorem duties are reduced year by year.34 These measures have significantly affected the export interests of Chinese PV producers. As a result, on 14 August 2018, China requested consultations with the 27

See Appellate Body Report, Argentina-Safeguard Measures on Imports of Footwear, WT/DS121/ AB/R, adopted 12 January 2000, para.84; Appellate Body Report, Korea-Definitive Safeguard Measure on Imports of Certain Dairy Products, WT/DS98/AB/R, adopted 12 January 2000, paras. 76–77; See also Fang (2022), p. 245. 28 Namely, Suniva, Inc. and SolarWorld Americas, Inc. 29 WTO Panel Report, United States - Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 2.2. 30 Ibid., para. 7.21; See also Fang (2022), p. 243. 31 WTO Panel Report, United States - Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 2.2. 32 Ibid. 33 Ibid., para. 2.1. 34 Ibid., para. 2.3.

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United States concerning the definitive safeguard measure imposed by the US on imports of crystalline silicon PV products.35 After unsuccessful consultations, China asked to establish a WTO panel on 11 July 2019 to review the legality of the US safeguard measure.36 Since then, the curtain has been opened on a 2-year dispute between the US and China over the US safeguard measure on imports of PV products. On the face of it, the dispute between China and the US over imported PV products resulted from political and trade friction between the two countries.37 However, this case was merely a continuation of trade conflicts over environmental goods from past years.38 The first WTO dispute between the US and China over photovoltaic products started in 2011. SolarWorld Americas, Inc., the US subsidiary of the German company SolarWorld, united six other manufacturers and demanded that the USITC initiate a double-anti investigation (i.e., anti-dumping and antisubsidy investigation) against China’s PV export products.39 The US commerce department eventually ordered the imposition of a 5-year countervailing duty on imports of Chinese PV products.40 Immediately thereafter, at the request of EU solar manufacturers, the European Commission also imposed an anti-dumping duty on imports of Chinese PV products.41 China launched a counterattack against the US and EU through the WTO Dispute Settlement Body (DSB) in the face of the US and EU’s anti-dumping and countervailing measures. China requested a WTO panel to rule that the US countervailing duty imposed on imports of Chinese products, including PV products, violated WTO rules.42 In addition, China claimed that the EU (Italy’s and Greece’s) FIT programmes used to promote domestic solar manufacturers constituted WTO-inconsistent subsidies.43 China won the dispute against the US countervailing measures.44 For the latter, China did not request the establishment of a WTO panel to review the case. However, WTO panel reports on CanadaRenewable Energy and India-Solar Cells are conducive to China’s claims (i.e., the FIT programmes were incompatible with WTO rules because they contained local content requirements).45 Despite these rulings favourable to China’s claims, the

35

Ibid., para. 1.1. Ibid., para. 1.3. 37 Fang (2020), pp. 103–105. 38 Brewster et al. (2016), pp. 327–328. 39 Shi (2019), p. 54. 40 Shi (2019), p. 54. 41 Bougette and Charlier (2018), p. 171. 42 Brewster et al. (2016). 43 See Request for Consultations by China, European and Certain Member States-Certain Measures Affecting the Renewable Energy Generation Sector, WT/DS452/1, 7 November 2012; See also Kent and Jha (2014), p. 250. 44 Charnovitz and Fischer (2015), p. 177. 45 Charnovitz and Fischer (2015), p. 192. 36

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panel report on US-Countervailing Measures (China) did not substantially prohibit the US from imposing countervailing duties on imports of Chinese PV products.46 As Brewster noted, the US could continue to implement double-anti investigations against specific imports, such as PV products, as long as it made up for the investigations’ procedural problems.47 In addition, the WTO panels’ rulings on FIT programmes were a double-edged sword for China. Although China could invoke the rulings to challenge the EU’s green subsidy policy, China’s own green subsidy policy would also fail to comply with WTO rules according to the rulings. The essence of the PV product disputes is the dilemma facing the PV industry: whereas any government needs to provide subsidies to develop renewable energy industries,48 these measures would violate WTO rules and thus incur anti-dumping or countervailing measures. The US–China dispute in this case also arose in this context. One might envisage promoting the development of renewable energy industries through green subsidy policies consistent with WTO rules. For example, countries support green energy irrespective of its source. Unfortunately, such a policy undermines the development of domestic renewable energy industries. Another sensible question one could ask is whether the development of domestic renewable industries is necessary to achieve the purpose of green energy. As shown below, the development of domestic renewable energy industries (including the PV industry) is needed to ensure the stable use of green energy to reduce GHG emissions.49 Relying on a few foreign producers of green products undermines countries’ energy security. It makes it impossible for countries to have stable, equitable and politically unconditional access to the green products needed to produce clean energy. Furthermore, consumer-oriented subsidies such as FIT programmes are insufficient to support the development of renewable energy industries alone. The examples of the EU and Brazil demonstrate that this sort of subsidy does not promote but rather significantly harms the development of their renewable energy industries.50 Studies have shown that consumers who receive subsidies still tend to purchase cheap imported green products.51 Thus, whereas these subsidies may induce consumers to buy renewable energy products, they do not provide support to domestic producers. In contrast, China’s producer-oriented subsidies have been more effective in developing renewable energy industries.52 Therefore, to promote the development See WTO Panel Report, United States – Countervailing Duty Measures on Certain Products from China, WT/DS437/AB/R, adopted 16 January 2015, pp. 117–118. 47 Brewster et al. (2016), p. 327. 48 Kent and Jha (2014), p. 251. 49 See Sect. 3.1. 50 See Hochstetler and Kostka (2015); See also Bougette and Charlier (2018), p. 172. 51 Bougette and Charlier (2018), pp. 172–173. 52 Shi (2019), pp. 49–51; Song et al. (2022); See also Jing Cao and Felix Groba, Chinese Renewable Energy Technology Exports: The Role of Policy, Innovation and Markets, Discussion Papers of DIW Berlin 1,263, DIW Berlin, German Institute for Economic Research, 2013, https://ideas.repec. org/p/diw/diwwpp/dp1263.html. 46

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of the domestic PV industry, countries promoting free-market competition must resort to contingent protection measures against PV products dumped into their internal markets.53 Arguably, WTO panels’ rulings failed to resolve PV product disputes effectively. This set the stage for this China–US dispute to occur.

2.2

The Panel’s Rulings

In challenging the legality of the US safeguard measure, China’s claims revolve around the elements that need to be satisfied for safeguard measures under Article XIX of the GATT and the Agreement on Safeguards: unforeseen developments, the effect of the obligations incurred, and the causal link between the increased imports and serious injury.54 China believes that the US safeguard measure does not satisfy any of these elements.55 In particular, China contended that the serious injury facing US solar manufacturers resulted from their own missteps rather than import factors.56 In addition, China argued that the USITC’s procedure for imposing the safeguard measure was flawed.57 In summary, China requested that the WTO panel find that the US acted inconsistently with: 1. Article XIX:1 (a) of the GATT 1994 and Article 3.1 of the Agreement on Safeguards because the US failed to establish, prior to the application of the measures, that the increases in imports were the result of ‘unforeseen developments’ and were the ‘effect of obligations incurred’ under the GATT 1994 by the United States;58 2. Articles 2.1, 3.1, and 4.2(b) of the Agreement on Safeguards because the US failed to establish the required “causal link” between the increased imports and the serious injury found to exist;59 3. Articles 2.1, 3.1, and 4.2 (b) of the Agreement on Safeguards because the US failed to ensure that injury caused by other factors was not attributed to increased imports;60

53

My argument does not say that people shall ignore the adverse effects of contingent trade protective measures on access to cheap green products and abatement. Indeed, I argue that WTO panels should comprehensively consider the constitutional values of contingent protection measures and green subsidies to ensure that WTO members’ domestic measures help reduce GHG emissions. See Sect. 4. 54 Lee (2014), p. 56. 55 WTO Panel Report, United States - Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 3.1. 56 Ibid., para. 7.191. 57 Ibid., para. 3.1. 58 Ibid. 59 Ibid. 60 Ibid.

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4. Articles 3.1 and 3.2 of the Agreement on Safeguards because the US provided nonconfidential summaries to interested parties with such delay that the parties were not provided with an adequate opportunity to exercise their right to present a defence, and because the actual public summaries were not sufficient so as to permit interested parties to reasonably present a defence.61 Of course, the US denied that it violated the aforementioned WTO rules.62 The panel analysed in turn the arguments made by both parties.

2.2.1

Unforeseen Developments and the Effect of the Obligations Incurred

The first point of contention, in this case, is whether the US safeguard measure on crystalline silicon photovoltaic (CSPV) products complied with the requirement that imports increased ‘as a result of unforeseen developments and of the effect of the obligations incurred’.63 Specifically, the USITC must demonstrate: (1) the existence of ‘unforeseen developments’, (2) that imports increased as a result of the ‘unforeseen developments’, and (3) that imports increased as a result of the effect of the obligations incurred by the US.64 China accuses the USITC of failing to demonstrate appropriately compliance with these requirements in its investigation reports.65 In this case, the US argued that the SG Agreement did not require a member’s competent authority to demonstrate compliance with the unforeseeable development requirements in its investigation reports.66 On this issue, academic opinion and WTO jurisprudence are widely divided. There is general agreement among academics that the conditions for the imposition of safeguards under Article 2 of the SG Agreement do not include ‘the increased imports have to be the result of unforeseen developments’.67 In contrast, in Argentina-Footwear (EC) and Korea-Dairy, the Appellate Body (AB) held that ‘any safeguard measure imposed after the entry into force of the WTO Agreement must comply with the provisions of both the Agreement on Safeguards and Article XIX of the GATT 1994.’68 That is, a WTO

61

Ibid. Ibid., para. 3.2. 63 Ibid., para. 7.8. 64 Ibid., para. 7.11. 65 Ibid., para. 7.9. 66 WTO Panel Report, United States - Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.10. 67 Mavroidis et al. (2010), p. 500. 68 See Appellate Body Report, Argentina-Safeguard Measures on Imports of Footwear, WT/DS121/ AB/R, adopted 12 January 2000, para.84; Appellate Body Report, Korea-Definitive Safeguard Measure on Imports of Certain Dairy Products, WT/DS98/AB/R, adopted 12 January 2000, paras. 76–77. 62

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member’s competent authority must demonstrate the existence of unforeseen developments in its investigation report. In the present case, the panel did not explain this thorny issue. Interestingly, this did not prevent the panel from examining the legality of the US safeguard measure. As we will see, since the panel found that the USITC report met all unforeseen development requirements, it did not need to address this issue.69

The Existence of Unforeseen Developments The panel began its analysis by examining whether there were unforeseen developments in this case. WTO jurisprudence has provided a clear interpretation of the phrase ‘as a result of unforeseen developments’. In Argentina-Footwear (EC), the AB interpreted that the dictionary definition of ‘unforeseen’ is synonymous with ‘unexpected’.70 In addition, the AB specified that ‘unforeseen’ does not mean ‘unforeseeable’ in the context of Article XIX of the SG Agreement.71 The dictionaries define the latter as ‘unpredictable’ or ‘incapable of being foreseen, foretold or anticipated’.72 Obviously, ‘unforeseeable’ emphasises the state of being absolutely unable to foresee that an event will occur. Instead, the term ‘unexpected’ does not imply this absolute nature. The panel reviewed the USITC report based on this criterion. In the report, the USITC stated that the US could not have foreseen the following: 1. China would implement a series of industrial policies, five-year plans, and other government support programs favouring renewable energy product manufacturing, including CSPV products; 2. The effect of such industrial policies, plans, and support programs would lead to the development and expansion of capacity to manufacture CSPV products in China to levels that substantially exceeded the level of its internal consumption; 3. This increased capacity would be largely directed to export markets such as the US and would take advantage of the existence of programs implemented by the US government to encourage renewable energy consumption; 4. The US’ use of authorised tools, such as anti-dumping and countervailing duty measures on imports from China, would have limited effectiveness and instead

69

Ibid., para. 7.62. See Appellate Body Report, Argentina-Safeguard Measures on Imports of Footwear, WT/DS121/ AB/R, adopted 12 January 2000, para.91; See also Appellate Body Report, Korea-Definitive Safeguard Measure on Imports of Certain Dairy Products, WT/DS98/AB/R, adopted 12 January 2000, para. 84. 71 See Appellate Body Report, Argentina-Safeguard Measures on Imports of Footwear, WT/DS121/ AB/R, adopted 12 January 2000, para. 91. 72 Ibid. 70

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lead to rapid changes in the global supply chains and manufacturing processes. . .73 As China has pointed out in this case, it is not unusual for a country to seek economic development and energy security.74 Therefore, it is unlikely that the US could not have foreseen that the Chinese government would support the development of its renewable energy industries. This argument becomes even more rational in the context of countries seeking to achieve sustainable development. After all, using clean energy to reduce GHG emissions is a commitment shared by all countries in multilateral climate conventions, including the Paris Agreement.75 There is, of course, controversy among scholars about when the development-induced import increase should be unforeseen.76 Albeit, the Hatter’s Fur case presented that the moment of unforeseen is when the concession was negotiated.77 One might think that for an emerging issue such as climate change, governments certainly could not have foreseen the relevant industrial developments when signing the GATT 1994.78 Therefore, the unforeseen condition seems to have lost its significance. However, this is not the case. Take, for example, the renewable energy issue in this case. Even at the time of drafting the GATT 1994, WTO members would have foreseen that other governments would promote the development of renewable energy industries. This is because countries had already started climate negotiations before signing the GATT 1994.79 In addition, China has also provided a reasonable explanation for the last point raised by the USITC. Namely, academic research has well demonstrated that antidumping and countervailing measures can lead to increased imports from other countries with lower duties.80 Admittedly, China’s arguments make common sense. Regrettably, however, there was a serious flaw in China’s arguments that led the panel to withhold support for China’s view. In this case, the US emphasised that what it was unable to foresee was the scale of the effort, the speed with which the Chinese boosted production, the overcapacity that it created, and the degree to which these effects spilt into other countries where Chinese producers expanded their operations.81 This argument refines the circumstances of ‘unforeseen developments’

73

See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.21. 74 Ibid., para. 7.23. 75 See Shadikhodjaev (2015), pp. 479–480; Delimatsis (2016), p. 2; Young (2016), p. 332; Tamiotti and Ramos (2016), p. 505. 76 See Mavroidis et al. (2010), p. 505; Fang (2022), p. 249. 77 See GATT Report, US-Fur Felt Hats, GATT/CP/106, adopted 22 October 1951, p. 9; See also Messerlin and Fridh (2006), p. 724. 78 Fang (2022), p. 249. 79 The famous earth summit regarding climate change was held in Rio de Janeiro in June 1992. 80 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.23. 81 Ibid., para. 7.24.

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and is more in line with the requirement of case-by-case analysis. In contrast, China’s definition of the ‘unforeseen developments’ in this case was too broad. Suppose the panel supported China’s argument. In this case, any safeguard measure imposed by WTO members on renewable energy products would not meet the ‘unforeseen developments requirement’. This would render Article XIX of the GATT and the SG Agreement meaningless. Countries would have to resort to more trade-restrictive anti-dumping and countervailing measures to provide their own renewable energy industries with contingent protection.82 This consequence is undesirable. In this case, the panel accepted the US view.83 It is noteworthy that this was the first time that a panel found that a member’s safeguard measure met the ‘unforeseen developments requirement’.84

Imports Increased as a Result of the Unforeseen Developments Article XIX:1 (a) requires a logical link between the unforeseen developments and the resulting increase in imports for each product subject to a safeguard measure.85 This was demonstrated by the AB report on US-Steel Safeguards. Briefly, the AB stated that: There must, therefore, be a ‘logical connection’ linking the ‘unforeseen developments’ and an increase in imports of the product that is causing, or threatening to cause, serious injury. Without such a ‘logical connection’ between the ‘unforeseen developments’ and the product on which safeguard measures may be applied, it could not be determined, as Article XIX:1 (a) requires, that the increased imports of ‘such product’ were ‘a result of’ the relevant ‘unforeseen development’. Consequently, the right to apply a safeguard measure to that product would not arise. . . .86

In this case, the argument between the US and China on this requirement revolved around the standard of proof. In China’s view, it was improper for the USITC to conclude in its report that there was such a logical link based on mere inference.87 This argument implied that the USITC must provide direct evidence of a logical relationship between the unforeseen developments at issue and the increase in imports of the products that were causing or likely to cause serious injury. In contrast, the US argued that GATT Article XIX:1(a) did not require import-specific information on a transaction-by-transaction, company-by-company, or country-by-

82

See Mavroidis et al. (2010), pp. 465–471. See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.27. 84 See Mavroidis et al. (2010), p. 508; Fang (2022), p. 242. 85 Mavroidis et al. (2010), p. 502. 86 See Appellate Body Report, United States-Definitive Safeguard Measures on Imports of Certain Steel Products, WT/DS248/AB/R, adopted 10 December 2003, paras. 318-19 and 322. 87 WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.31. 83

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country basis, i.e., direct evidence demonstrating the logical link above.88 Furthermore, China did not entirely refute the USITC’s findings. The USITC report asserted that Chinese-affiliated producers massively increased their production in Korea, Malaysia, Thailand, and Viet Nam.89 In response to this argument, China argued only that Chinese producers’ investment and production should not increase imports of PV products from Korea.90 This became an important reason why China failed to prove that the USITC report violated the WTO rule above. The panel eventually rejected China’s claim for two main reasons. The first reason was that the panel opined that the absence of direct evidence did not undermine the linkage that the USITC established between China’s policies, plans, and programmes and the significant volume of increased imports from China.91 Although the panel did not substantiate this view in its report, WTO jurisprudence can significantly support the panel’s opinion. In examining increased imports, the Argentina-Footwear (EC) AB ruled that the panel should be looking at trends instead of isolated transactions or absolute numbers based on an end-point to end-point comparison.92 Certainly, the AB’s ruling was not made in relation to the standard of proving a logical relationship between unforeseen developments and increased imports. However, one can still clearly see the similarities between the two issues. I consider that the panel may corroborate its view based on this AB ruling. Furthermore, as noted above, China’s failure to refute the USITC’s findings regarding the production of Chinese producers in countries other than Korea, such as Malaysia, was the second reason. In fact, this failure was fatal. Safeguard measures aim to adjust for import growth from all sources rather than targeting a single or a specific group of countries.93 Thus, even if the panel were to find that Chinese producers’ production in Korea was indeed unrelated to the increased imports, it could not conclude that Chinese producers did not contribute to an increase in imports from other countries. Since imports from countries other than Korea accounted for almost two-thirds of the increase in imports,94 once China failed to deny the relationship between production by Chinese producers in these countries and increased imports, it could not deny the USITC report’s compliance with the WTO rule (i.e., imports increased as a result of the unforeseen developments).

88

Ibid., para. 7.33. Ibid., para. 7.33. 90 Ibid., para. 7.31. 91 Ibid., para. 7.38. 92 See Appellate Body Report, Argentina-Safeguard Measures on Imports of Footwear, WT/DS121/ AB/R, adopted 12 January 2000, para. 129. 93 See Mavroidis et al. (2010), p. 465. 94 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.34. 89

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Imports Increased as a Result of the Effect of the Obligations Incurred by the US The last issue is whether imports increased as a result of the effect of the obligations incurred by the US. WTO members promised the maximum tariffs they could impose on specific products when they joined the WTO, i.e., bound tariff rates. Article XIX:1(a) requires WTO members to demonstrate a logical link between the increase in imports of the product for which they are imposing safeguard measures and the bound tariff rate they have committed to for that product. In other words, a WTO member cannot curb the product’s import growth by raising the tariff rate because of its obligation regarding bound tariff rates and thus has no choice but to resort to a contingent protection measure, such as a safeguard measure. In this case, the US argued that CSPV products covered by the safeguard measure were provided for in subheading 8541.40.60 of the US harmonised tariff schedule and had been free of duty under the general duty rate since at least 1987.95 It was unable to limit the imports of CSPV products by raising the tariff rate. Thus, the imports of CSPV products increased due to the effect of its WTO obligations. In response to the US claim, China made two arguments. First, China argued that the US general zero-duty rate on CSPV products since at least 1987 was neither a ‘commitment’ nor a ‘tariff concession’ under Article II of the GATT 1994. Moreover, China argued that the US did not commit to this obligation in previous GATT negotiating rounds.96 Second, China opined that, even if the USITC identified a zero bound tariff rate as the obligation incurred, the US did not necessarily impose a safeguard measure on the imports of CSPV products, as it could have imposed a contingent measure other than safeguard measures.97 The panel did not support China’s position. Indeed, there was a severe disagreement between the panel and China on the factual finding of whether the USITC report indicated that the general zero-tariff rate on CSPV products was the US’s WTO obligation. China argued that the statement in the USITC report did not explicitly state that the zero-tariff rate on CSPV products was the US’s WTO obligation.98 In the panel’s view, China’s analysis was too formalistic and ignored the meaning expressed in other statements in this report.99 Through a comprehensive reading of the USITC report, the panel found one paragraph in the report clearly indicating that the zero-tariff rate on CSPV products was the US’s WTO obligation:

95

Ibid., para. 7.50. Ibid., para. 7.48. 97 Ibid., para. 7.48. 98 Namely, CSPV products covered by the safeguard measure are provided for in subheading 8541.40.60 of the US harmonised tariff schedule and have been free of duty under the general duty rate since at least 1987. 99 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.56. 96

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In this case. . .The US has been a GATT member since January 1, 1948 and has incurred the obligations of WTO membership since January 1, 1995, whereas the government of China acceded to the WTO effective December 11, 2001. Prior to China’s WTO accession, there was a series of negotiations with individual and collective WTO members, including the US, before they agree to extend the WTO’s trade liberalisation and market access benefits to China.100

Moreover, GATT Article XIX:1(a) does not stipulate that WTO members must use safeguard measures only when other contingent protection measures, including antidumping and countervailing measures, are not available. Given this, the panel did not support China’s second argument.101 Furthermore, China’s argument was also highly contradictory to its own position. In US-Countervailing Measures (China), China explicitly opposed imposing anti-dumping and countervailing measures on PV products. Is China’s argument, in this case, suggesting that the US can impose anti-dumping and countervailing duties on imports of Chinese PV products? This must not be the case.

2.2.2

Causal Link Between Increased Imports and Serious Injury

Article 2.1 of the SG Agreement provides that for safeguards to be imposed, a product must be imported in such increased quantities, absolute or relative to domestic production, to cause serious injury. This provision contains three conditions for imposing safeguard measures: (1) increased quantities of imports; (2) serious injury or threat of serious injury to the domestic industry; and (3) the existence of a causal link between the increased imports and serious injury.102 The US and China disagreed mainly on the third point in the present case. In this case, China argued that three categories of positive elements emerged during the USITC’s investigation of serious injury to the US domestic industry: (1) capacity, production, and shipments; (2) employment; and (3) capital expenditures, R&D expenses, and the value of production assets.103 In other words, during the USITC investigation, the US domestic industry showed an improvement in the data related to these elements. In China’s view, those improvements suggested that the increase in imports had not caused serious injury to the US domestic industry.104 In addition, China invoked Article 4.2(b) of the SG Agreement, which requires WTO members to investigate damage to the domestic industry caused by factors other than imports.105 These nonimport factors must be excluded by WTO members

100

Ibid., para. 7.54. Ibid., para. 7.60. 102 Mavroidis et al. (2010), pp. 511–534. 103 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.161. 104 Ibid., para. 7.162. 105 Ibid., para. 3.1(b). 101

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when considering whether an increase in imports has caused serious injury to the domestic industry.106 Of course, it is worth noting that a finding of nonimport factors does not mean that there is no causal link between the increase in imports and serious injury.107 As long as the single factor of increased imports is sufficient to cause serious injury to the domestic industry, there is still a causal link between that increase in imports and the serious injury. In this case, China argued that nonimport factors caused serious injury to the US domestic industry. China argued that the US domestic industry overly focused on the commercial and residential segments and avoided competing in the utility segment.108 In China’s view, this decision by US domestic manufacturers made them unable to meet increasing demand.109 In addition, China believed that the types and quality of products, the delivery issue, and the service offered by US producers also reduced their market competitiveness.110 In addition to these missteps, China believed that nonimport factors, including declining government incentive programmes, declining raw material costs, and the need to attain ‘grid parity’ with other sources of electricity,111 have caused serious injury to the US domestic industry.112 In response to China’s arguments, the USITC report investigated in three parts a causal link between the increase in imports and serious injury. First, the USITC report discussed the relationship between the increased imports and serious injury. The report concluded that the US domestic PV industry suffered a serious injury in the form of adverse price conditions, lost market share, financial deterioration, and plant closures.113Second, the USITC report explained why these positive elements cited by China did not change the fact that increased imports had severely damaged its domestic PV industry.114 Finally, the USITC report analysed the nonimport factors mentioned by China and concluded that these factors were not the causes of injury.115 The panel analysed the arguments of the US and China on each of these issues. As the dispute arose from their different judgment of the facts, the panel’s analysis was

106

Mavroidis et al. (2010), p. 534. Mavroidis et al. (2010), p. 536. 108 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.89. 109 Ibid., para. 7.90. 110 Ibid., para. 7.191(a). 111 Grid parity means an alternative energy source, such as solar and wind power, can generate power at a levelized cost of electricity that is less than or equal to the price of power from the electricity grid. 112 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.191(b). 113 Ibid., pp. 43–56. 114 Ibid., pp. 56–62. 115 Ibid., para. 7.195. 107

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essentially a fact-check of the matters in dispute between the two sides. Finally, the panel entirely accepted the US view that the USITC report proved a causal link between the increased imports and serious injury.116

2.2.3

The USITC’s Treatment of Confidential Information

WTO members must observe due process when imposing safeguard measures on imported products. In the context of Article 3.1 of the SG Agreement, due process requires that a member’s competent authority investigate the damage caused by imports to the domestic industry following established procedures and make the results of the investigation public in accordance with GATT Article X. This provision aims to ensure that all interested parties are clearly informed of the reasons for the authority’s decision to impose safeguard measures and thus can respond effectively to the decision. As the AB stated in US-Steel Safeguards, a member must set forth findings and reasoned conclusions on all pertinent issues of facts and law since this is the only basis upon which panels can base their findings.117 Thus, although Article 3.1 does not set out detailed procedural rules,118 the panel was still strict in requiring investigating bodies to ensure the transparency of their investigations.119 Failing to ensure this due process will render a safeguard measure inconsistent with WTO rules.120 However, Article 3.2 of the SG Agreement provides an exception for the disclosure of confidential information to protect business secrets; any confidential information shall not be disclosed without the permission of the party submitting it. Of course, this provision does not mean that investigating authorities are free to hide evidence. Instead, Article 3.2 of the SG Agreement provides that ‘parties providing confidential information may be requested to furnish nonconfidential summaries thereof or, if such parties indicate that such information cannot be summarised, the reasons why a summary cannot be provided.’ In this case, China contended that the USITC failed to provide sufficient nonconfidential summaries of confidential information to allow interested parties to present a meaningful defence. Specifically, China argued that the USITC deprived the interested parties of an adequate opportunity to present a defence because it did

116

Ibid., para. 7.189. See Mavroidis et al. (2010), p. 493; WTO Appellate Body Report, United States-Definitive Safeguard Measures on Imports of Certain Steel Products, WT/DS248/AB/R, adopted 10 December 2003, para. 299. 118 Mavroidis et al. (2010), p. 494. 119 Mavroidis et al. (2010), pp. 495–498. 120 See WTO Appellate Body Report, United States-Definitive Safeguard Measures on Imports of Certain Steel Products, WT/DS248/AB/R, adopted 10 December 2003, para. 303. 117

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not provide nonconfidential summaries of its prehearing reports to them.121 China was also unsatisfied with the timing of the release of the final USITC report. Given that the date of publishing the nonconfidential versions of the USITC report and submitting comments to the trade policy staff committee fell on the same day,122 China considered that this arrangement prevented interested parties from commenting on this report’s contents in a timely manner.123 In addition, China opined that the USITC practice of requiring interested parties to destroy or return confidential information before submitting arguments or comments to the trade policy staff committee prevented them from making arguments or comments based on such confidential information.124 Accordingly, China requested that the panel rule that the USITC acted inconsistently with Article 3 of the SG Agreement.125 In response to China’s arguments, the US argued that Article 3.2 of the SG Agreement did not contain these procedural conditions. Rather, the US opined that the USITC’s practices went beyond the obligations under Article 3.2 of the SG Agreement, including providing interested parties with prehearing injury and remedy reports and an opportunity to comment on these reports to the trade policy staff committee.126 Certainly, the USITC’s procedure for publishing its final report was not perfect. However, as widely recognised by scholars, it is true that Article 3.2 of the SG Agreement does not provide any detailed procedural rules.127 Moreover, it does not provide for any right to access confidential information.128 The panel also rejected China’s claim on this basis.129 Even if the panel supports China’s claim, it will not be able to prevent the US from imposing safeguards on imports of PV products in the future. After all, the US needs only to improve its domestic laws’ procedure rules to impose safeguard measures on imported PV products in the future.

2.2.4

Conclusion of the Panel’s Rulings

This section provides a comprehensive review of the panel’s rulings. It can be seen that the panel sided with the US on all issues and ultimately ruled that China failed to

121

See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, para. 7.300. 122 Ibid., para. 7.298. 123 Ibid., para. 7.301. 124 Ibid., para. 7.302. 125 Ibid., para. 7.293. 126 Ibid., paras. 303–306. 127 Mavroidis et al. (2010), p. 494. 128 Mavroidis et al. (2010), p. 492. 129 See WTO Panel Report, United States-Safeguard Measure on Imports of Crystalline Silicon Photovoltaic Products, WT/DS562/R, circulated 2 September 2021, paras. 7.307–7.311.

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prove that the US violated WTO rules. The most striking point is that the panel in this case recognises for the first time the legality of a member’s safeguard measures. This ground-breaking ruling has undoubtedly raised the eyebrows of scholars. However, it is worth noting that the panel did not provide any new interpretation of the WTO rules regarding safeguard measures. The panel continued to follow its previous analytical framework and jurisprudence. The reason for its first endorsement of the legality of a safeguard measure is that China failed to prove that the US violated the corresponding WTO rules in accordance with the existing case law. In other words, the panel’s rulings result from a fact-check of the matters in dispute rather than a change in jurisprudence. Despite this, the rulings still have significant implications for the application of safeguard measures and national climate policies. This chapter will then examine the impact of this case on WTO members’ national strategies for promoting the use of clean energy.

3 Impact of US-Safeguard Measure on PV Products on WTO Members’ National Strategies for Promoting the Use of Clean Energy One stone stirred up a thousand waves. The panel report on the US-Safeguards Measure on PV Products has significant implications for the international trade of PV products. Moreover, those implications will be extended to national policies to address climate change. The panel report clearly showed that WTO members could apply safeguard measures legitimately.130 Because safeguard measures restrict the free trade of PV products to some extent, the panel’s rulings could open the floodgate to uninhibited use of safeguards and trigger a wave of green protectionism (i.e., countries abuse safeguard measures to limit the trade of PV products unreasonably).131 Some scholars argue that green protectionism will slow the progress of global reductions in GHG emissions because it reduces access to the products needed to reduce emissions, particularly in developing countries.132 This chapter aims to shed new light on safeguard measures’ impact on the clean energy industry and the fight against climate change. I believe that the panel report will help diversify the PV products’ supply chains and prevent pollution throughout their life cycle. Of course, the panel’s rulings are not a decisive victory for the fight against climate change, as they still have significant limitations. This section will discuss the positive and negative effects of the panel report on WTO members’ national strategies to promote the use of clean energy in terms of the two aspects above.

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Fang (2022), p. 261. Fang (2022), p. 265. 132 See Fang (2022), pp. 267–268; Schefer and Arnaiz (2016), p. 72; Wu (2016), p. 279. 131

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Diversifying the Supply Chains of PV Products

The panel report on US-Safeguards Measure on PV Products has created the possibility for WTO members to use safeguards to limit imports of PV products.133 Although safeguards are only temporary measures,134 a member’s domestic solar manufacturers still have the opportunity to apply for an extension of the measures already imposed.135 Given this, safeguards can be a policy tool used by WTO members to regulate imports of PV products. When governments use them properly, they can serve to optimise PV product supply chains, namely, protecting the local solar producers from overexposure to imported PV products and thus enabling them to be stable suppliers to the domestic market. Existing research has shown that a correct combination of contingent protection measures and green subsidies, including research and development subsidies and FIT programmes, can effectively promote the domestic PV industry’s development.136 When countries use safeguards to reduce imports of PV products from foreign monopolies, the local PV industry will gain more domestic orders and thus have room for further development. Once the local PV industry in each country has developed to a certain extent, the international market will become diverse in terms of suppliers. As a result, there will be healthy commercial competition in the PV product sector.137 It will also be easier for countries to design their PV import portfolios and thus diversify their PV product supply chains. It is worth noting that diversifying PV product supply chains is extremely important for countries to combat climate change. This is because a diversified import portfolio ensures the stability of a country’s access to PV products. It helps ensure a country’s clean energy security, allowing for the stable use of clean energy to reduce GHG emissions. The role of supply chain diversification in ensuring clean energy security can be understood by reviewing the issue of traditional fossil energy security. Traditionally, energy security means that a country has a reliable supply of energy at reasonable prices to support the economy and industry.138 Most oil-consuming countries are highly dependent on the international market for oil imports due to the geographical imbalance between oil-producing and major oil-consuming countries.139 However, oil imports are affected by factors such as politics, geographical location, religious beliefs, natural disasters, wars, and

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Fang (2022), p. 261. See Mavroidis et al. (2010), p. 466. 135 Fang (2022), p. 262. 136 Bougette and Charlier (2018), pp. 181–183. 137 Experienced readers may regard my argument as an infant industry theory. One of the classical publications about this theory is W. Max. Corden’s Trade Policy and Economic Welfare. Please read Corden (1997), pp. 139–161. However, here I do not refer to this theory. I argue for the importance of the diversity of the supply chains of PV products. 138 See Vivoda (2009), p. 4615. 139 Vivoda (2009), p. 4616. 134

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international shipments.140 Political factors, in particular, affect the stability of oil supplies.141 Because of the importance of oil to a country’s economic development and defence security, diplomatic relations between oil-exporting and importing countries always determine the conditions for oil exports. When there is diplomatic friction between an oil-exporting country and an importing country, the latter will have to pay higher purchase prices or lose access to oil imports. To reduce the uncertainty of energy security, major oil-importing countries, such as the US, EU, Japan, and China, have adopted import portfolios to diversify their oil (and natural gas) supply chains.142 Nevertheless, studies show that it is still difficult for countries to break away from dependence on specific oil exporters.143 In the era of clean energy, green products, including solar cells and panels, will offer countries the possibility to break away from this dependency. A significant advantage of clean energy over traditional energy sources is that it can be produced artificially. Countries can create clean energy, such as solar and wind power, by importing the upstream products used to make it. Scholars call that indirect energy imports.144 Empirical studies have shown that indirect energy imports will significantly ensure a country’s energy security.145 Suppose that green product suppliers are diverse. In this case, a country can diversify its indirect energy imports by buying upstream products such as solar panels used to produce clean energy from different sources. Conversely, if green product producers are overly concentrated in a few countries, importing countries will lose the opportunity to diversify their indirect energy supply chains and again face energy supply instability. The consequence could be that many countries would not have stable, equitable and politically unconditional access to the green products needed to produce clean energy. It is, therefore, essential that countries eliminate the monopoly of a few exporting countries on green products. In this sense, the WTO panel’s affirmation of safeguard measures is undoubtedly beneficial for the healthy development of the clean energy industry and for countries to achieve their sustainable development objectives to combat climate change. However, this panel report has significant limitations in terms of promoting the supply chain diversification of PV products. As mentioned above, safeguards can level the playing field of the international market of PV products to a large extent. Solar producers can take advantage of this level playing field to develop into an available international supplier for PV products. However, the limitation of safeguards is that they cannot directly order consumers (i.e., the downstream industry of

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Vivoda (2009), p. 4616; Sato et al. (2017), p. 41. See Kashcheeva and Tsui (2015); Mityakov et al. (2013), p. 1091. 142 See Vivoda (2009), pp. 4617–4,621; Sato et al. (2017), p. 41; Vivoda (2019), p. 967; Rosa et al. (2022), p. 124097; Lesbirel (2004), p. 1; Vivoda and Manicom (2011), p. 246; Xu et al. (2014), p. 8329. 143 Sato et al. (2017), p. 41. 144 Sato et al. (2017), p. 42. 145 Sato et al. (2017), p. 47. 141

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green products) to diversify their green product supply chains. As studies demonstrate, governments’ ability to intervene in indirect energy imports, such as PV products, is more limited than in the case of oil imports.146 In most cases, private companies have full rights to choose their PV product suppliers. Governments can only encourage private companies to diversify their PV product supply chains through indirect measures, including special trade policies such as free trade agreements.147 At present, direct government intervention in private companies’ choice of PV product suppliers would violate WTO rules such as the most-favoured-nation treatment. This panel report was not given the opportunity to discuss this issue. This question remains to be answered by WTO panels or WTO members in future dispute settlements or negotiations. Furthermore, as mentioned above, safeguards alone cannot guarantee the healthy development of a country’s domestic PV industry. Green subsidy programmes, including FIT programmes, must be reasonably implemented by governments to develop the local green industry.148 As the case did not involve WTO members’ green subsidy policies, the panel did not have the opportunity to reinterpret WTO panels’ position on these policies’ legality. In previous decisions, panels have rejected the legality of FIT programmes and have failed to distinguish between justified green subsidies and unjustified ones. As a result, countries will continue to compete uncontrollably in the area of green subsidies, which thus will prevent the establishment of a fair and competitive market. In conclusion, this panel report cannot alone improve the state of WTO members’ domestic PV industry.

3.2

Preventing Pollution Throughout the Life Cycle of PV Products

Although solar power is a clean and renewable energy source, the PV products required to produce solar power, such as solar cells and modules, can cause serious environmental damage, particularly to the environment where they are produced. The PV product production process includes the upstream process, ranging from silica extraction to multi-Si purification; the midstream process, involving crystalline silicon ingot growth and wafering; and the downstream process, consisting of cell and module fabrication.149 Numerous scientific studies have shown that all of the above production processes cause serious environmental pollution, including chemical, water, soil, air, and light pollution.150 The production of polysilicon and silicon wafers for solar panels creates dangerous byproducts, particularly silicon 146

Sato et al. (2017), pp. 50–51. Sato et al. (2017), p. 51. 148 Bougette and Charlier (2018), pp. 181–183. 149 Fu et al. (2015), p. 180. 150 See, for example, Qi and Zhang (2017), p. 22133. 147

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tetrachloride and hydrofluoric acid.151 When these two substances are discharged into a river without adequate waste treatment, they pose a serious threat to the health of the aquatic species in the drainage basin and the surrounding population.152 Multicrystalline silicon PV production and PV module packaging are even more environmentally polluting.153 Furthermore, the PV industry is highly energy- and water-consuming. The PV industry requires large amounts of electricity and water to support daily production, significantly increasing GHG emissions.154 This problem is more severe in countries where electricity generation relies on fossil fuels.155 In addition to production-related pollution, the disposal of used solar panels could also lead to pollution, including battery waste containing lead, cadmium, antimony, and sulphuric acid.156 The entire life cycle of PV products is highly polluting. Therefore, when measuring the international trade of PV products’ contribution to the environment, one should not ignore their serious negative impact on the environment. Take the US-Safeguards Measure on PV Products case as an example. Studies have shown that the export of PV products significantly increased the GHG emissions of China (i.e., the exporter in this case).157 Moreover, only a small proportion of the PV products produced in China are used in the domestic market.158 Thus, a well-developed PV system has not helped China effectively phase out fossil fuels but rather increased its GHG emissions. In addition, Chinese PV companies have had difficulties meeting the environmental standards set by China for the PV industry, resulting in many environmental pollution incidents.159 This makes the PV industry more like a highly polluting industry in China (it could be the case for many other industries). This strange phenomenon presents a dilemma: while the export of Chinese PV modules supplied a large amount of clean energy to the world, it also caused significant environmental impacts in China.160 The panel report on US-Safeguards Measure on PV Products addresses this dilemma to some extent. Safeguards effectively curb PV product imports, thus forcing major PV product-exporting countries such as China to reduce their excess capacity. This would significantly reduce the environmental pollution and GHG emissions in these countries. Eventually, different countries’ solar manufacturers will together fill the reduced supply of PV products caused by safeguards. More 151

Yang et al. (2014), p. 563. Yang et al. (2014), p. 563. 153 Huang et al. (2017), p. 132. 154 Yang et al. (2015), p. 35. 155 Fu et al. (2015), p. 180. 156 Yang et al. (2014), p. 563. 157 See Yang et al. (2015), p. 35. 158 Shi (2019), p.50. 159 Yang et al. (2014), p. 563. 160 Yang et al. (2015), p. 35. 152

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evenly distributed production sites could avoid the severe environmental problems caused by the overproduction of PV products in a single country. One drawback to note is that this panel report does not consider the environmental impact factor in reviewing the legality of safeguards. While one could argue that the panel may have lowered the standard of review in this case,161 the panel did not provide any new basis for reviewing the legality of safeguards.162 The report follows the analytical framework and interpretative principles required in previous WTO jurisprudence.163 Therefore, its contribution to environmental protection is only a byproduct of its rulings on safeguards. Considering that these rulings are highly factspecific,164 WTO members may not be able to defend their safeguards in the same way as the US did in this case. Given this, it is difficult to expect that future panel reports will achieve the same effect.

4 A More Comprehensive Analytical Framework This chapter analyses how WTO panels reviewed the matters of US-Safeguards Measure on PV Products and briefly introduces WTO panels’ rulings on the legality of FIT programmes in other cases. Obviously, existing WTO rules require panels in PV industry disputes to focus on fact-specific analysis to determine whether the trade-restrictive nature of a domestic regulatory measure is appropriate. These rules explore economic value at the expense of the constitutional values embodied in safeguards or green subsidies, such as the various social and environmental rights granted to citizens in domestic constitutions. This deficiency in the analysis of legal values has diverted WTO panels’ rulings from the paramount concern of the times, namely, sustainable development. From a sustainable development perspective, WTO panels’ rulings should balance economic development, the environment, and social rights. In the UN 2030 Agenda for Sustainable Development, countries recognise that sustainable development encompasses these values above and are committed to achieving them in a balanced manner.165 This is because these values are closely interrelated. Economic growth provides the financial resources for environmental protection and the fulfilment of social rights. A healthy ecological environment and the realisation of social rights provide the enabling environment for economic development. Neglecting any of these interests will undermine achieving other SDGs. Therefore, WTO panels’

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Fang (2022), pp. 263–265. Fang (2022), p. 261. 163 See Sect. 2.2 of this chapter. 164 Fang (2022), p. 262. 165 UNGA ‘Report of the World Commission on Environment and Development: Our Common Future’ (1987) UN Doc A/42/427, p. 37. 162

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rulings on safeguards and green subsidies can neither only seek trade benefits (i.e., freedom of trade) nor solely pursue environmental and social rights values. Furthermore, the legal values of safeguards and green subsidies are different in individual cases. They involve highly complex issues, such as the supply chain’s impact on the development of the PV industry and the various types of pollution caused by PV products. Depending on national circumstances (e.g., production capacity, domestic demand, climatic conditions, the legislation and enforcement of environmental laws), the environmental impacts of safeguards and green subsidies vary. Therefore, WTO panels should take a case-by-case approach to comprehensively weigh all factors’ impacts on climate, economic, and social rights. In balancing conflicting interests, WTO panels must not sacrifice specific environmental or social rights to protect freedom of trade and vice versa. In other words, WTO panels must ensure that members’ measures are aimed at achieving the UN SDGs. UN members set the targets that need to be achieved to attain each SDG. There is no apparent contradiction between these targets. For example, there is no target saying that countries can develop their economies to the detriment of the environment to eradicate poverty or hunger. In this way, UN members ensure that the sustainable development values embodied in the various SDGs are coherent. This coherence also reflects the universality of the SDGs at the normative level. Namely, countries must achieve all SDGs to achieve sustainable development. Accordingly, WTO panels can determine whether a member achieves one SDG at the expense of other sustainable development interests166 by testing the impact of its measures on relevant SDGs. In PV industry disputes, WTO panels must judge the impact of members’ measures (such as subsidies and safeguard measures) on access to green products and environmental pollution. WTO panels should support restrictive measures on the imports of green products if these products cause severe environmental pollution to the exporting country. Trade restrictive measures would not entirely deprive an importing country of access to green products because it could obtain them from different sources (including domestic producers). However, allowing producers that cause severe pollution to export green products would devastate the environment of exporting countries. In the other cases, WTO panels would not necessarily support members’ restrictions on the imports of green products. Suppose that an importing country considers that it cannot recycle green products (e.g., solar panels) to avoid damage to its own environment. In this case, WTO panels should consider the problems the importing country faces. If the importing country lacks environmental legislation or ineffectively enforces environmental laws, WTO panels should request the importing country to address the corresponding problems and reject the import restrictions on green products. If, however, the importing country lacks the technology and financial resources to enforce environmental laws, WTO panels should consider the possibilities for the importing country to solve this problem, including

166 These interests include those belonging to the economic dimension of sustainable development, such as economic interests associated with eradicating poverty and hunger.

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international cooperation. Suppose that the importing country can solve this problem. In this case, WTO panels should support free trade and reject restrictions on the imports of green products. Otherwise, WTO panels should support safeguard measures on green products. This test also applies to other sustainable development disputes. I have named it as the sustainability test in another publication.167

5 Conclusion Prior to the US-Safeguard Measure on PV Products case, WTO jurisprudence had not effectively resolved PV product disputes between WTO members. As a result, solar manufacturers in many countries suffered a devastating crisis. A new decision is needed to break the dilemma faced by governments in developing the PV industry. This is crucial for them to achieve SDGs, such as mitigating the adverse effect of climate change on humanity. This chapter provides a detailed analysis of the panel report on US-Safeguard Measure on PV Products. While the panel report provides ground-breaking jurisprudence on the legality of safeguards, it is insufficient to improve the state of importing countries’ domestic PV industry. The findings of this chapter are presented below. This chapter finds that the panel report is conducive to the long-term healthy development of the PV industry. Specifically, it points out two things. First, the panel’s rulings diversify importing countries’ supply chains of PV products, thus ensuring their clean energy security. Second, the panel’s rulings help reduce environmental pollution throughout the life cycle of PV products. Unfortunately, the panel report has significant limitations in both of these areas. It does not address the legality issue of green subsidies. Numerous studies have confirmed the contribution of green subsidies to combatting climate change.168 To effectively slow global warming, governments must use green incentive policies, such as FIT programmes (what many scholars call renewable energy subsidies),169 to complement contingent protection measures.170 Most importantly, the panel did not integrate sustainable development elements into its consideration of this case. Thus, there is a high degree of contingency between the panel’s rulings and their contribution to combatting climate change. I suggest that WTO panels comprehensively consider the constitutional values of contingent protection measures and green subsidies when addressing PV product disputes. It is hoped that panels will balance the economic, environmental, and social values associated with these measures in line with the requirements of sustainable

167 I comprehensively developed the sustainability test in my doctoral thesis. See Zhao (forthcoming). 168 Kent and Jha (2014), p. 249; Weber (2015), p. 161. 169 Espa and Holzer (2018), p. 435; Borlini and Montanaro (2018), p. 86. 170 Bougette and Charlier (2018), p. 182.

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development. Of course, the existing WTO rules significantly limit panels’ analysis. WTO panels need new rules as the legal basis for resolving PV product disputes. While some countries are advancing plurilateral WTO negotiations on fossil fuel subsidy reform, this negotiation does not include norms related to green subsidies and contingent protection measures. Hopefully, WTO members will address these issues in future negotiations.

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Xinyan Zhao is Ph.D. Candidate at the University of Lausanne, where he studies international economic law. He is a Chinese scholar and holds a master’s degree from the University of Lausanne.

The Innovative Trade and Climate Action-Linkage in the EU-UK Trade and Cooperation Agreement: A Template for the EU’s New Approach to Green Trade Agreements Patrick Abel Contents 1 The Trade and Climate Action-Linkage Post Brexit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Expanding Substantive Provisions on Climate Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Climate Action as an Essential Element of the TCA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Non-Regression of Domestic Law in Combatting Climate Change . . . . . . . . . . . . . . . . . 2.3 Right to Regulate for Climate Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Integrating International Climate Treaties Into the FTA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5 Expanding Climate Action Commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.6 Interim Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 A Shift From “Soft” to “Hard” Dispute Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 The EU’s Promotional Approach to Sustainable Development FTA Chapters . . . . . 3.2 Dispute Settlement for Breaches of Climate-Related TCA Provisions . . . . . . . . . . . . . . 3.3 Arbitration Without Breaches of the TCA: Rebalancing . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Interim Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The TCA as a Template for Linking Trade and Climate Action in Future FTAs . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract Continental Europe and the UK have always had a special relationship— within and outside of the European Union (EU). British concerns over national sovereignty have led the UK to withdraw from the EU. Despite many disputes and alienation, it should not be forgotten that the EU and UK continue to share many interests and policy preferences. This includes climate action. The EU-UK Trade and Cooperation Agreement (TCA)—the international agreement which governs the new bilateral relationship post Brexit—reflects this: The parties were able to agree on innovative provisions on climate action. These are unprecedented in the EU’s practice of free trade agreements (FTAs). This article explores how the TCA intertwines trade and investment commitments with climate action. It claims that the TCA may serve as a template for the EU’s (and even third states’) external trade P. Abel (✉) University of Passau, Passau, Germany e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 205–234, https://doi.org/10.1007/8165_2022_91, Published online: 18 November 2022

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and climate policy in the future—and has foreshadowed the Commission’s new approach to green FTAs communicated on 22 June 2022 (see European Commission, The Power of Trade Partnerships: Together for Green and Just Economic Growth, 22.6.2022, COM(2022) 409 final). As an analytical basis, the article will, firstly, outline why climate action constituted a relevant issue in negotiating the new relations between the UK and the EU (Sect. 1). It will then map and systematise the innovative provisions of the TCA on trade and climate change, distinguishing substantive law (Sect. 2) and dispute settlement (Sect. 3). In doing so, the article compares the TCA to the designs of earlier EU FTAs and situates the TCA within the parties’ obligations in international climate change law. Lastly, taking a birds-eye perspective, the article contends that the TCA may serve as a template for trade and climate action-linkages in future FTAs (Sect. 4).

1 The Trade and Climate Action-Linkage Post Brexit The TCA constitutes the first FTA which disintegrates economic relations rather than forging closer ties. By withdrawing from the EU, the UK not only left the European Single Market. EU environmental and climate action rules ceased to apply as well. As it had wished, the Kingdom regained the autonomy to set its own standards.1 Accordingly, the TCA does not harmonise the climate laws of the parties. However, diverging climate laws in EU and UK law may cause non-tariff barriers to trade between the two partners. Indeed, one of the EU’s main concerns in negotiating the TCA was that the UK could lower its environmental—and climate action—standards to achieve a competitive advantage for UK over EU businesses,2 especially in a setting with zero tariffs that the parties eventually reached.3 For this reason, Title X of Part Two of the TCA envisages a “level playing field for open and fair competition and sustainable development”. It contains rules to prevent a race-to-the-bottom of standards.4 This includes climate change and environmental regulation among other policies. As Article 355(1) TCA5 expresses, the parties thereby aim at establishing “fair competition [. . .] conducive to sustainable development” (emphasis added). Therein, we may identify the trade and climate 1

See the letter by David Frost to Michel Barnier of 19.5.2020, pp. 2-3, https://assets.publishing. service.gov.uk/government/uploads/system/uploads/attachment_data/file/886168/Letter_to_ Michel_Barnier_19.05.20.pdf. 2 European Parliamentary Research Service (2021) The Level Playing-Field for Labour and Environment in EU-UK Relations. PE 590.576, https://www.europarl.europa.eu/RegData/etudes/ BRIE/2021/690576/EPRS_BRI(2021)690576_EN.pdf (accessed 30.6.2022), p. 2. 3 Leonelli (2021), p. 614. 4 On this rationale in EU trade policy, see Hradilová and Svoboda (2018), pp. 1021–1022. 5 Hereinafter, Articles cited without specifying a treaty relate to the TCA.

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action-linkage which opens up the TCA to a topic otherwise covered by international environmental law. Indeed, environmental, labour and sustainable development (“SD”) chapters have become one of the defining features of the EU’s latest generation of FTAs.6 Other states follow similar agendas. The US pioneered this trend with the Environment and Labour Side Agreements of NAFTA in 1994.7 Moreover, FTAs may also serve as vectors to agree on cooperation in matters that are not strictly trade or investment related. Agreements such as the TCA may induce more stringent climate action by the other treaty party if they condition economic benefits on compliance with standards promoting climate action. Increasingly, the EU and its member states build on the Union’s economic weight to pursue (geo-) strategic interests in their foreign affairs—a “trade policy that supports the EU’s open strategic autonomy”.8 This is imperative for effective climate action and even called for under Article 191(1) TFEU. The EU cannot halt global warming by adopting internal policies alone. Due to the global cumulative effect of greenhouse gas emissions (GHG), the international community must act together. Indeed, the EU and UK are parties to the Paris Agreement (PA).9 Therein, the parties agreed on temperature goals to hold the increase in the global average temperature to well below 2 °C and to pursue efforts to limit the increase to 1.5 °C above pre-industrial levels (Article 2(1)(a) PA). The parties of the PA will periodically communicate and undertake nationally determined contributions to that end which will represent a progression over time (Article 3 PA), embedded in an elaborate system of periodical revisions and transparency obligations. Trade and investment can provide the resources needed for that climate action but may also increase emissions.

2 Expanding Substantive Provisions on Climate Action To enable the parties to promote climate-favourable trade and to pursue climate action better, the TCA adds new instruments to the trade and climate action-toolbox. This section will explore how its substantive provisions break new ground in addressing climate change by the following features: Climate action as an essential element of the TCA (Sect. 2.1), non-regression of domestic climate action standards (Sect. 2.2), the right to regulate for climate action (Sect. 2.3), integrating 6

See for example Durán (2020), pp. 1034–1043 on the key elements of SD chapters. North American Agreement on Environmental Cooperation (concluded 14.9.1993, effective 1.1.1994) (1993) ILM 32(6):1480–1498; North American Agreement on Labor Cooperation (concluded 14.9.1993, effective 1.1.1994) (1993) ILM 32(6):1499–1518; for a historical overview that includes subsequent FTAs see Bartels (2016), pp. 376–379. 8 European Commission (2021) Trade Policy Review. COM(2021) 66 final, p. 4; for a characterisation of EU trade policy as a “vector for the EU’s identity in international affairs”, see Araujo (2016), pp. 40–49. 9 Paris Agreement (concluded 22.4.2016, effective 4.11.2016) 3156 UNTS 1. 7

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international treaties and norms on climate action into the TCA (Sect. 2.4) and agreeing on new climate action obligations (Sect. 2.5). The analysis excludes rules which relate to climate action only indirectly and which we can already encounter in earlier EU FTAs, for example on biodiversity, corporate responsibility and general cooperation on environmental matters.

2.1

Climate Action as an Essential Element of the TCA

For the first time in the EU’s treaty practice, the TCA upgrades climate action to an “essential treaty element” in its Article 764(1). Thereby, the TCA emphasises climate action as a common policy goal of utmost importance. It is now on par with high-ranking values such as democratic principles, the rule of law, human rights and countering the proliferation of weapons of mass destruction (see Article 763)— principles that essential elements-clauses in earlier EU FTAs had already covered.10 The assertive language in Article 764 is particularly notable. It calls for “the fight against climate change” and identifies climate change as an “existential threat to humanity”, mirroring Article 191(1) TFEU.11 This weight accorded to climate action may affect the interpretation of all other TCA provisions as relevant context. Furthermore, as an essential element, climate action plays a role for the termination of the TCA. Article 60(1) Vienna Convention on the Law of Treaties (VCLT) allows for unilateral termination of a bilateral treaty in case of a material breach by the other party. Pursuant to Article 60(3)(b) VCLT, a material breach can consist in “the violation of a provision essential to the accomplishment of the object and purpose of the treaty”. Building on this, either party may unilaterally terminate or suspend the operation of the TCA or any supplementing agreement in whole or in part as provided in Article 772 if it considers that “there has been a serious and substantial failure by the other party” to fulfil an essential element—in our case, the fight against climate change. It is worth mentioning that this ground for termination does not require any adverse impact on trade or investment. Rather, Article 772(4) defines the test of “a serious and substantial failure” as a situation of a “gravity and nature [which] would have to be of an exceptional sort that threatens peace and security or has international repercussions”. Interestingly, the provision specifies this regarding climate action by stating that “an act or omission which materially defeats the object and purpose of the Paris Agreement shall always be considered as a serious and substantial failure 10

See for example Article 1(1) EU-Central America Association Agreement; Article 2(1) EU-Moldova Association Agreement; Article 1(1) EU-Vietnam Framework Agreement; Article 1(1) EU-Canada Strategic Partnership Agreement; for an analysis see Bartels (2013), pp. 299–301. 11 Gehring MW (2021) Analysis 5 of the Brexit Deal: Environment and Climate Provisions. EU Law Analysis Blog Post, http://eulawanalysis.blogspot.com/2021/01/analysis-5-of-brexit-dealenvironment.html considers that “[t]he language is one of the strongest found in any trade agreement”.

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for the purposes of this Article.” Parties may fulfil this requirement for example if they abandon the temperature goals enshrined in Article 2(1)(a) PA or terminate the PA. The systemic consequences are far-reaching: The parties link the TCA’s fate with the Paris climate regime. This may incite the parties’ long-term support for the PA.

2.2

Non-Regression of Domestic Law in Combatting Climate Change

The analysis will now turn to specific provisions on climate action in Part Two of the TCA on Trade. First, to the domestic climate laws of the parties: Article 391(2) prohibits the parties to regress from the domestic levels of environmental protection or climate action reached. In contrast, the parties must only aspire to increase standards (Article 391(5) TCA). With minor differences, all EU FTAs of the recent regeneration generally follow a similar approach.12 Yet, as will be shown, the TCA’s clause is broader in scope. The main purpose of the clause is to safeguard a level playing field between fairly competing traders and investors.13 From the perspective of international climate change law, Article 391(2) meets Article 4(2) PA halfway: The UK and the EU cannot step back from a level of climate action they have reached—while not owing the other party under the TCA to take progressively more ambitious steps (but only to strive to do so). Article 391(2) prohibits 1. weakening or reducing the environmental levels of protection or climate level of protection (including a failure to effectively enforce), 2. in a manner affecting trade or investment.

2.2.1

Weakening or Reducing Levels of Protection

Earlier EU FTAs only prescribe not to weaken the environmental levels of protection.14 For the first time, the TCA also specifically mentions the climate level of

12

See for example Article 188 EU-CARIFORUM FTA; Article 296(2) EU-Ukraine Association Agreement; Article 16.2(2) EU-Japan FTA; Article 12.12(2) EU-Singapore FTA; Article 277(1) and (2) EU-Colombia, Peru and Ecuador FTA; Article 13.7(2) EU-Korea FTA and Article 24.5(2) CETA. In contrast, for example, Article 273 EU-Armenia Comprehensive and Enhanced Partnership Agreement as well as Article 2(3) EU-Mexico- and Article 2(3) EU-MERCOSURAgreement in Principle only contain hortatory language in this regard. For a scholarly analysis see Durán (2020), pp. 1038–1040. For a contrary position, see Leonelli (2021), pp. 622–624 who argues that the non-regression clauses are aspirational in nature due to the right to regulate clauses— however, it appears much more convincing to understand the former as limitations of the latter. 13 For similar clauses in earlier FTAs, see Durán (2020), p. 1039. 14 The non-regression clauses of other modern EU FTAs vary slightly in the wording by which they express that the parties may not change domestic law to decrease environmental protection,

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protection separately. Article 390(1)-(3) defines both terms: “Environmental levels of protection” means the levels of protection provided overall in a Party’s law which have the purpose of protecting the environment, including the prevention of a danger to human life or health from environmental impacts. Article 390(1) lists some examples, including industrial and air emissions, nature and biodiversity conservation. For the Union, the term refers to the level of protection common to all EU member states. Article 390(3) defines “climate level of protection” as the level of protection with respect to emissions and removals of GHG and the phase-out of ozone depleting substances. It further states that with regard to GHG the EU sets a 40% economy-wide 2030 target, including the Union’s system of carbon pricing. For the UK, the relevant benchmark is the UK’s economy-wide share of this EU 2030 target, including the UK’s system of carbon pricing. In the meantime, both parties have already defined more ambitious unilateral reduction targets, 68% (UK) and 55% (EU) by 2030.15 It appears that the parties wanted to emphasise that climate action is particularly relevant to them by including “climate level of protection” as an additional reference of the non-regression obligation. In this view, the climate level of protection forms part and parcel of the environmental levels of protection. In the same vein, Article 391(4) states that the abovementioned GHG reduction targets contribute to defining the environmental levels of protection. However, climate action and environmental protection do not only reinforce another but also collide at times. Consider for example that the parties may lower the environmental permit requirements for wind power stations to achieve their GHG reduction targets. Concerns that the rotors of wind power stations may impair with nature conservation have already been brought before domestic and international courts.16 It is thus possible that a party reduces the environmental level of protection to strengthen climate action and vice versa. It seems that both situations would trigger Article 391 (2) because the provision relates to the two alternatives of weakening environmental or climate change levels of protection—a result that

including for example not to “relax or lower” the environmental protection (e.g. Article 16.2 (2) EU-Japan FTA) or not to “waive or otherwise derogate” from environmental laws (e.g. Article 24.5(2) CETA). Only Article 12.12 (1) EU-Singapore FTA does not express specifically that a derogation to lower standards is prohibited by using the neutral formulation “shall not waive or otherwise derogate from [. . .] its environmental and labour laws [. . .]”. Object and purpose of this provision, however, can only be understood as to preventing that the parties introduce lower environmental and labour standards to gain a competitive advantage. 15 For the UK, see UK Government (2020) United Kingdom of Great Britain and Northern Ireland’s Nationally Determined Contribution, https://assets.publishing.service.gov.uk/government/uploads/ system/uploads/attachment_data/file/943618/uk-2030-ndc.pdf; for the EU see Regulation (EU) 2021/1119 (“European Climate Law”) OJ 2021 L 243/1, Article 4(1). For an analysis that observes equal climate action ambition by the EU and the UK post Brexit, see Kuzemko et al. (2022), p. 15. 16 See for example ECtHR, Vecbaštika and others v Latvia, Appl. No. 52499/11, Decision of 19.11.2019, ECLI:CE:ECHR:2019:1119DEC005249911; CJEU, Case C-24/19, A and Others (Wind turbines at Aalter and Nevele), ECLI:EU:C:2020:503.

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would run counter to the purpose of the provision. To resolve this, one should take the definition of “climate level of protection” in Article 390(3) literally, relating only to the emission reduction targets. An example for a weakening or reducing the climate level of protection would be to undercut the GHG targets specified in Article 390(3). In turn, the “micro-level”—for example the environmental conditions for projects that help meeting climate action targets—would only be measured against the overall environmental levels of protection of the respective party, assessing the impact on nature conversation and climate action together.

2.2.2

Affecting Trade or Investment

The second test of a trade- or investment impact is present in the non-regression clauses of all earlier EU FTAs.17 In 2017, an Arbitral Panel established under the Dominican Republic-Central America-US-FTA (CAFTA-DR) had to interpret a similar non-regression clause in Article 16.2.1 CAFTA-DR related to labour standards.18 It understood the phrase “in a manner affecting trade between the Parties” to mean that a measure “confers some competitive advantage on an employer or employers engaged in trade between the Parties”.19 It is submitted that Article 391(2) must be interpreted to be broader in meaning. In contrast to the CAFTADR, the TCA also covers changes that affect investment. It is thus not necessary to prove a systemic change of competitive conditions that affect trade flows. In addition, Article 391(2) is not restricted to enforcement but also covers legislative changes. It should be sufficient to show that a legislative modification could alter the way investors and traders compete—for example, introducing more lenient technical regulations that may increase GHG-emissions and lower costs for businesses. Arguably, the definition proposed here constitutes a rather low bar.20 This corresponds with the observations of the Panel of Experts Constituted under Article 13.15 of the EU-Korea FTA. In its 2021 Report, the Panel compared the non-regression clauses of the CAFTA-DR and the EU-Korea FTA in an obiter dictum. In addition to textual differences, Article 16.2.1 CAFTA-DR had not “the

17

Durán (2020), pp. 1038–1039. The provision states: “A Party shall not fail to effectively enforce its labor laws, through a sustained or recurring course of action or inaction, in a manner affecting trade between the Parties, after the date of entry into force of this Agreement.” 19 In the Matter of Guatemala – Issues Relating to the Obligations under Article 16.2.1(a) of the CAFTA-DR, Final Report of the Panel, 14.6.2017, http://www.sice.oas.org/tpd/usa_cafta/Dispute_ Settlement/final_panel_report_guatemala_Art_16_2_1_a_e.pdf, para. 190. 20 In the same vein Bronckers and Gruni (2021), pp. 32–33; for a contrary position see Greener UK (2020) Initial Environmental Analysis of the EU-UK Trade and Cooperation Agreement, https:// greeneruk.org/sites/default/files/download/2020-12/GreenerUK_initial_analysis_of_the_EU-UK_ deal.pdf, p. 1; Morris M (2020) The Agreement on the Future Relationship: A First Analysis, https://www.ippr.org/files/2020-12/agreement-on-future-relationship-ippr-assessment-1-.pdf, p. 7; Leonelli (2021), pp. 625–627. 18

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same contextual setting of sustainable development as the EU-Korea FTA” and did not “refer to the range of multilateral and international agreements and declarations” as the EU-Korea FTA does.21 Therefore, the CAFTA-DR’s Panel (narrow) interpretation could not be transferred to the corresponding EU-Korea FTA treaty provision.22 This holds true for other EU FTAs such as the TCA as well.

2.2.3

Differences to Other EU FTAs

Appreciating the presented two-steps test, it is notable that the TCA omits additional requirements that are present in other FTAs. First, the treaties with Japan, Ukraine, Korea and Canada all prohibit to weaken or reduce the level of protection “to encourage trade or investment”, thus requiring a certain regulatory intention.23 Article 391(2) does not contain comparable language.24 The purpose for which a party changes its environmental and climate laws thus has no bearing on the triggering of the non-regression clause. Furthermore, some agreements specify that the parties shall not weaken protection by “waiving or derogating” from “laws” (Singapore, Canada, Vietnam), “laws and regulations” (Japan) or “laws, regulations or standards” (Ukraine, South Korea). The TCA does not elaborate on this any further. This means that the type of measures which may qualify for a reduction of the level of protection is broad.25 It may not only include new laws but also administrative decisions or potentially even a change of jurisprudence which systemically affect the overall level of environmental protection. Moreover, Article 391(2) mentions failure to effectively enforce relevant laws as an example for a weakening or reducing of the levels of protection. Earlier FTAs usually consider such lack of enforcement in a separate paragraph26 and require “a

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Panel of Experts Proceeding Constituted under Article 13.15 of the EU-Korea Free Trade Agreement, Report of the Panel of Experts, 20.1.2021, https://trade.ec.europa.eu/doclib/ docs/2021/January/tradoc_159358.pdf, para. 93. 22 Panel of Experts Proceeding Constituted under Article 13.15 of the EU-Korea Free Trade Agreement, Report of the Panel of Experts, 20.1.2021, https://trade.ec.europa.eu/doclib/ docs/2021/January/tradoc_159358.pdf, paras 90–93. 23 See Bartels (2017), p. 206; Bronckers and Gruni (2021), p. 30. In the abovementioned Panel Report on the Guatemala case, the Panel denied in paras 49–152, 197 that intention by the parties was a requirement; however, the wording of Article 16.2.1 CAFTA-DR also does not contain any language indicative of this. 24 The same is true for Article 13.3(2) EU-Vietnam FTA. For a contrary position see European Parliamentary Research Service (2021) The Level Playing-Field for Labour and Environment in EU-UK Relations. PE 590.576, https://www.europarl.europa.eu/RegData/etudes/BRIE/2021/690 576/EPRS_BRI(2021)690576_EN.pdf, p. 7 which considers that requirements present in other EU FTAs are implied in the TCA. 25 In the same vein Bronckers and Gruni (2021), p. 32. 26 Only Article 16.2(2) s. 2 EU-Japan FTA expressly connects the obligation to effectively enforce with the previously mentioned obligation not to relax or lower the level of protection as the former served “to that effect”, that is, as an expression of the latter.

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sustained or recurring course of action or inaction” for a violation.27 In contrast, Article 391(2) does not contain this qualification either. Already a single derogation from environmental or climate law is sufficient. In addition, Article 394(1) (a) contains further commitments for effective enforcement by domestic authorities. All in all, one may thus conclude that the non-regression obligation of the TCA is particularly broad compared to earlier EU FTAs28—and thus potentially more effective in upholding the domestic climate action standards that the parties reach.

2.3

Right to Regulate for Climate Action

The TCA accompanies the abovementioned non-regression obligation with a right to regulate clause. Article 356(1) reaffirms each party’s right to set its policies and priorities and to determine the appropriate levels of protection. With regard to services and investment as well as digital trade, Article 132(2) and 198 even specifically mentions climate change among other policy objectives that the parties may pursue. Earlier EU FTAs do not explicitly refer to climate action in right to regulate provisions but cover it as part of environmental protection.29 The normative result is, however, the same. The clause serves to reassure that the trade and investment provisions of the TCA will not be interpreted in an imbalanced manner that generally prioritises the economy over climate action.

2.4

Integrating International Climate Treaties Into the FTA

Having considered the provisions that address domestic regulation, the analysis will now turn to international climate change law. Article 400 et seq. connect the TCA with the broad net of international environmental and climate norms.

2.4.1

Reaffirming and Integrating International Climate Treaties

EU FTAs of the recent generation contain clauses which recognise and integrate multilateral environmental treaties into the bilateral trade relations, thereby setting a

27

For example, Article 13.7(1) EU-Singapore FTA; Article 24.5(3) CETA; for an exceptional contrary example see Article 290(3) EU-Central America Association Agreement. 28 Supported for example by Gehring MW (2021) Analysis 5 of the Brexit Deal: Environment and Climate Provisions. EU Law Analysis Blog Post, http://eulawanalysis.blogspot.com/2021/01/ analysis-5-of-brexit-deal-environment.html (accessed 29.6.2022). 29 For example, Article 268 EU-Columbia, Peru and Ecuador FTA; Article 13.2 EU-Vietnam FTA.

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minimum environmental standard.30 They reaffirm “multilateral environmental governance and agreements”, commit the parties to effectively implement their environmental treaties and call for cooperation. Due to the open language of most of these clauses, they cover the PA as well, sometimes even specifically citing it and other climate change treaties. Article 400 contains a provision on multilateral environmental agreements modelled against the aforementioned practice. As such, it dynamically includes climate change treaties that the parties ratify in the future. Moreover, Article 401 enshrines a separate trade and climate-change provision.31 Its para. 1 recognises the importance of agreements and instruments for climate action—which appears superfluous in light of Article 400. Article 401(2)(a) is more innovative. It stipulates that each party commits to effectively implementing the UNFCCC, and the Paris Agreement of which one principal aim is strengthening the global response to climate change and holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1,5°C above pre-industrial levels.

Thereby, for the first time, an EU FTA explicitly integrates the Paris temperature goals. We only encounter similar language in Article 24(1) s. 1 EU-Japan Strategic Partnership, the framework agreement overarching the EU-Japan FTA. The legal character of the temperature goals and other provisions of the PA have been extensively discussed and remains controversial, the different positions including the full spectrum of obligations of result, obligations of conduct to aspirational soft law.32 Unfortunately, Article 401(2)(a) carefully avoids to clarify this question. The provision does not state that the parties “commit to holding the increase in the global average temperature” below the Paris goals. Rather, they commit to effectively implementing the PA as such and as a whole. Article 401(2)(a) then only describes that the temperature goals constitute one principle aim of the PA. In other words, the provision reaffirms the temperature goals only indirectly as part of the commitment to honour the PA. Hence, this leads back to the general controversy over the legal character of the temperature goals within the PA. In this regard, the TCA could have been more ambitious by clarifying that the parties commit to the Paris temperature goals as a self-standing obligation of conduct or even of result. Nevertheless, a couple of years after the conclusion of the PA, including the temperature goals into the FTA reinforces their authority.

30

See for example Article 13.5(2) EU-Vietnam FTA; for scholarly analyses across all EU FTAs, see Durán (2020), pp. 1035–1038; Leonelli (2021), p. 616–617. 31 Similar provisions are enshrined in Article 275 EU-Colombia, Peru and Ecuador FTA and Article 13.6 EU-Vietnam FTA. 32 For a viewpoint that the temperature goals represent a binding collective obligation of all PA parties, see Huggins (2018), p. 204; for a contrary position, see Mayer (2021), pp. 595–597.

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Respecting Environmental and Climate Principles

In addition, pursuant to Article 393, each party “commits to respecting the internationally recognised environmental principles to which it has committed”. This type of obligation has not featured in EU FTA practice so far.33 This provision promotes climate action without linking it to trade and investment. Article 393(1) broadly covers all types of “recognised environmental principles”, listing as examples of their sources: the Rio Declaration on Environment and Development, the UN Framework Convention on Climate Change and the Convention on Biological Diversity. Notably, the Rio Declaration on Environment and Development34 is not an international treaty but a soft law declaration adopted by the General Assembly. Importantly, Article 393(1) does not refer to customary law reflected in the Rio Declaration but directly to this document. This appears to more generally open Article 393(1) to including principles from similar non-binding sources without requiring them to reflect customary international law. Article 393(1) would then operate as a vehicle that accords legally binding effect between the parties to norms that are otherwise soft law in nature only—by using the obligatory language “commit to respecting”. Recently, the Report of a Panel of Experts constituted under the EU-Korea FTA on a labour-related dispute confirmed that a similar norm converted soft to hard law: Pursuant to Article 13.4(3) EU-Korea FTA, the “Parties, in accordance with the obligations deriving from the membership of the ILO and the ILO Declaration on Fundamental Principles and Rights at Work [. . .], commit to respecting, promoting and realising” a list of core labour principles. The ILO Declaration itself is a soft law instrument. The Panel affirmed that the obligatory language “to commit” constitutes “the binding link” between the ILO Declaration and “new obligations the Parties place upon themselves in their FTA”.35 The same applies to Article 393(1). Which norms qualify as “recognised environmental principle” is not defined any further, leaving this term somewhat ambiguous. We encounter only a non-exhaustive list in Article 393(1)(a)-(e) which are all relevant for climate action: integration of environmental protection through impact assessments (with another separate obligation for impact assessments in Article 393(2)), preventative action, precautionary approach (also listed separately in Article 356(2)),36 that environmental damage should as a priority be rectified at source and the polluter pays principle. Furthermore, the parties also reaffirmed environmental impact assessment procedures and agreed that these must include public participation in Article 393(2) and 33

Article 16.9 EU-Japan FTA; Article 13.11 EU-Vietnam FTA only briefly recognise the precautionary approach. 34 UN Doc A/CONF.151/26 (Vol. I). 35 Panel of Experts Proceeding Constituted under Article 13.15 of the EU-Korea Free Trade Agreement, Report of the Panel of Experts, 20.1.2021, https://trade.ec.europa.eu/doclib/ docs/2021/January/tradoc_159358.pdf, para. 129. 36 For a criticism that this public international law notion sets a higher standard than the EU precautionary principle, see Leonelli (2021), pp. 619–620.

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(3). Read together with Article 394(1)(b) which imposes the obligation to ensure that “administrative or judicial proceedings are available to natural and legal persons with a sufficient interest” in environmental and climate matters, these provisions mirror aspects of the Aarhus Convention on a rudimentary level.37

2.5

Expanding Climate Action Commitments

Furthermore, the parties agreed on additional climate action commitments under the TCA that have not already been multilateral international obligations of the parties before. They go beyond the aspirational clauses in earlier FTAs to promote higher environmental protection.

2.5.1

Ambition of Economy-Wide Climate Neutrality by 2050

In Article 355(3), the parties reaffirm their ambition of achieving economy-wide climate neutrality by 2050. Climate neutrality is commonly understood as a balance between remaining emissions and negative emissions by anthropogenic activities which remove GHG from the atmosphere. The target year of 2050 resonates in Article 4(1) PA subject to which the parties aim at achieving such balance “in the second half of the 21st century, on the basis of equity, and in the context of sustainable development and efforts to eradicate poverty.” However, the provision is also subject to two restrictions: It is only a best-effort obligation to be ambitious in targeting climate neutrality. And the net zero-goal only relates to the economy whereas Article 4(1) PA covers all types of emissions emanating from the parties. It is in this limitation that Article 355(3) reflects its character as a trade- and investment-related provision. Despite this rather careful approach, the provision still qualifies as innovative in the EU’s practice given that its earlier FTAs do not mention any net zero emissions-targets at all.

2.5.2

Carbon Pricing

Article 392 on carbon pricing constitutes another novelty in the EU’s FTA practice. It requires that parties “must have in place an effective system of carbon pricing as of 1 January 2021”.

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Convention on Access to Information, Public Participation in Decision-Making and Access to Justice in Environmental Matters (concluded 25.6.1998, effective 30.10.2001) 2161 UNTS 447.

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Term and Concept “Carbon pricing” represents a market-based regulatory approach to combat climate change. GHG emissions produce external costs due to global warming which are not reflected in market prices of goods and services. Carbon pricing means imposing (internalising) costs for these adverse effects on the sources of the GHG emissions. Typical subtypes are a carbon tax or an emissions trading system (ETS, “cap-andtrade system”).38 The alternative (or complement) is command-and-control regulation which prohibits certain climate-adverse behaviour without building on market mechanisms. The EU has been employing an ETS since 2005,39 the UK even since 2002.40 By leaving the EU on 31 December 2020, the UK also ceased to participate in the EU ETS. Unilaterally, the UK required businesses to comply with the EU ETS until the end of April 2021 and replaced it with a new (near-identical) UK ETS effective on 19 May 2021.41 The EU’s ETS changed at the beginning of 2021 which marked the start of its phase four: Inter alia, the emission allowances now annually decline at a faster pace than before and less companies will continue to qualify for free allocations (that serve to prevent carbon leakage).42 This shows that the UK’s and EU’s carbon pricing systems run the danger of diverging in the future, even if the UK has by large followed the EU practice so far.

Obligations Under the TCA In Article 392 (1), the parties commit to a market-based mechanism to GHG. The term “system of carbon pricing” allows the parties to change from an ETS to other market-based approaches such as a carbon tax, or to employ multiple approaches at the same time. Conversely, the provision does not proscribe the adoption of command-and-control regulation. 38 An ETS defines the maximum amount of GHG that certain sectors may emit per year and converts these amounts into certificates that companies must acquire for their emissions. Companies can also trade certificates and thus profit from sustainable practices. For a general analysis on ETS, see e.g. Munro (2018). For a general introduction into market mechanisms, including carbon taxes, see Hsu (2016), pp. 240–278. 39 Directive 2003/87/EC, OJ 2003 L 275/32. 40 HM Government and others (2022) Developing the UK Emissions Trading Scheme (UK ETS). https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/ file/1067125/developing-the-uk-ets-english.pdf, p. 14. 41 For an overview of the new UK ETS, see for example Grantham Research Institute on Climate Change and the Environment (2022) The Future of UK Carbon Policy: How Could the UK Emissions Trading Scheme Evolve to Help Achieve Net-Zero? https://www.lse.ac.uk/ granthaminstitute/wp-content/uploads/2022/04/The-future-of-UK-carbon-policy_How-could-theUK-ETS-evolve-to-help-achieve-net-zero.pdf, p. 4; for a comparison to the EU ETS see Pollitt (2022), pp. 171–172. 42 Directive (EU) 2018/410, OJ 2018 L 76/3.

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Under which conditions a system qualifies as being “effective” remains open. Article 392(3) only establishes a minimum standard that the systems “shall uphold the level of protection” provided for by Article 391, the provision on non-regression. More specifically, this relates to Article 391(4) which in turn points to the emissions reduction goals agreed on in Article 390(3). In other words, the carbon pricing systems must at least aim at and be capable of reaching the EU target of 40% economy-wide reduction by 2030 and the original share of the UK of this 2030 target, respectively. The sectors to which the ETS must apply are laid down in Article 391(2), namely electricity generation, heat generation, industry and aviation. The provision thus excludes maritime and road transport as well as emissions from buildings which the EU plans to include into its ETS as part of its “Fit for 55” package.43 The UK is discussing to expand its ETS to maritime transport and to waste incineration and energy waste.44 This again reflects the danger that the two systems may start to diverge already in the 2020s. Curiously, Article 392(5) opens up the possibility that the parties may abolish their carbon pricing systems in the future: They shall maintain their system only “insofar as it is an effective tool for each Party in the fight against climate change”; in any event, they must “uphold the level of protection provided for by Article 391 TCA”. This appears to collide with Article 392(1) which requires the parties to have an “effective” system in place—which would prevent the situation envisaged under Article 392(5) from materialising. Furthermore, as a matter of economics, it is not controversial that carbon pricing generally does constitute an effective regulatory tool to address climate change if structured and implemented properly.45 It would run counter to the spirit of Article 392 if the parties, by (deliberatively) construing or maintaining an ineffective carbon pricing system, could trigger para. 5 and circumvent their obligations enshrined in the other four paragraphs. Overall, it thus seems that Article 392(5) does not have a meaningful scope of application—other than stating the obvious that parties will not have to uphold a carbon pricing system if it becomes obsolete, perhaps due to climate action successes in a distant future.

No ETS Linkage, No Mention of Cardon Border Adjustment Mechanisms In light of the similarities between the EU’s and UK’s ETS and the climate action ambition of both parties, it would have made sense to link the two ETS – and thus to allow for emissions trading across borders. Bigger ETS are more liquid and less

See COM(2021) 551 final, 4, https://ec.europa.eu/info/sites/default/files/revision-eu-ets_withannex_en_0.pdf 44 See HM Government and others (2022) Developing the UK Emissions Trading Scheme (UK ETS), https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attach ment_data/file/1067125/developing-the-uk-ets-english.pdf, p. 101. 45 Hsu (2016), pp. 240–244. 43

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volatile.46 Yet, the parties could not agree to do so. Instead, Article 392(6) only imposes a duty to cooperate on carbon pricing and to seriously consider linking. This is a best-efforts obligation to put the matter on the agenda while retaining full discretion for the final political decision. Neither does the TCA mention a carbon border adjustment mechanism (CBAM). The European Commission has proposed a regulation to establish a CBAM to prevent carbon leakage.47 The UK is discussing such a measure as well.48 The idea of the draft EU CBAM is to require EU importers of certain goods to buy carbon certificates. These certificates correspond to the carbon price they would have had to pay had they produced the respective good in the EU (and had thus been subject to the EU ETS). This should assure that importers do not achieve an unfair competitive advantage over EU producers due to lax climate action provisions in the country of origin. The draft covers iron, steel and aluminium (among other goods) which form an important part of exports from the UK to the EU.49 Importantly, however, Article 9 of the draft EU CBAM-Regulation allows to recognise a carbon price that importers have already paid in the country of origin. The method of how this is recognised and calculated is left to further implementing acts that the Commission may adopt. The UK ETS could be such a system. Companies which export GHG-heavy goods from the UK to the EU and are subject to the UK ETS already pay a carbon price. To increase the chances of such coordination, it would have been in the interest of both parties to introduce related obligations in the TCA—for example by agreeing that the parties strive to take account of the other parties’ carbon pricing in a potential CBAM.50

2.5.3

Renewable Energies

Furthermore, the TCA contains provisions on renewable energies. Energy is the sector with the highest GHG emissions worldwide and in the EU, and the second highest in the UK.51 More trade between the parties due to liberalisation may increase energy needs. Thus, a transition to clean energy is essential for successful climate action and relevant for the trade and climate action-linkage.52 The PA does not specify how the parties should arrange their energy sectors. In EU law, the 46

Kuzemko et al. (2022), p. 11 with a critique and further references. COM(2021) 564 final, https://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A52021 PC0564. 48 House of Commons (2022) Greening imports: a UK carbon border approach, Fifth Report of Session 2021–22, https://committees.parliament.uk/publications/9570/documents/162115/default/. 49 Lowe S (2021) CBAM: What Might an EU Carbon-Border Adjustment Mechanism Mean for the UK? Blog Post of 3.8.2021, https://ukandeu.ac.uk/eu-cbam-uk/. 50 Or simply by linking the parties’ ETS which would likely prevent coverage by the draft EU CBAM, see Kuzemko et al. (2022), p. 11. 51 Data from https://ourworldindata.org/emissions-by-sector. 52 Dent (2021), pp. 2–4. 47

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Renewable Energy Directive (RED II) obliges the member states to increase the share of renewable energy to 32% by 2030.53 By withdrawing from the EU, the UK is not subject to RED II anymore and can now unilaterally determine its energy mix. The TCA reacts to this disintegration with Part II, Title VIII on Energy. It is not only one of the longest and most detailed sector-specific titles of the TCA. It is also much more comprehensive than the energy-related provisions of earlier FTAs,54 only followed by the EU-Singapore and the EU-Vietnam FTAs as well as the EU-Kazakhstan Enhanced Partnership and Cooperation Agreement.55 This includes new obligations related to renewable energies. Firstly, the UK reaffirmed “its ambition for the share of energy from renewable sources in gross final energy consumption in 2030 as set out in its National Energy and Climate Plan” in Article 319(3)(a). This provision is relatively week as the UK only owes “ambition”, not to actually reach the cited 2030 target. Notwithstanding, one may recall that the UK is subject to domestic non-regression and to comply with the PA as presented above. In this light, it is hard to imagine that the UK retains broad discretion to step away from its renewable energy share ambitions. In comparison, the EU reaffirmed the abovementioned target of RED II in Article 319(2), thereby introducing an obligation of result. However, both parties are already planning to introduce more ambitious unilateral goals anyway.56 Secondly, the TCA accords additional privileges to sustainable energy. For example, flanking a general obligation to “promote [. . .] the use of energy from renewable sources”, Article 319(1) requires rules on licencing or equivalent measures applicable to renewable energy sources to be necessary and proportionate. Quite specific is the obligation in Article 320(2) that biofuels, bioliquids and biomass “shall only be supported as renewable energy if they meet robust criteria for sustainability and greenhouse gas emissions saving, which are subject to verification.” This is a matter of utmost importance especially for the transition of the transportation sector to clean energies. Overall, compared to earlier EU FTAs, it is already innovative that the TCA contains substantive commitments to renewable energy at all. Yet, this consensus remains temporary as the entire Title VIII on Energy ceases to apply on 30 June 2026 pursuant to Article 331 (with the option that the Partnership Council—the main

53

Directive (EU) 2018/2001, OJ 2018 L 328/82 (RED II). The EU’s FTAs usually only contain rather general obligations of conduct “to strive to facilitate” trade and investment in goods or services of particular relevance to climate change, including sustainable energy, see for example Article 16.5(c) and Article 16.12(h) EU-Japan FTA; Article 24.9(2) and 24.12(f) CETA; Article 26.6(2) EU-Korea FTA; from the literature, see Dent (2021), pp. 10–16 who observes a focus on different forms of cooperation. 55 These Chapters and provisions contain obligations against non-tariff barriers to trade and investment in renewable energy, e.g. on standards, technical regulations and conformity assessments; see Dent (2021), p. 16. 56 For the EU, see European Commission, RED III Proposal, COM(2021)557 final; for the UK, see https://www.gov.uk/government/news/major-acceleration-of-homegrown-power-in-britains-planfor-greater-energy-independence. 54

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treaty body of the TCA—may extent the application for one year at a time). Thus, the last word on how the parties support renewable energies in their bilateral trade relations is not yet spoken.

2.5.4

Subsidies

The TCA also gives special attention to the role of subsidies for climate action in Article 367(14) and in Annex 27 on “Energy and Environmental Subsidies”.57 Article 367, a particularly long provision, relates to “prohibited subsidies and subsidies subject to condition”. Its para. 14 recognises with unusually strong wording “the importance of a secure, affordable and sustainable energy system and environmental sustainability, notably in relation to the fight against climate change which represents an existential threat to humanity.” For this reason, these “shall be aimed at, and incentivise the beneficiary in, delivering a secure, affordable and sustainable energy system and a well-functioning and competitive energy market or increasing the level of environmental protection compared to the level that would be achieved in absence of the subsidy.” While Article 367(14) explicitly states that such subsidies must still conform with the general principles enshrined in Article 366, the former provision informs the interpretation of the latter: Inter alia, the very high abstract importance of subsidies for climate action affirmed in Article 367(14) will affect the analysis of the subsidies’ proportionality under Article 366(1)(b), making it easier to pass this test. It also clarifies that subsidies are an appropriate policy instrument for climate action in the sense of Article 366(1)(e). Annex 27 contains even more specific commitments for subsidies on clean energies which shall be touched upon here only briefly. They mainly reinforce that such subsidies should not undermine the obligations on competition in electricity markets—while, however, at the same time also allowing for non-competitive procedures and privileging measures to combat carbon leakage. Notably, Annex 27(5) again strengthens climate action inter alia with the obligation that “[s]ubsidies for the decarbonisation of emissions linked to own industrial activities shall achieve an overall reduction in greenhouse gas emissions.”

2.6

Interim Conclusion

Overall, the analysis has shown that the TCA contains plenty of innovative provisions on trade and climate action. Some expand earlier designs of EU FTAs while others are without precedent. In addition, only certain climate action-related

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Subsidies are important in light of indications that the UK aims at introducing a new state aid system focussing on a green economy, see Kuzemko et al. (2022), p. 10.

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provisions have a connection to the impact on inter-party trade and investment.58 While we have encountered areas in which the parties could have cooperated even more strongly, the TCA defines a new benchmark for integrating substantive climate action commitments into an FTA.

3 A Shift From “Soft” to “Hard” Dispute Settlement The provisions of the TCA on dispute settlement are just as innovative as their substantive counterpart. For the first time in the EU’s FTA practice, the TCA (partly) provides for sanction-based adjudicatory dispute settlement on environmental and climate matters. It departs from a “soft” paradigm in dispute settlement focussed on “promotional” solutions in trade and environment-matters for which the EU had been famous so far (Sect. 3.1). This section will analyse the new features of dispute settlement for breaches of climate-related provisions (Sect. 3.2). Separately, it will consider the new procedure for divergence of climate change laws, which parties may activate even without claiming any treaty breaches: the rebalancing mechanism (Sect. 3.3).

3.1

The EU’s Promotional Approach to Sustainable Development FTA Chapters

The first EU FTA which introduced environmental, labour and/or SD chapters was the EU-CARIFORUM Economic Partnership Agreement.59 Since then, almost all FTAs have excluded these chapters from the general dispute settlement procedure, that is, inter-state arbitration.60 Instead, the EU invented Panels of Experts as a specific dispute settlement forum for such disputes. Just as arbitral tribunals, these Panels would be instituted ad hoc. The disputing parties would appoint the panellists who, however, must have particular experience and qualifications related to SD topics. Panels issue a report on a party’s alleged misbehaviour with regard to the SD, environmental and/or labour chapter. However, the claimant cannot enforce the report by temporarily suspending obligations under the FTA (“trade sanctions”). Rather, the EU focussed on resolving any SD-related disputes by diplomatic means

58

Following the observation in the Opinion of A.G. Sharpston, Opinion 2/15, EU:C2016:992, para. 491 that already the EU-Singapore FTA contains provisions on labour and environmental protection “in isolation from their possible effects on trade”; see also Durán (2020), pp. 1043–1049. 59 On the origins see Bartels (2013), pp. 305–306. 60 The only exception is the EU-CARIFORUM FTA which partly allows environment-related, sanction-based dispute settlement on SD matters, however excluding labour- and environmentalrelated provisions in Article 213(2), see Durán (2020), pp. 1041 fn. 41.

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in an institutionalised framework of FTAs.61 Scholars have contrasted this approach to US FTAs who have always provided for trade sanctions to enforce (more narrowly drafted) labour- or environment-related treaty provisions since NAFTA’s side agreements.62 Many have criticised the EU’s enforcement design of SD chapters and environmental provisions as ineffective63 and proposed to introduce a sanction-based model.64

3.2

Dispute Settlement for Breaches of Climate-Related TCA Provisions

The TCA breaks with this tradition of “soft” enforcement of SD chapters and environmental obligations. If one party violates certain climate-related TCA provisions, the TCA allows for dispute settlement which may now also result in trade sanctions similar to the US model. This complements the new rebalancing mechanism, a novelty that draws more attention in scholarly analyses65 but which should be distinguished from other dispute settlement procedures that will be addressed in this section first.

3.2.1

The Different Applicable Procedures

Dispute settlement on climate action-related provisions is subject to a complicated system. We can distinguish four different avenues:

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But consider the institutional provisions in earlier EU FTAs which include a treaty body (Committee on Trade and Sustainable Development), domestic advisory groups and a civil society forum which monitor the respondent’s reaction to reports and which themselves constituted an innovation in the early 2010s, see Durán (2013), pp. 136–139. 62 For this comparison, see for example Bartels (2017), pp. 208; Hradilová and Svoboda (2018), pp. 1031–1039; Durán (2020), p. 1042; for a comparative analysis of US FTAs’ enforcement of provisions on labour standards which function similarly to their environmental counterparts, see Abel (2018), pp. 158–180; for an analysis of innovative enforcement of forest protection-related obligations in the US-Peru FTA, see Pacheco Restrepo (2019), pp. 250–257. 63 See for example European Parliament, Resolution on Human Rights and Social and Environmental Standards in International Trade Agreements, P7_TA(2010)0434, 25.11.2010, para. 22(c); Bartels (2013), pp. 311–312; Bronckers and Gruni (2021), p. 33. For a critique related to labour standards which identifies problems also in terms of substance and scope, see Harrison (2019), pp. 270–272. 64 Bronckers and Gruni (2021), pp. 37–39; for a proposal that includes claims by individuals in the trade and labour context, see Stoll et al. (2018), pp. 410–422; for a contrary position see Hradilová and Svoboda (2018), pp. 1039–1041. 65 See for example Bronckers and Gruni (2021), pp. 32, 40 who consider that the TCA introduced sanctions by means of the rebalancing provision, without however also reflecting on dispute settlement before Panels of Experts.

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• Exclusion: no dispute settlement procedure at all, leaving the parties without enforcement option; – applicable to most provisions of Part Two Title XI Chapter 1 on “General Provisions” on the level playing field, namely the general obligations to recognise the principle of SD and to pursue long-term efforts to achieve open and fair competition (Article 355(2) and (4)); • “Ordinary” Panel of Experts: consultation, followed by dispute settlement before a Panel of Experts pursuant to Article 408 and 409; – applicable to the net zero goal in Article 355(3) (see Article 357 s. 2) and to Part Two Title XI Chapter 8 on “Other Instruments for Trade and Sustainable Development” (Article 397-406), including the provisions on multilateral environmental agreements as well as trade and climate change; • Panel of Experts “with extended powers”: consultation, followed by dispute settlement before a Panel of Experts which enjoys additional authorities under Article 409(1), 749 and 750, including a compliance procedure which may authorise trade sanctions; – applicable to Part Two Title XI Chapter 7 on “Environment and Climate” (Article 390-395), including the provisions on domestic non-regression, carbon pricing and on environmental and climate principles (see Article 407(2) and 410(2)); • General inter-state arbitration: Part Six Title I applies, allowing for consultations followed by arbitration which may lead to trade sanctions in a compliance procedure; – applicable to aspects of terminations based on the essential elements clause (see Article 735(2)(h)),66 the precautionary approach in Article 356(2) (see Article 357 s. 1)67 and to all obligations in Part Two Title VIII on Energy, including renewable energies, however, with some modifications for subsidies (e.g. no jurisdiction for individual subsidies, see Article 301(3) and 375).By the last category, we may thus observe at the outset that parties may invoke some important climate action-related provisions in general arbitration under the TCA which includes the option for trade sanctions.

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Peers (2022), p. 54. Lydgate E et al. (2021) Taking Stock of the UK-EU Trade and Cooperation Agreement: Governance, State Subsidies and the Level Playing Field. UKTPO Briefing Paper 54, https:// blogs.sussex.ac.uk/uktpo/files/2021/01/BP_54.pdf, p. 4 consider this to be particularly relevant for actions against the UK.

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New Panels of Experts with Extended Powers to Authorise Trade Sanctions

But even ordinary panels of experts and panels of experts with extended powers—as we shall call these bespoke procedures here—depart from the traditional EU promotional approach for SD chapters. First of all, extending the powers of Panels of Experts in certain cases is a major innovation by itself. As seen, earlier EU FTAs featured obligations not to regress from the domestic level of protection. Yet, they were subject to dispute settlement before a Panel of Expert without any particular modifications.68 In contrast, in case of the TCA, Article 749 and 750 apply mutatis mutandis (Article 410(2)). This means that the claimant has access to a compliance procedure and trade sanctions— the general compliance procedure under Article 749 and 750 applies that forms part of the general dispute settlement procedure under Part Six Title I. As a consequence, such a Panel of Expert does not qualify as a forum for purely promotional dispute settlement anymore.69 Rather, it conforms with the US approach to environment and labour standard provisions in their FTAs.

3.2.3

Binding Declaratory Determinations by “Ordinary” Panels of Expert

Second, compared to Panels of Experts in earlier EU FTAs, the TCA’s “ordinary” Panels of Experts have undergone more subtle, important changes as well. It is still correct that their reports are not subject to a sanctions-based compliance procedure. However, it is submitted that the reports of ordinary Panels of Experts can contain declaratory determinations which impose international obligations on the parties to comply (similar to declaratory judgments of courts).70 It is just that the substantive obligation to comply is not enforceable by a compliance procedure and trade sanctions. This is an important distinction71 as scholarship so far has considered reports by Panels of Experts in most earlier EU FTAs to express only non-binding recommendations.72

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Durán (2020), p. 1042. In the same vein Collins (2021), p. 619; Countouris N, Ewing KD, Hendy J (2021) The EU-UK Trade and Cooperation Agreement and workers’ rights. ETUI Policy Brief No 3/2021, https://www. etui.org/sites/default/files/2021-03/The%20EU-UK%20Trade%20and%20Cooperation%20Agree ment%20and%20workers%27%20rights_2021.pdf, p. 3; House of Commons (2021) The UK-EU Trade and Cooperation Agreement: Level Playing Field. Briefing Paper No. 9190, https:// researchbriefings.files.parliament.uk/documents/CBP-9190/CBP-9190.pdf, p. 53. 70 Herrmann and Abel (2022), para. 144. 71 On the distinction between binding character, justiciability and enforceability, see Bodansky (2016), p. 143. 72 Bronckers and Gruni (2021), p. 37; in the same direction Durán (2020), p. 1042. Article 298(3) EU-Central America Association Agreement even defines the residual terms of reference as entrusting the Panel “to make non-binding recommendations for solution of the matter”. 69

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The claim that the Panels’ reports under the TCA exert binding effect rests on the wording and the systematic structure of Article 409. This provision defines the composition of a Panel and the procedure it follows. Compared to earlier FTAs, it contains new wording indicative of the mentioned binding effects. For example, it defines the residual terms of reference of a Panel as “to examine, in the light of the relevant provisions, the matter referred to in the request for the establishment of the panel of experts, and to deliver a report in accordance with this Article that makes findings on the conformity of the measure with the relevant provisions” (para. 5, emphasis added). In contrast, the corresponding provisions of earlier EU FTAs entrust a Panel with examining and “making recommendations for the resolution of the matter”.73 Under the TCA, the interim and final report by the Panel sets out “the findings of fact, its determinations on the matter including as to whether the respondent Party has conformed with its obligations under the relevant Chapter or Chapters and the rationale behind any findings and determinations that it makes” (para. 9, emphasis added). In contrast, for example, Article 16.18(5) EU-Japan FTA considers reports to “setting out the findings of facts, the interpretation or the applicability of the relevant Articles and the basic rationale behind any findings and suggestions.”74 Thus, earlier FTAs do not contain comparable obligatory language but focus on hortatory expressions. Furthermore, the Panel of Expert’s report rendered pursuant to Article 409 constitutes the basis on which the parties may suspend obligations in case of a violation of the non-regression clause (see above on Article 410). If the report was not binding, it would be systematically unsound if parties could enforce compliance by applying temporary cross-retaliation. The only argument against a binding effect of reports appears to be Article 409(9) s. 2 which states: “For greater certainty, the Parties share the understanding that if the Panel makes recommendations in its report, the respondent Party does not need to follow these recommendations in ensuring conformity with this

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Direct quotes of Article 16.18(2) EU-Japan FTA and Article 12.7(6) EU-Singapore FTA; similarly Article 13.17(6) EU-Vietnam FTA; Article 23.10(8) CETA; Article 285(2) and (4) EU-Colombia, Peru and Ecuador-FTA; Article 17(6) of the Trade and Sustainable Development Chapter of the EU-Mercosur Association Agreement in Principle. Closer to the TCA is Article 17(6) of the Trade and Sustainable Development Chapter of the Modernized EU-Mexico Global Agreement which entrusts the Panel with “findings and recommendations for the resolution of the matter”. 74 Similarly Article 12.17 EU-Singapore FTA: “findings of facts, the applicability of the relevant provisions, and the basic rationale behind any findings and recommendations”; Article 13.15 (2) EU-Korea FTA: “The Parties shall make their best efforts to accommodate advice or recommendations of the Panel of Experts on the implementation of this Chapter.” Closer to the TCA is Article 23.10(11) CETA which stipulates that reports include “findings of fact, its determinations on the matter including as to whether the responding Party has conformed with its obligations under this Chapter and the rationale behind any findings, determinations and recommendations that it makes” (emphasis added).

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Agreement.”75 However, it is submitted that this provision does not express that Panel reports are always legally non-binding. Rather, it explains that if and to the extent the Panel itself decides to issue non-binding recommendations, the respondent does not have to confirm with these. This follows from the wording of the cited provision: It relates to “recommendations” which one may juxtapose to the term “determinations” contained in Article 409(9) s. 1. This textual difference is not accidental. Rather, Article 409 provides Panels with the jurisdiction to issue binding determinations and non-binding recommendations—subject to possible changes of the Panel’s terms of references which the parties may alter in their “arbitration” agreement, as reflected in Article 409(5).

3.3

Arbitration Without Breaches of the TCA: Rebalancing

A complete novelty in FTA dispute settlement is the mechanism of “rebalancing” under Article 411. It constitutes a new trade remedy76 which does not require a treaty violation by a party. Rather, there must be a divergence of regulations of the parties that impacts trade or investment. Regulatory areas covered include climate action among others. Article 411 imposes certain requirements for a rebalancing: The regulatory divergences between the parties must be “significant” and cause “material impacts on trade or investment” (para. 2 s. 1). Then, either party “may take appropriate rebalancing measures” which must be “strictly necessary and proportionate in order to remedy the situation” (para. 1). Rebalancing consists in suspending obligations under the TCA. This is subject to an arbitral procedure (paras 3-12) which gives either party under certain conditions the right to suspend obligations and react to a rebalancing by the other party with own suspensions of obligations, respectively.77 While it is clear that the purpose of Article 411 is economic, that is, to guarantee ease of cross-border trade and investment in the long-term, rebalancing may affect climate action as well: Divergence may occur because one party lowers its climate standards while the other party leaves its corresponding regulation unchanged. Then, 75

This argument for a non-binding effect is suggested for example by Countouris N, Ewing KD, Hendy J (2021) The EU-UK Trade and Cooperation Agreement and workers’ rights. ETUI Policy Brief No 3/2021, https://www.etui.org/sites/default/files/2021-03/The%20EU-UK%20Trade%20 and%20Cooperation%20Agreement%20and%20workers%27%20rights_2021.pdf, p. 3; House of Commons (2021) The UK-EU Trade and Cooperation Agreement: Level Playing Field. Briefing Paper No. 9190, https://researchbriefings.files.parliament.uk/documents/CBP-9190/CBP-9190. pdf, p. 63. 76 Lester S (2020) Will the Post-Brexit EU-UK Trade Agreement Limit Regulatory Competition. CATO Blog Post of 28.12.2020, https://www.cato.org/blog/will-post-brexit-eu-uk-trade-agree ment-limit-regulatory-competition. 77 For a more detailed analysis see Collins (2021), pp. 627–630; for an overview distinguishing rebalancing from the other dispute settlement procedures described above, see Peers (2022), pp. 76–78.

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the threat of facing rebalancing under the TCA may discourage the party from lowering its climate standards in the first place, in addition to the non-regression clause. However, the same might apply in the opposite direction: If a party increases climate protection while the other one does not, this may trigger a rebalancing as well.78 As the provision at least does not rule out this latter possibility explicitly, it may disincentivise greater (unilateral) ambition in climate action. Notwithstanding, these effects on climate action and on barriers to trade and investment will likely be modest at best. Especially considering the right to regulate that is also reaffirmed in Article 411(1), the tests of “significant” regulatory divergence and a “material” impact on trade or investment should be interpreted to set a rather high bar.79 In this vein, Article 411(2) s. 4 raises the evidentiary requirements by calling for “reliable evidence” rather than “conjecture or remote possibility” in assessing the impact. Moreover, the concerned party will have to show that precisely the regulatory differences have caused the impact on trade or investment—which may often be hard to prove due to multidimensional reasons for changes in trade and investment flows.

3.4

Interim Conclusion

Overall, the TCA has taken major steps towards a sanction-based dispute settlement and enforcement procedure for climate action-related provisions. The changes may increase the effectiveness of climate action-provisions and complement the EU’s traditional promotional approach.80 However, the new remedy of rebalancing does not qualify as a tool to induce stronger climate action through trade and investment. In the present version, it exclusively aims at preventing non-tariff barriers to trade and investment from arising over time. If it was to serve the former function as well,

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Ortino F (2022) Protecting Workers’ Rights Using the EU-UK Trade and Cooperation Agreement, https://www.tuc.org.uk/sites/default/files/2022-01/Protecting%20Workers%27%20Rights% 20using%20the%20EU-UK%20TCA%20report%20for%20the%20TUC%20by%20Professor%20 Federico%20Ortino%20%281%29.pdf, p. 31 argues that because this would run counter to the commitment to maintaining high standards in Article 355(4), rebalancing would be unavailable in this scenario; however, one would have expected Article 411 to express this in clear terms, but the wording is neutral in this regard. 79 Supported by Gehring MW (2021) Analysis 5 of the Brexit Deal: Environment and Climate Provisions. EU Law Analysis Blog Post, http://eulawanalysis.blogspot.com/2021/01/analysis-5-ofbrexit-deal-environment.html; Collins (2021), pp. 623–626. Lydgate E et al. (2021) Taking Stock of the UK-EU Trade and Cooperation Agreement: Governance, State Subsidies and the Level Playing Field. UKTPO Briefing Paper 54, https://blogs.sussex.ac.uk/uktpo/files/2021/01/BP_54. pdf, p. 6 consider the effects to be unclear. 80 In general, on the question if the EU should include sanctions for SD related provisions in FTAs, see for example Bronckers and Gruni (2021), pp. 37–39 for a supportive and Durán (2020), pp. 1058–1063 for a sceptical position.

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it would require clarification that improving climate standards can never—or only subject to even higher requirements—justify a rebalancing.

4 The TCA as a Template for Linking Trade and Climate Action in Future FTAs From a bird’s eye view, the TCA achieves the highest degree of linking trade and climate action in the EU’s FTA practice so far—and perhaps also compared to many FTAs of other states worldwide. Naturally, the political and legal setting was favourable to that end: Both parties have adopted ambitious domestic climate action measures on which the TCA could build on.81 Other trading partners may be much more reluctant to accept similar commitments.82 In addition, as the TCA represents the first FTA to disintegrate economic relations, the negotiations started off from the high climate action standard of EU law. It is of course easier to agree not to lower a high standard that had already been applicable to the parties than a scenario in which one of the prospective treaty parties had not been very active in climate action before. Notwithstanding, the climate-related content we encountered in the TCA is not exclusive to the relations between the EU and the UK—as the proposal discussed in the negotiations to dynamically converge the future environmental policies of the parties would have been.83 The ideas that stand behind the new substantive and procedural features of the TCA appear to be transferable to other states and FTAs. It is fair to say that the TCA represents a rather strong new precedent of how preferential trade agreements can go hand in hand with commitments for climate action. The TCA’s trade-and-climate linkage revolves around the idea of fair competition: against a race-to-the-bottom in climate standards and in favour of liberal economic relations framed by regulation that protects public goods—here, the atmosphere as a global common. The TCA also expresses a desire for a decarbonised economy. To be sure, one could imagine an FTA that advocates such an economic

81

On the role of the UK as a supporter of climate action in the time of its EU membership, see Dupon and Moore (2019), pp. 52–56; on how regulatory convergence occurs more slowly “starting from a position of convergence”, see Armstrong (2018), p. 1115. 82 This had been the position in the European Commission (2018) Non-Paper, Feedback and Way Forward on Improving the Implementation and Enforcement of Trade and Sustainable Development Chapters in EU Free Trade Agreements. https://trade.ec.europa.eu/doclib/docs/2018/february/ tradoc_156618.pdf, p. 3. On the new EU-New Zealand FTA that has been concluded after the editorial deadline of this chapter, see only Ceretelli C (2022) EU-New Zealand FTA: Towards a New Approach in the Enforcement of Trade and Sustainable Development Obligations, EJIL:talk! Blog Post of 28.9.2022, https://www.ejiltalk.org/eu-newzealand-fta-towards-a-new-approach-inthe-enforcement-of-trade-and-sustainable-development-obligations/ 83 On such “evolution” clauses, see Leonelli (2021), pp. 629–631 with further references.

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model even more strongly. Nevertheless, the TCA already integrates climate action to such a degree that it may serve as a role model for states who share the policy idea of an eco-social market economy. From the perspective of international environmental law, the TCA qualifies as an instrument that induces climate action by conditioning commitments to liberalise bilateral trade and investment. By and large, the TCA rests rather well with the Paris regime.84 It is perhaps the FTA which most strongly and holistically embeds its provisions into the wide net of multilateral environmental treaties—including new agreements to be concluded in the future. Embracing international standards may help to align the treaty parties in their domestic regulations.85 However, arguably, there are still unused potentials. For example, the obligation of non-regression of domestic standards meets the Paris Agreement only halfway as the latter calls for progression (and not only: conservation) of the level of ambition in the nationally determined contributions.86 The parties could also have linked their ETS or at least agreed on a more detailed roadmap to discuss this issue further. This reflects the framework character of the TCA87 which calls upon the parties to negotiate more detailed rules in many areas. Surely, the treaty could have decoupled climate action more strongly from effects of climate action regulation on trade and investment, thereby coming closer to purely environmental commitments.88 Notwithstanding, the TCA covers more detailed climate action commitments than any preceding EU FTAs has. Turning to the EU more specifically, the analysis shows that the trade and climate action-linkage of the TCA does not have to remain an isolated case particular to the disintegration of the UK from the EU. The new provisions do build on earlier EU FTAs and extend their coverage. For the time being, they represent the peak level of the EU’s SD chapters and environmental provisions in FTAs. Among the different innovations, partly introducing climate action-related provisions to a “hard” dispute settlement procedure constitutes the greatest leap forward. While the TCA is not yet comparable to how US FTAs provide for sanction-vested dispute settlement in trade and environmental matters,89 the climate-trade linkage has now gained teeth in the EU FTA practice for the first time. It has the potential of remedying critique that EU SD and environmental chapters are not effective enough—complementing rather than replacing the EU’s promotional strategy to trade and climate action.

84

For a contrary assessment, see Leonelli (2021) pp. 635–637. Armstrong (2018), p. 1114. 86 In the same vein Wachowiak J (2021) EU-UK climate cooperation post-Brexit: A case for optimism? EPC Policy Brief, https://epc.eu/content/PDF/2021/EU-UK_Climate_cooperation_PB. pdf, p. 2. 87 Peers (2022), p. 50. 88 This is the main criticism by Leonelli (2021), pp. 635–637. 89 See for example the criticism presented by House of Commons (2021) The UK-EU Trade and Cooperation Agreement: Level Playing Field. Briefing Paper No. 9190, https://researchbriefings. files.parliament.uk/documents/CBP-9190/CBP-9190.pdf, p. 52. 85

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Thereby, the TCA foreshadowed the Commission’s new trade policy approach communicated on 22 June 2022 and may serve as a template for it. In the present geopolitically instable context, the EU is determined to “further enhance the contribution of trade agreements to sustainable development”.90 This includes to comprehensively incorporate international standards and commitments, mainstreaming SD throughout the entire FTAs, strengthening the monitoring of SD obligations and, after long reluctance, more assertive enforcement, including trade sanctions as a last resort.91 With regard to the PA, “the intention would be to capture failure to comply with obligations that materially defeats the object and purpose of the agreement.”92 This new agenda is in line with the EU’s obligation under Article 191 TFEU to promote measures against climate change at international level. In light of Russia’s act of aggression against Ukraine, the TCA as a new template may form a part of how the EU shapes and deepens its trade relations with like-minded partners.93 It also reflects how the EU could leverage the strength of its internal market to induce more climate action-oriented behaviour of other states—and to strengthen its strategic autonomy in the process. As tensions between the EU and the UK increase over the rules applicable to Northern Ireland at the time of writing,94 the long-term status of the TCA appears precarious. In any event and at the very least, its trade and climate action-provisions may well represent a legacy that impacts the EU’s trade and external climate policy on a broader scale.

References Abel P (2018) Comparative conclusions on arbitral dispute settlement in trade-labour matters under US FTAs. In: Gött H (ed) Labour standards in international economic law. Springer, Cham, pp 153–184 Araujo BAM (2016) The EU Deep Trade Agenda: law and policy. OUP, Oxford Armstrong KA (2018) Regulatory alignment and divergence after Brexit. J Eur Public Policy 25(8): 1099–1117 Bartels L (2013) Human rights and sustainable development obligations in EU Free Trade Agreements. Legal Iss Econ Integr 40(4):297–313

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European Commission, The Power of Trade Partnerships: Together for Green and Just Economic Growth, 22.6.2022, COM(2022) 409 final, p. 1. 91 COM(2022) 409 final, pp. 4–12. 92 COM(2022) 409 final, p. 11. 93 In the same vein as a general reform proposal without focus on the TCA, see Dröge et al. (2018), p. 30. 94 On 15.6.2022, the European Commission (re-)launched infringement proceedings against the UK “for not complying with significant parts” of the Ireland/Northern Ireland Protocol, see https://ec. europa.eu/commission/presscorner/detail/en/IP_22_3676. On a general level, see Usherwood (2021), p. 121 who analyses that politically, “there appears to be no clear trajectory for future relations”.

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Bartels L (2016) Social issues: labour, environment and human rights. In: Lester L, Mercurio B, Bartels L (eds) Bilateral and regional trade agreements, commentary and analysis, vol 1, 2nd edn. CUP, Cambridge, pp 364–384 Bartels L (2017) Human rights, labour standards, and environmental standards in CETA. In: Griller S, Obwexer W, Vranes E (eds) Mega-regional trade agreements. OUP, Oxford, pp 202–215 Bodansky D (2016) The legal character of the Paris agreement. Rev Eur Commun Int Environ Law 25(2):142–150 Bronckers M, Gruni G (2021) Retooling the sustainability standards in EU Free Trade Agreements. J Int Econ Law 24(1):25–51 Collins D (2021) Standing the test of time: the level playing field and rebalancing mechanism in the UK-EU trade and cooperation agreement (TCA). J Int Disp Settlement 12(4):617–636 Dent CM (2021) Trade, climate and energy: a new study on climate action through free trade agreements. Energies 14(4363):1–30. https://doi.org/10.3390/en14144363 Dröge S, van Asselt H, Das K, Mehling M (2018) Mobilising trade policy for climate action under the Paris Agreement. Options for the European Union. SWP Research Paper, Berlin Dupon C, Moore B (2019) Brexit and the EU in global climate governance. Polit Gov 7(3):51–61 Durán GM (2013) Innovations and implications of the trade and sustainable development chapter in the EU-Korea Free Trade Agreement. In: Harrison J (ed) The European Union and South Korea. Edinburgh Scholarship Online, Edinburgh, pp 124–145 Durán GM (2020) Sustainable development chapters in EU Free Trade Agreements: emerging compliance issues. Common Mark Law Rev 57(4):1031–1068 Harrison J (2019) Governing labour standards through free trade agreements: limits of the European Union’s trade and sustainable development chapters. J Common Mark Stud 57(2):260–277 Herrmann C, Abel P (April 2022, 19th supplement) EU-Vereinigtes Königreich Großbritannien und Nordirland. In: Krenzler HG, Herrmann C, Niestedt M (eds) EU-Außenwirtschafts- und Zollrecht. C.H. Beck, München Hradilová K, Svoboda O (2018) Sustainable development chapters in the EU free trade agreements: searching for effectiveness. J World Trade 52(6):1019–1042 Hsu SL (2016) International market mechanisms. In: Carlarne CP, Gray KR, Tarasofsky RG (eds) The Oxford handbook of international climate change law. OUP, Oxford, pp 249–284 Huggins A (2018) The evolution of differential treatment in international climate law: innovation, experimentation, and ‘Hot’ law. Clim Law 8(3-4):195–206 Kuzemko C, Blondeel M, Froggatt A (2022) Brexit implications for sustainable energy in the UK. Policy Polit (early view as of 2022):1–20, https://doi.org/10.1332/ 030557321X16510710991392 Leonelli GC (2021) From extra-territorial leverage and transnational environmental protection to distortions of competition: the level playing field in the EU-UK trade and cooperation agreement. J Environ Law 33(3):611–638 Mayer B (2021) Temperature targets and state obligations on the mitigation of climate change. J Environ Law 33(3):585–610 Munro J (2018) Emissions trading schemes under international economic law. OUP, Oxford Pacheco Restrepo YV (2019) Enforcement practice under preferential trade agreements: environmental consultations and submissions on environmental enforcement matters in the US-Peru TPA. Legal Iss Econ Integr 46(3):247–262 Peers S (2022) So close, yet so far: the EU/UK trade and cooperation agreement. Common Mark Law Rev 59(1):49–80 Pollitt MG (2022) The further economic consequences of Brexit: energy. Oxford Rev Econ Policy 38(1):165–178 Stoll PT, Gött H, Abel P (2018) A model labour chapter for future EU trade agreements. In: Gött H (ed) Labour standards in international economic law. Springer, Cham, pp 381–430 Usherwood S (2021) ‘Our European Friends and Partners’? Negotiating the trade and cooperation agreement. J Common Mark Stud 59(S1):115–123

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Patrick Abel is assistant professor and post doc-senior researcher at the University of Passau. He is a German lawyer and holds an MJur from the University of Oxford and a PhD from the University of Göttingen. Patrick has published on matters of German and European constitutional law, European and international economic law, environmental law and general international law. He currently pursues a research project (Habilitation) on constitutional law and the transformation of markets, the state and the EU through climate change.

The Investment Treaty Regime and the Clean Energy Transition Myriam Gicquello and Emily Webster

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The Investment Treaty Regime at the Crossroads of the Clean Energy Transition . . . . . . . 2.1 Regulatory Chill and Climate Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Fossil Fuel Companies, Host States, and Climate Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 The EU and Climate Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Context: Germany, the Netherlands, and Bulgaria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Response to Foreign Investors and the Threat of ISDS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Renewable Energy and the Investment Treaty Regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Spain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Czech Republic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 The Reform of the Investment Treaty Regime to Ensure the Clean Energy Transition . . . 6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract The investment treaty regime (ITR) has been heavily criticised for the barriers it creates to domestic responses to climate change and the problem of regulatory chill. This chapter investigates these claims focussing on the Energy Charter Treaty (ECT), and comparing the differentiated impact of investor-state dispute settlement (ISDS) under the ECT for richer and poorer EU member states in response to fossil fuel phase-outs (Germany, the Netherlands and Bulgaria) and policies promoting investment in renewable energies (RE) (Spain and the Czech Republic). It acknowledges the significant barriers that ISDS can and has created to the introduction of law, regulation and policies to facilitate the energy transition, particularly in poorer states, but draws attention to the possibilities of the ITR supporting policies attempting to scale-up RE. It concludes with recommendations M. Gicquello (✉) Newcastle University, Newcastle upon Tyne, UK e-mail: [email protected] E. Webster University of Cambridge, Cambridge, UK e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 235–266, https://doi.org/10.1007/8165_2022_96, Published online: 23 December 2022

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for reform of the ITR to enable it to support the energy transition and contribute to the global response to climate change in the small period of time in which this must occur to prevent catastrophic global temperature increases.

1 Introduction Climate change is one of the greatest threats facing humanity requiring large-scale collective action across the globe. It has been characterized as a “super wicked problem”1 which will profoundly alter society both through its physical impacts, particularly upon vulnerable communities, and because of the great legal, political and economic changes required to respond to it. The Paris Agreement 20152 introduced the collective target of keeping temperature increases within 2 °C with “best efforts” to meet 1.5 °C.3 Consistent with this, there have been swathes of new national policies and laws aimed at mitigating climate change and facilitating the energy transition.4 Nevertheless, analysis of current climate policies predicts a pathway of around 2.7 °C warming, overshooting the temperature goals by at least 1 °C.5 The limited time with which to take meaningful action, and the greater urgency to act as this time decreases, means that there will likely be more abrupt and interventionist law and regulation introduced over the coming years, intended to drastically reduce the use of fossil fuels and scale-up green energies. Indeed, climate change interacts with, and creates contestation with, many existing legal regimes6 which have evolved in significantly more stable planetary conditions, but that have also contributed to the problem itself.7 One area of contestation with climate change action is the investment treaty regime (ITR)—comprising both international investment law and arbitration (Investor-State Dispute Settlement (ISDS)). This fragmented regime with thousands of investment treaties interpreted by hundreds of ephemeral arbitral tribunals has curbed the ability of states to regulate in the public interest owing to unjustified inconsistencies of interpretation.8 Concretely, a state adopting a climate policy 1

Levin et al. (2012). Fisher et al. (2017). Paris Agreement (adopted 12 December 2015, entered into force 4 November 2016) FCCC/CP/ 2015/10/Add 1. 3 Paris Agreement, Article 2(1)(a). 4 Nachmany and Setzer (2018) ‘Global Trends in Climate Change Legislation and Litigation: 2018 Snapshot’ http://www.lse.ac.uk/GranthamInstitute/publication/global-trends-in-climate-change-leg islation-and-litigation-2018-snapshot/. 5 Climate Action Tracker (2021) ‘Temperatures’: https://climateactiontracker.org/global/tempera tures/. 6 Fisher et al. (2017). 7 Kotzé and Kim (2019). 8 Ortino (2019). 2

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negatively impacting a foreign investor and/or investment is likely to be threatened by, or sued in, ISDS. However, given this fragmentation of the ITR (both substantive and procedural), which in turn contributes to inconsistencies of interpretation by tribunals, states cannot predict whether they would be found liable and how much compensation they may have to pay to regulate.9 ISDS is already a very popular means used by energy companies to enforce the protections offered in investment treaties.10 Considering the need to urgently phaseout fossil fuels and to scale up the green energy transition, it is likely that ISDS cases challenging climate policies will further be initiated by such companies, which are, after all, “fighting for their survival”.11 The Energy Charter Treaty (ECT)—a multilateral investment agreement covering the energy sector with 53 signatories— has increasingly been mobilised by fossil fuel and renewable energy (RE) companies. It is the most invoked investment treaty in ISDS, and more cases are expected to follow as states increasingly regulate to transition to clean energy.12 The ECT will protect most fossil fuel investments impacted by climate policies making it the “greatest contributor to those potential ISDS claims”.13 Yet, owing to its climate-blindness, by not differentiating between low-carbon and high-emitting investments, and to its outdated and ambiguous standards of investment protection—primarily protecting fossil fuel companies—the ECT is facing increased criticism.14 As such, stakeholders and contracting parties have called for its modernisation while France has advocated for collective withdrawal and Italy, has already withdrawn.15 Climate change, and the law, regulation and policies introduced in response to it, has therefore created a point of irritation for the ITR doctrinally, while also offering a catalyst for calls for reform. Despite the friction between the ITR and climate change, it could still be a “force for good” by supporting the clean energy transition.16 The transition to green energy requires private funds, especially in low-income countries. The International Energy Agency (IEA) estimates that USD 2.5 trillion of private finance will be needed every year between 2026 and 2030.17 However, this contribution would still not be enough to achieve the targets of the Paris Agreement since RE now only accounts for more than 20% of the global energy, meaning that an additional USD 44 trillion of

9

Ortino (2019). Of 1023 investment arbitrations counted by the United Nations Conference on Trade and Development (UNCTAD) up to January 2020, 17% (173) of these cases concerned an investment in or related to fossil fuels, with 92% of these related to oil and gas: Tienhaara and Cotula (2020). 11 Tienhaara (2018), p. 239. 12 Di Salvatore (2021). 13 Tienhaara et al. (2022), p. 703. 14 Thiessen (2022). 15 Brauch (2021). 16 Boute (2012), p. 616. 17 IEA (2021) ‘World Energy Outlook 2021’ https://iea.blob.core.windows.net/assets/4ed140c1-c3 f3-4fd9-acae-789a4e14a23c/WorldEnergyOutlook2021.pdf. 10

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investment is needed to meet climate objectives, which will likely be obtained from private finance.18 The ITR and its enforceable protections for investors could encourage such investments by offering the necessary guarantees and protections to investors in RE. For example, investors in renewables have increasingly used ISDS over the past decade with more than half of the cases brought under the ECT concerning such investments.19 In this chapter, we argue that while there are significant criticisms to make in relation to the ITR and its potential to conflict with climate and energy transition law and policy, the picture is in reality far more complex and reveals a heavily context dependent situation. While both fossil fuel and RE companies have used ISDS to challenge states’ regulations, these cases have a differentiated impact upon low- and high-income countries. When it comes to regulations aiming at phasing-out fossil fuels, for rich, often western European states, a pay-to-regulate strategy is feasible, while for poorer, particularly many eastern European states, this may create a significant barrier to the energy transition particularly in those states that are reliant upon coal. At the same time, however, the ITR could promote investment in renewables by providing foreign investors with enforceable standards of investment protection. In Sect. 2, we further analyse the relationship between the ITR and the clean energy transition. In Sect. 3, we investigate how fossil fuel companies with investments in Germany, the Netherlands, and Bulgaria have already used or could use the ECT to stall and/or challenge the adoption of climate laws and policies. In Sect. 4, we focus on how foreign investors in RE have similarly used the ECT and its ISDS mechanism in Spain and the Czech Republic to freeze subsidies facilitating the clean energy transition. Finally, in Sect. 5 we discuss the reform of the ECT and its ISDS mechanism or alternative options to make this regime more climate-friendly and compatible with the need to urgently act upon climate change.

2 The Investment Treaty Regime at the Crossroads of the Clean Energy Transition Despite the potential of the ITR to support the clean energy transition, discussions about their relationship have primarily focused on its conflicting nature. Considering the urgency to transition to a low-carbon economy, states are increasingly introducing climate mitigation and adaptation policies, many of which are aimed at the decarbonisation of the energy sector. These climate policies could be challenged before arbitral tribunals, should they negatively impact foreign investments. The International Monetary Fund (IMF) has recently accepted this reality, emphasising that ISDS and the ECT could act as a barrier to climate action by “protect[ing] fossil 18

Tienhaara and Downie (2018). ECT Secretariat (2022), ‘List of Cases’ https://www.energychartertreaty.org/fileadmin/ DocumentsMedia/Statistics/Chart_ECT_cases_-_1_June_2022.pdf. 19

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fuel investments which can lock in large amounts of emissions, or alternatively expos[ing] authorities to legal action for breach of that protection when seeking to adopt regulatory measures to curtail fossil fuel activity”.20 Yet, the jurisprudence emerging from investment tribunals concerning conflicts between environmental regulations—the right of the state to regulate for environmental concerns, including climate change—and investment protection is not constant. While states usually invoke their right to regulate and raise the environmental character of the regulation as a defence, this argument has, at times, been completely dismissed by arbitral tribunals thus giving full force to investment protection. But, at other times, tribunals have adopted an “upgraded approach” and accepted this argument to either discharge or mitigate the state’s liability.21 Both interpretations are therefore likely to be endorsed by arbitral tribunals in future disputes, making it difficult for states to predict the outcome of the dispute and whether and how much it will have to pay to regulate. The lack of both a doctrine of precedent in arbitration and of clear standards of investment protection in turn leaves room for extra-legal factors to influence the outcome of ISDS disputes,22 further contributing to the uncertainty and unpredictability of the ITR. The position adopted by some tribunals to protect investments at all costs could be explained by the fact that these tribunals (consisting of international arbitrators) derive their jurisdiction (and thus income) from investment treaties and are experts in this area rather than another such as human rights or climate change law;23 while also being rather “suspicious of state regulation”.24

2.1

Regulatory Chill and Climate Regulation

Given the uncertain state of the relationship between the ITR and climate change, it is not surprising that the ITR is deemed responsible for regulatory chill.25 In the context of tobacco and climate policies, Tienhaara identified three types of regulatory chill: internalisation chill, threat chill, and cross-border chill; each impacting states’ conduct at different stages of the policymaking process.26 Although difficult

20

Prasad et al. (2022), p. 5. Viñuales (2016), p. 24. 22 Viñuales (2015), p. 5 (‘The composition of the tribunal (including the background of arbitrators), the factual context of the dispute (including media scrutiny), the legal strategy of the parties (reflected in the pleadings) or the potential intervention of third parties. All these different variables may have an impact on the (dis)inclination of the tribunal to integrate environmental concerns into its reasoning’). 23 Prislan (2012), p. 480. (‘Investment lawyers, like any other epistemic community, prioritise their own concerns and interests over those of others’). 24 Marley (2014), p. 1014. 25 Tienhaara (2018), p. 232 (‘Governments will fail to regulate in the public interest in a timely and effective manner because of concerns about ISDS’). 26 Tienhaara (2018). 21

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to quantify,27 regulatory chill has been evidenced anecdotally and raised by states as an explanation for not regulating or postponing regulations to mitigate or adapt to climate change. For instance, state officials from the United States, New Zealand, Denmark, and France have already explicitly identified the ITR as a barrier to the adoption of climate change policies.28 This is further echoed by the Vice President of Chevron, who openly stated: “the mere existence of ISDS is important as it acts as a deterrent” to the introduction of regulation.29 Regulatory chill has already been documented for tobacco and environmental regulations, but also more recently for climate regulations; with the expectation that this will grow.30 One instance has recently been observed in France. In 2017, France planned to phase-out all fossil fuels by 2040, by banning the renewal of exploitation permits;31 allowing a progressive phase-out with some fossil fuel projects ending as soon as 2021 and most of them halted by 2030.32 However, Vermillion—a Canadian oil and gas company producing around 70% of French oil—threatened to action ISDS claiming breaches of the ECT where it would ask for billions of euros in compensation should France pass this draft law into legislation.33 France later backtracked and instead adopted legislation that allows for exploitation permits for oil and gas to be renewed until at least 2040, substantially delaying the energy transition.34 This U-turn prompted the environmental minister at the time, Nicolas Hulot to resign, citing the influence of private actors and corporate lobbying on policymaking.35 Such regulatory chill is possible due to the characteristics of the ITR—the fragmentation of both investment treaties and tribunals associated with vague and

27 See however, Berge and Berger (2021) conducting empirical research to document regulatory chill for domestic environmental regulations. 28 Bonnitcha J (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf; Tienhaara and Cotula (2020), p. 21 (‘A senior US policymaker stated that, although the US has never lost an investor-state arbitration, in certain situations national public interest regulation “ha[d] not been put in place because of fears of ISDS”’). 29 Nelsen A, ‘TTIP: Chevron Lobbied for Controversial Legal Right as “Environmental Deterrent”’, The Guardian, 26 April 2016: https://www.theguardian.com/environment/2016/apr/26/ttipchevron-lobbied-for-controversial-legal-right-as-environmental-deterrent. 30 Tienhaara (2018). 31 Van Asselt (2021). 32 ‘Blocking Climate Change Laws with ISDS Threats’ (2019): https://10isdsstories.org/wpcontent/uploads/2019/06/Vermilion-vs-France.pdf. 33 Moon (2021). 34 Le Hir P, ‘Les Députés Finalisent la Loi Hulot sur les Hydrocarbures’, Le Monde, December 2017: https://www.lemonde.fr/climat/article/2017/12/01/les-deputes-finalisent-la-loi-hulot-sur-leshydrocarbures_5223370_1652612.html. 35 Ouest-France (2018) ‘Démission Surprise de Nicolas Hulot: Le Verbatim de son Interview’: https://www.ouest-france.fr/politique/nicolas-hulot/demission-surprise-de-nicolas-hulot-le-verba tim-de-son-interview-5939479.

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broad standards of investment protection inconsistently interpreted—which then makes it impossible for states to predict what would happen should they regulate for the clean energy transition and be brought to arbitration. Given the uncertainty and unpredictability generated by the ITR, a new generation of investment protection agreements has been adopted by the EU and its partners in order to protect, restore, the right of the state to regulate upon some matters. For example, the Fair and Equitable Treatment (FET) provisions in these agreements now list what would lead to their breach,36 and allow tribunals to rely on legitimate expectations which are also defined in this context as: ‘a specific representation to an investor to induce a covered investment. . . and upon which the investor relied in deciding to make or maintain the covered investment, but that the Party subsequently frustrated’.37 In doing so, the contracting states thus crystallized earlier interpretations given by investment tribunals to try putting an end to uncertainty and unpredictability. Yet, ‘these recent treaties leave various questions unanswered’.38 New investment treaties now also reaffirm the contracting parties’ ‘right to regulate within their territories to achieve legitimate policy objectives’.39 The EU-Canada Comprehensive and Economic Trade Agreement (CETA) goes even further in highlighting that the exercise of regulatory powers by a contracting state adversely impacting an investor or clashing with its expectations does not automatically entail a breach of its investment obligations.40 However, while this new treaty practice explicitly recognizes the right of the state to regulate, what this entails in practice is still limited for two reasons. First, owing to the fragmentation of the ITR, thousands of ‘old’ investment treaties are still applicable (such as the ECT). And second, this new generation of investment treaties also fails ‘to draw clear boundaries with regard to the applicable standards of review’; hence, ‘leaving the choice of the applicable standard of review to the future adjudicator’ therefore retaining some uncertainty.41 In addition to the uncertainty and unpredictability generated by the ITR and its fragmentation, regulatory chill is also fed by the fact that this regime confers power and leverage on private companies—through direct and full access to ISDS that other interested parties, such as domestic investors, do not have or only to a limited extent through amicus curiae participation.42 This imbalance of the ITR then allows private companies, often from high-income countries, to influence policymaking.

36

E.g., Comprehensive and Economic Trade Agreement (CETA) (2016), Article 8.10 para. 2; EU-Vietnam Investment Protection Agreement (EUVIPA) (2019), Article 2.5; EU-Singapore Investment Protection Agreement (EUSIPA) (2018), Article 2.4. 37 CETA (2016), Article 8.10 para. 4; EUVIPA (2019), Article 2.5 para. 4; EUSIPA (2018), Article 2.4 para. 3. 38 Ortino (2019), p. 167. 39 CETA Article 8.9; EUVIPA (2019), Article 2.2; EUSIPA (2018), Article 2.2. 40 CETA (2016), Article 8.9. 41 Ortino (2019), p. 173. 42 Although tribunals are not bound to consider the views of the amicus curiae in their final decision: UNCITRAL, Glamis Gold, Ltd v. USA, Award, 8 June 2009.

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Most investment treaties—with the exception of the new generation of investment treaties mentioned above and concluded over the past decade—focus on protecting foreign investments at all costs, while usually not mentioning and safeguarding other rights or areas that also deserve protection and could mitigate such investment protection such as human rights, the environment, and climate change.43 Although numerous investment treaties have been concluded since the 1990s, they generally remain silent on climate change matters despite the agreement of the United Nations Framework Convention on Climate Change in 1992.44 In addition to this imbalance in the substance of investment treaties, namely conferring rights to investors and obligations to states, there is also a procedural imbalance “between effective and enforceable dispute settlement processes for enforcing international economic law and weak or no dispute settlement processes for enforcing climate commitments”,45 further hindering the achievement of climate goals. Foreign investors also have access to ISDS to challenge states’ regulations, whereas domestic investors can only bring a challenge before their domestic courts. These domestic investors therefore do not have a “free risk insurance”— arbitration—against state regulation deemed harmful to their investment.46 Such “insurance” allows the risks of an investment to be shifted from private companies to taxpayers through the large sums of compensation awarded by international arbitrators to foreign companies or the negotiation of large compensation packages leveraged by the threat of a claim. It is the strategic use of ISDS that acts as leverage to inflate compensation schemes or to influence state’s regulations; a strategy which is unavailable to domestic investors. Indeed, this strategic use of ISDS is explicitly acknowledged and encouraged by law firms: Companies in industries most affected by states’ climate change obligations (e.g., fossil fuels, mining, etc.) should audit their corporate structure and change it, if needed, to ensure they are protected by an investment treaty. [. . .] It is [. . .] important to assess which treaty would best protect the company from any adverse climate-related government measures.47

As discussed in Sect. 3, Germany offers an example where fossil fuel companies have used the threat of ISDS to leverage substantial compensation.

Columbia Center on Sustainable Investment (2022) ‘Climate Action Needs Investment Governance, Not Investment Protection and Arbitration’: https://www.oecd.org/investment/investmentpolicy/OECD-investment-treaties-climate-change-consultation-responses.pdf, para. 17. Sachs et al. (2020). 44 Bernasconi-Osterwalder and Brauch (2019). 45 Bernasconi-Osterwalder and Brauch (2019), p. 7. 46 Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf; with Sachs et al. (2020) considering this insurance as being akin to a subsidy. 47 Columbia Center on Sustainable Investment (2022) ‘Climate Action Needs Investment Governance, Not Investment Protection and Arbitration’: https://www.oecd.org/investment/investmentpolicy/OECD-investment-treaties-climate-change-consultation-responses.pdf, para. 12. 43

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Foreign investors are thus accorded more protection than domestic investors in a similar situation given that they benefit from a range of protections embedded in investment treaties and from an access to ISDS to enforce them. In addition, arbitral tribunals are usually more generous than domestic courts when it comes to awarding financial compensation. For example, tribunals have not limited themselves to the amount invested and lost by the investor to calculate compensation, but have also compensated for the loss of future income.48 This practice then contributes to the enormous amounts granted to foreign investors, far outweighing the initial investment. To illustrate this huge discrepancy, Bonnitcha and Brewin draw upon the Tethyan Copper v. Pakistan case in which arbitrators awarded “USD 4 billion plus interest for Pakistan’s failure to grant the necessary approvals for the investor to build and operate a mine – even though the mine was never built”.49 Interestingly, they note that “this award is almost as large as the International Monetary Fund’s bailout that had been agreed two months earlier with the intention of saving the Pakistani economy from collapse”.50 Concurrently, ISDS has a track record that is favourable to fossil fuel industries. This may not be surprising considering that “representatives of the fossil fuel industry played a critical role in the development of current international investment law and ISDS”.51 Not only were fossil fuels investors successful in 72% of the cases once the dispute had passed the jurisdictional threshold (in 32% of the cases), but the amount awarded to these same investors was on average five times higher than the compensation awarded in non-fossil fuel arbitrations.52 According to Di Salvatore, the average amount awarded and settled for in fossil fuel arbitrations is USD 606.6 million and USD 126 million in non-fossil fuel arbitrations.53 One reason for this may be that fossil fuel investors often claim more compensation than non-fossil fuel claimants once they initiate arbitration with an average of USD 1.4 billion claim compared to USD 560.8 million for non-fossil fuel investors.54 Given these high figures, it is therefore expected that there will be “tremendous potential financial losses for countries across income levels if ISDS claims are successful” with a liability estimate ranging between USD 92 and USD 340 billion.55

Bonnitcha J and Brewin S (2020) ‘Compensation Under Investment Treaties: What Are the Problems and What Can Be Done’: https://www.iisd.org/system/files/2020-12/compensationinvestment-treaties-en.pdf. 49 Bonnitcha J and Brewin S (2020) ‘Compensation Under Investment Treaties: What Are the Problems and What Can Be Done’: https://www.iisd.org/system/files/2020-12/compensationinvestment-treaties-en.pdf, p. 3. 50 Bonnitcha J and Brewin S (2020) ‘Compensation Under Investment Treaties: What Are the Problems and What Can Be Done’: https://www.iisd.org/system/files/2020-12/compensationinvestment-treaties-en.pdf, p. 3. 51 Di Salvatore (2021), p. 8. 52 Di Salvatore (2021), p. 15. 53 Di Salvatore (2021), p. 18. 54 Di Salvatore (2021), p. 18. 55 Tienhaara et al. (2022). 48

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Although this chapter focuses on the imbalance between wealthier and poorer EU states, it draws attention to the even greater imbalance created by the ITR between developing and developed countries. Indeed, the threat of ISDS may be more powerful in developing countries than in developed ones, given that the former may have “less capacity and resources to fight lengthy and expensive ISDS cases”.56 Research by Samples has demonstrated that in ISDS claims, the majority of claimants are from high-income countries while respondents from lower-middle income and low-income countries account for a third of all claims.57 Indeed, according to Schultz and Dupont, lower income countries were successful in only 27% of all concluded cases brought against them between 1998 and 2010, whereas for high income countries this figure was 46%.58 They argue that this demonstrates that the investment law system inherently favours economically stronger countries to the detriment of weaker, low income, countries.59 This is especially true for arbitrations related to fossil fuels investments. As highlighted above, these cases usually entail the payment of generous awards by states. Yet, out of the fossil fuel arbitrations initiated up to 31 December 2020, 92% of the cases involved a claimant from a high-income country and were mostly directed towards lower-middle and upper-middle income countries.60 In addition to the payment of such huge awards—should a state be found liable and ordered to pay such huge compensations—the costs of arbitration and legal defence are also very high. While this may not be an obstacle for fossil fuel companies, this may be for poor countries, requiring them to mobilise around USD 4.7 million on average in addition to the arbitral tribunal’s fees and expenses averaging at around USD 1 million.61 This, in turn illustrates how the ITR makes it more difficult for poorer, low-income, and developing countries, to adopt climate policies; though they are the first to feel the devastating effects of climate change. Indeed, Tienhaara et al note that ISDS cases initiated by the fossil fuel industry to challenge climate regulations

ClientEarth (2019) ‘Potential Solutions for Phase 3: Aligning the Objectives of UNCITRAL Working Group III with States’ International Obligations to Combat Climate Change’ https:// uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/wgiii_clientearth.pdf, p. 4. 57 Samples (2019), p. 143. ClientEarth (2019) ‘Potential Solutions for Phase 3: Aligning the Objectives of UNCITRAL Working Group III with States’ International Obligations to Combat Climate Change’ https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/ wgiii_clientearth.pdf, p. 4. 58 Schultz and Dupont (2015), p. 1167. 59 Schultz and Dupont (2015), pp. 1166–1167. 60 Di Salvatore (2021), p. iv. 61 Hodgson M, Kryvoi Y, Hrcka, D (2021) ‘2021 Empirical Study: Costs, Damages and Duration in Investor-State Arbitration’: https://www.biicl.org/documents/136_isds-costs-damages-duration_ june_2021.pdf. Di Salvatore (2021), p. 18. With legal costs sometimes even exceeding USD 30 million per case: Brauch (2020). 56

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would create “a flow of finance from those countries to private companies primarily based in the Global North”.62 Finally, there is also an imbalance between foreign investors and other interested stakeholders. As Johnson et al state, investment treaties have the “potential to distort governance” by giving “greater weight to the voice and interests of investors, potentially at the expense of other stakeholders”.63 Foreign investors have access to ISDS, which is one powerful tool to review state’s regulations and to let arbitral tribunals exercise governance, making ISDS not only “a mechanism to settle specific investment disputes, but also a structure of global governance”.64 Although in a rather conflicting relationship at the present time, the ITR and climate change could be complementary given the need for private finance to facilitate the energy transition in a limited period of time.65 The ITR could therefore promote and encourage such investments if it is carefully designed and reformed. However, as it stands now and as illustrated below with the behaviour of fossil fuel investors, the current regime does not fulfil that goal and rather diverts investments away from clean energy.66

3 Fossil Fuel Companies, Host States, and Climate Policies States must urgently adopt policies to phase-out of fossil fuels in order to avoid even greater global temperature increases than are already locked in, thereby limiting the disruption to social, economic, legal and political processes and causing greater harm to individuals and communities. To meet the 2 °C target set by the Paris Agreement, a third of oil reserves, half of gas reserves, and more than 80% of coal reserves should “remain untouched”; while meeting the 1.5 °C target requires 58% of oil, 59% of gas, and 89% of coal reserves to remain in the ground.67 A range of domestic law, regulation and policies are available to facilitate the energy transition, such as, “the denial or revocation of permits for the exploration, development, transport, or use of coal, gas, or petroleum resources; planned

Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf, p. 219. 63 Johnson et al. (2019), pp. 82–83. 64 Marley (2014), p. 1009. 65 Boute (2012). 66 Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf, p. 10 (‘The current investment treaty regime is incompatible with climate action goals both because it diverts investment away from climate-friendly towards climate-risky projects, and because it is antagonistic to the types of policy needed’). 67 Van Asselt (2021), p. 1. McGlade and Ekins (2015). Welsby et al. (2021). 62

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phase-outs of certain energy sources; removal of fossil fuel subsidies; the introduction of carbon taxes; stricter emissions standards; and electric vehicle mandates”; measures which could all be challenged in ISDS.68 Some of them result in the stranding of assets, which would induce significant losses to investors in fossil fuels. The power sector alone would have stranded assets worth USD 1.8 trillion, while stranded assets in the upstream oil and gas industry would be at least worth USD 3 trillion; with some analysts predicting between USD 7–17 trillion.69 Given these losses, the fossil fuel industry—already the “most litigious” in ISDS70—is expected to increasingly use ISDS to obtain compensation.71 These cases could not only be initiated by fossil fuel companies themselves, but also by any “financial investor that holds direct or indirect, majority or minority equity stakes in companies operating in the industry”;72 meaning that states are particularly vulnerable to ISDS for measures aimed at decarbonisation, given the scope of protection afforded by investment treaties. The ECT has already been invoked in 17% of all fossil fuel arbitrations,73 and will likely still be the most invoked treaty in future fossil fuel arbitrations.74 The use of ISDS based on the ECT will make the cancellation of oil and gas projects more costly, by at least USD 5–20 billion, given the usually generous compensation awarded by arbitral tribunals in fossil fuel arbitrations.75 The same holds true with the phase-out of coal with the ECT protecting “at least 51 power plants exposed to stranded asset risk”.76 Europe is therefore a “key regional hotspot”,77 with low and middle-income countries being more vulnerable to ISDS than high-income countries given that their coal infrastructures “are often younger, so investors are more likely

68

Center for International Environmental Law, ClientEarth, and the International Institute for Sustainable Development (2022) ‘Submission to the Organisation for Economic Co-operation and Development on Investment Agreements and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf, p. 62. 69 Center for International Environmental Law, ClientEarth, and the International Institute for Sustainable Development (2022) ‘Submission to the Organisation for Economic Co-operation and Development on Investment Agreements and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf, p. 62; IRENA (2017) ‘Stranded Assets and Renewables: How the Energy Transition Affects the Value of Energy Reserves, Buildings and Capital Stock’: https://www.irena.org/publica tions/2017/Jul/Stranded-Assets-and-Renewables. Tienhaara and Cotula (2020); Hansen (2022); Mercure et al. (2021). 70 Di Salvatore (2021), p. 8. 71 Tienhaara et al. (2022). 72 Tienhaara and Cotula (2020), p. 1. 73 Di Salvatore (2021), p. iv. 74 Tienhaara et al. (2022). 75 Tienhaara et al. (2022). 76 Tienhaara and Cotula (2020), p. 3. 77 Tienhaara and Cotula (2020), p. 2.

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to suffer financial losses in the transition to cleaner forms of energy”, requiring compensation.78 Signatories of the ECT have already taken steps to phase-out coal, which translated in the negotiation of compensation schemes or the instigation of ISDS by foreign investors. The following discussion will focus on Germany and the Netherlands, which have adopted different approaches when it comes to compensating investors, and Bulgaria as a country heavily reliant on coal.

3.1

The EU and Climate Change

All the countries discussed in this section are member states of the EU and therefore subject to its climate law and policy. While the EU has competence in environmental matters, including climate change, it does not have competence in energy matters meaning that there is room for conflict between EU climate law and domestic energy policies. For our purposes, the most significant legal measure is the new European Climate Law, which sets a legally binding commitment of net zero by 2050, and at least 55% greenhouse gas (GHG) reduction compared to 1990 by 2030, meaning that member states must contribute toward achieving this EU-wide target.79 In terms of renewable energies, the recast Renewable Energy Directive helps to facilitate the energy transition through binding targets for renewables of at least 32% of the EU’s energy mix by 2030, although this may be amended to 40% if the EU Commission’s proposed reform to the directive is accepted.80 The EU is therefore laying the path toward the energy transition, and failure to comply could result in a member state being taken to the Court of Justice of the EU (CJEU) by the Commission.

3.2 3.2.1

Context: Germany, the Netherlands, and Bulgaria Economies

Both Germany and the Netherlands are considered high income countries with Bulgaria classed as a middle-income country and one of the poorest EU member states (see Table 1). The richer a country is, the more likely its government will be

78

Tienhaara and Cotula (2020), p. 32. European Commission (2022) ‘European Climate Law’: https://ec.europa.eu/clima/eu-action/ european-green-deal/european-climate-law_en. Regulation 2021/119 establishing a framework for achieving climate neutrality, OJ L243/1 art 2.1, 4.1. 80 European Commission (2022) ‘Renewable Energy Targets’: https://energy.ec.europa.eu/topics/ renewable-energy/renewable-energy-directive-targets-and-rules/renewable-energy-targets_en; Directive (EU) 2018/2001 of the European Parliament and of the Council of 11 December 2018 on the promotion of the use of energy from renewable sources, OJ L328/82. 79

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Table 1 Data sources: IEA Countries & Regions (2015) Eurostat (2020) GDP USD (billion) Population (million) Contribution of GDP to EU (%)

Germany 3415.34 83.16 25

The Netherlands 808.33 17.44 6

Bulgaria 55.76 6.93 >1

willing, and able, to pay-to-regulate to introduce climate law and policy and the less likely the threat of ISDS, or inability to pay vast sums in compensation demanded by foreign investors, will disincentivise energy transition policies. In addition, less wealthy countries, such as Bulgaria, may be more likely to rely on foreign investors to support domestic fossil fuel production, thereby creating more avenues for ISDS claims as pressure mounts to introduce law and policies to reach net zero by 2050.

3.2.2

Climate Law, Policy, and Litigation

All three states have introduced domestic climate laws and policies that are both general and sectoral in nature,81 implementing EU commitments and the Paris Agreement. However, only Germany and the Netherlands have introduced legally binding GHG reduction targets of net zero by 2045 and 95% reduction compared to 1990 levels by 2050 respectively with interim targets for 2030.82 The Bulgarian government has demonstrated much greater reluctance to respond to climate change, and in June 2022, it was the only EU member state to abstain on voting on the Climate Law arguing that it “does not reflect sufficiently our national position”.83 Yet, all three states have committed to phasing-out coal with Bulgaria’s target set at 2038–204084 and Germany “ideally by 2030”.85 The Netherlands phase-out is also

81

German Federal Ministry for the Environment, Nature Conservation, Nuclear Safety and Consumer Protection, ‘National Climate Policy’: https://www.bmuv.de/en/topics/climate-adaptation/ climate-protection/national-climate-policy. 82 Government of the Netherlands (2019) ‘Climate Policy’: https://www.government.nl/topics/ climate-change/climate-policy. German Federal Ministry for the Environment, Nature Conservation, Nuclear Safety and Consumer Protection, ‘National Climate Policy’: https://www.bmuv.de/en/ topics/climate-adaptation/climate-protection/national-climate-policy. 83 Simeonova M, Trifonova M (2021), ‘Bulgaria’s Abstention from the Fight against Climate Change – European Council on Foreign Relations’. ECFR, 23 July 2021: https://ecfr.eu/article/ bulgarias-abstention-from-the-fight-against-climate-change/. 84 Ember Climate (2021) ‘A German 2030 Exit Will Isolate Remaining EU Coal Power Polluters’: https://ember-climate.org/app/uploads/2021/12/English-Remaining-EU-Coal-Power-Polluters.pdf. 85 Vela A (2021) ‘German Government Deal Sets 2030 Coal Phase-out Date but Makes Poor Commitments on Gas’: https://eeb.org/german-government-deal-sets-2030-coal-phase-out-datebut-makes-poor-commitments-on-gas-ngos-say/.

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aimed at 2030 however, recently this was amended to limit coal-fired power stations operations to no more than 35% of their capacity between 2022 and 2024.86 The much more ambitious GHG reduction targets of Germany and the Netherlands, and their earlier coal phase-outs, have been in response to successful domestic litigation brought by citizens due to the inadequacy of the response to climate change.87 Bulgaria has, to date, faced no such litigation meaning that the intransigence of the government is not countered by the oversight of the courts to ensure alignment with EU and international climate obligations. Thus, the Netherlands and Germany find themselves placed between the domestic courts and the EU on the one hand, and foreign investors financially harmed by enhanced climate and energy transition law and policies, and subsequent threat of ISDS claims, on the other.

3.2.3

Energy Mix

In all three states the majority of energy is currently derived from fossil fuels,88 with Bulgaria primarily reliant upon coal. Additionally, by “2030, the Bulgaria electricity mix will have one of the lowest shares of wind and solar in the EU”.89 Another constraint to the energy transition in Bulgaria is the importance of the mining sector, which is expected to grow further by 2030. Domestic and foreign investment is therefore important and sought after by the Bulgarian government in order to facilitate this growth.90 Indeed, the government is, among other things, reportedly “elaborating a new energy strategy to 2030, with a horizon to 2050. The key priorities are: guaranteeing energy security and the financial stability of companies in the energy sector”.91 Both Germany and the Netherlands have energy transition policies aiming to scale-up the use of renewables in the energy mix.92 Interestingly, in response to the LSE, ‘Law Prohibiting Coal in Electricity Production - Netherlands - Climate Change Laws of the World’: https://climate-laws.org/geographies/netherlands/laws/law-prohibiting-coal-in-electricityproduction. 87 Urgenda Foundation v The Netherlands [2015] HAZA C0900456689; Neubauer, et al v Germany [2021] Federal Constitutional Court 1 BvR 2656/18, 1 BvR 96/20, 1 BvR 78/20, 1 BvR 288/20, 1 BvR 96/20, 1 BvR 78/20. 88 IEA, ‘Germany - Countries & Regions’: https://www.iea.org/countries/germany. IEA, ‘The Netherlands - Countries & Regions’: https://www.iea.org/countries/the-netherlands. 89 Ember Climate (2022) ‘Bulgaria Falling Behind in the Electricity Transition’: https://emberclimate.org/app/uploads/2022/02/NECP-Factsheet-Bulgaria.pdf. 90 Euracoal (2020) ‘Coal Industry Across Europe, 7th edition’: https://public.euracoal.eu/download/ Public-Archive/Library/Coal-industry-across-Europe/EURACOAL-Coal-industry-across-Europe7th.pdf. 91 Euracoal (2020) ‘Coal Industry Across Europe, 7th edition’: https://public.euracoal.eu/download/ Public-Archive/Library/Coal-industry-across-Europe/EURACOAL-Coal-industry-across-Europe7th.pdf. 92 Government of the Netherlands (2022) ‘Reducing Dependence on Russia’: https://www. government.nl/topics/gas/reducing-dependence-on-russia. 86

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Russian war against Ukraine, in February 2022 the German economy ministry announced the Government’s intention to speed up the transition to renewables as a consequence of the war in order to reduce the country’s reliance on Russian gas which, in 2021, accounted for 32% of Germany’s gas.93 Consequently, in 2022, reform of the Renewable Energy Sources Act was proposed to increase the interim renewables target to 80% by 2030.94 Both Germany and the Netherlands have moved to burn more coal in the short-term to address the gas crisis, while the war has also acted as an impetus in the Netherlands to transition away from fossil fuels to renewable and nuclear energy as a way to lessen dependence on Russian fossil fuels.95 However, the Netherlands and Germany have also announced that they will work together to establish a new gas field in the North Sea for production to begin in 2024 indicating that securing fossil fuels is still an important issue for both states.96

3.3 3.3.1

Response to Foreign Investors and the Threat of ISDS Germany

Germany has so far been a respondent in five ISDS cases,97 three of which have now been settled.98 The last settlement was agreed with Vattenfall—a Swedish company—in 2021 after 9 years of ISDS proceedings challenging the German decision to phase out nuclear energy99 in response to the nuclear disaster in Fukushima in 2011.100 As a result of this abrupt change in policy, Vattenfall initiated

93 Tantussi M, ‘Germany to Speed Renewables Push Due to Ukraine Crisis’. Reuters 28 February 2022. https://www.reuters.com/business/energy/germany-hike-onshore-wind-solar-tender-vol umes-document-2022-02-28/. 94 LSE, ‘Renewable Energy Sources Act (EEG, Latest Version EEG 2021)’: https://climate-laws. org/geographies/germany/laws/renewable-energy-sources-act-eeg-latest-version-eeg-2021. 95 Weise Z, ‘Gas Crisis in One EU Country Would Swiftly Spread, Dutch Minister Warns’. Politico 27 June 2022. https://www.politico.eu/article/rob-jetten-netherlands-gas-crisis-in-one-eu-countrywould-swiftly-spread-dutch-minister-warns/. Government of the Netherlands (2022) ‘Reducing Dependence on Russia’: https://www.government.nl/topics/gas/reducing-dependence-on-russia. 96 Government of the Netherlands (2022) ‘The Netherlands and Germany Are Going to Extract Gas in the North Sea’: https://www.rijksoverheid.nl/actueel/nieuws/2022/06/01/nederland-enduitsland-gaan-gas-winnen-op-noordzee. 97 Two fossil fuel, one nuclear and two renewables. 98 UNCTAD (2022) ‘Investment Dispute Settlement Navigator, Germany’: https:// investmentpolicy.unctad.org/investment-dispute-settlement/country/78/germany/respondent. 99 ICSID Case No. ARB/12/12, Vattenfall AB and others v. Federal Republic of Germany, Discontinuance Order, 9 November 2021. 100 Páez-Salgado D (2021) ‘A Battle on Two Fronts: Vattenfall v. Federal Republic of Germany’: http://arbitrationblog.kluwerarbitration.com/2021/02/18/a-battle-on-two-fronts-vattenfall-v-fed eral-republic-of-germany/.

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arbitration against Germany in 2012 under the ECT.101 While initiating ISDS, Vattenfall also brought a constitutional case before the German Federal Constitutional Court. In 2016, the Court decided in favour of Vattenfall by considering that their constitutional rights had been infringed by the policy change without payment of compensation and that Vattenfall had suffered a breach of their legitimate expectations.102 This judgment prompted Germany to later amend its policy, though this change was similarly deemed unconstitutional by the Federal Constitutional Court in 2020.103 Germany ultimately put an end to this legislative, judicial, and arbitral saga by settling with Vattenfall for €1.4 billion.104 Germany now plans to phase-out coal by 2038. While investors are similarly detrimentally impacted by being forced to shut down operations progressively, this plan and the responses of both Germany and its investors are different. On the one hand, Germany pre-emptively stopped any court or arbitral case by negotiating a generous compensation package “intended to offset the loss of potential profits” for RWE (€2.6 billion) and LEAG (€1.75 billion) by which these companies agreed to “refrain from taking legal action against the shutdown”.105 Yet, as no agreement could be reached with Uniper on the amount due for compensation, the Datteln IV plant commissioned in 2020 is still allowed to continue its operations.106 On the other hand, it is debatable whether Germany would have been found in breach of its investor’s legitimate expectations. The research service of the German Parliament had found that Germany was “not liable to compensate [coal] plant operators”.107 Furthermore, given the climate commitments taken by states in international agreements, it could be argued that investors could and should have

101

ICSID Case No. ARB/12/12, Vattenfall AB and others v. Federal Republic of Germany. Páez-Salgado D (2021) ‘A Battle on Two Fronts: Vattenfall v. Federal Republic of Germany’: http://arbitrationblog.kluwerarbitration.com/2021/02/18/a-battle-on-two-fronts-vattenfall-v-fed eral-republic-of-germany/. BVerfG, Judgment of the First Senate of 6 December 2016, 1 BvR 2821/ 11. 103 Páez-Salgado D (2021) ‘A Battle on Two Fronts: Vattenfall v. Federal Republic of Germany’: http://arbitrationblog.kluwerarbitration.com/2021/02/18/a-battle-on-two-fronts-vattenfall-v-fed eral-republic-of-germany/. BVerfG, Order of the First Senate of 29 September 2020, 1 BvR 1550/ 19. 104 Ballantyne J (2021) ‘Vattenfall Saga at an End’: https://globalarbitrationreview.com/vattenfallsaga-end. 105 German Federal Ministry for the Environment, Nature Conservation, Nuclear Safety and Consumer Protection, ‘Frequently Asked Questions on Germany Coal’s Phase Out’: https://www. bmuv.de/en/topics/climate-adaptation/climate-protection/national-climate-policy/translate-toenglish-fragen-und-antworten-zum-kohleausstieg-in-deutschland. 106 German Federal Ministry for the Environment, Nature Conservation, Nuclear Safety and Consumer Protection, ‘Frequently Asked Questions on Germany Coal’s Phase Out’: https://www. bmuv.de/en/topics/climate-adaptation/climate-protection/national-climate-policy/translate-toenglish-fragen-und-antworten-zum-kohleausstieg-in-deutschland. 107 Hagen et al. (2019). 102

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predicted changes in fossil fuel policies.108 Whether Germany has successfully avoided any legal action by coal investors in its own courts and/or ISDS is however not yet confirmed. Indeed, the large compensation amounts agreed upon are now under an “in-depth investigation” by the European Commission (EC) which considers these compensation schemes to be “likely to constitute state aid” and therefore in breach with EU state aid rules.109 One point of contention raised by the EC concerns the large amounts awarded to investors for losing foregone profits.110 Should this scheme be struck down by the EU, Germany may face ISDS cases should it continue its planned coal phase-out.111

3.3.2

The Netherlands

In contrast to Germany’s approach to the coal phase-out, the Netherlands offered less-than-full compensation to foreign investors.112 Compensation of USD 241.8 million was offered to Onyx, which it accepted; while €512 million was offered to RWE and €351 million to Uniper, which were declined. Both companies have initiated ISDS based on the ECT instead113 with Uniper asking for €1 billion of compensation and RWE €1.4 billion.114 Whereas the claimants both argue that they would suffer substantive losses with the Dutch decision to phase-out coal given the relatively young age of their power stations (15 and 7 years old), independent analysts suggest

Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf. 109 European Commission (2021) ‘State Aid: Commission Opens In-Depth Investigation into Compensation for Early Closure of Lignite-Fired Power Plants in Germany’: https://ec.europa.eu/ commission/presscorner/detail/en/ip_21_972. 110 European Commission (2021) ‘State Aid: Commission Opens In-Depth Investigation into Compensation for Early Closure of Lignite-Fired Power Plants in Germany’: https://ec.europa.eu/ commission/presscorner/detail/en/ip_21_972. 111 ICSID Case No. ARB/21/4, RWE v. Netherlands. ICSID Case No. ARB/21/22, Uniper v. Netherlands. 112 Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf. 113 Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf. 114 Brauch (2020). Mathiesen K, Aarup SA, Oroschakoff K, ‘EU Governments Whipsawed by Climate and Coal Lawsuits’. Politico, 4 February 2021. https://www.politico.eu/article/eugovernment-climate-and-coal-lawsuits/. 108

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that these plants are already “loss-making” hence, “a win in ISDS would be a windfall for these investors”.115 However, the Russian invasion of Ukraine has also been responsible for the recent bailouts of energy companies by European governments.116 The energy crisis instigated by Russia prompted Germany to take a 30% stake in Uniper, which was until then primarily owned by a Finnish parent company Fortnum with nearly 80% of its shares (now down to 56%).117 Yet, this bailout for which Germany handed in €15 billion also has implications beyond Germany for the clean energy transition. As a condition of the bailout—provided it is approved by the EC and Uniper shareholders—Uniper has agreed to withdraw its ISDS case against the Netherlands, which would ultimately make the Dutch energy transition less costly.118 Such an agreement demonstrates a potential new avenue of cooperation between member states to facilitate the Community-wide energy transition and overcome the barriers created by fossil fuel companies and for richer states to help those that are less able to pay-to-regulate.

3.3.3

Bulgaria

Bulgaria has so far been brought to ISDS as a respondent on ten occasions.119 Given Bulgaria’s reliance on coal energy and its very recent commitment to phase-out coal by 2038, it is not surprising that no ISDS case or threat thereof has been brought up by coal operators at this point.120 Should this plan go forward, it is therefore likely that Bulgaria will be confronted with threats or instigation of ISDS, particularly

Tienhaara K, Thrasher R, Simmons BA, and Gallagher KP (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/ investment/investment-policy/OECD-investment-treaties-climate-change-consultation-responses. pdf, p. 218. 116 Rosemain M, Thomas L, ‘France to Pay $10 Billion to Take Full Control of EDF’. Reuters, 19 July 2022. https://www.reuters.com/markets/europe/france-offers-12-euros-per-share-take-fullcontrol-edf-2022-07-19/. Steitz C, Lehto E, Hansen H, ‘Germany Hands $15 Billion Bailout to Uniper After Russian Gas Hit’. Reuters, 22 July 2022. https://www.reuters.com/markets/deals/ germanys-uniper-gets-15-bln-eur-state-bail-out-avert-collapse-2022-07-22/. 117 Steitz C, Lehto E, Hansen H, ‘Germany Hands $15 Billion Bailout to Uniper After Russian Gas Hit’. Reuters, 22 July 2022. https://www.reuters.com/markets/deals/germanys-uniper-gets-15-blneur-state-bail-out-avert-collapse-2022-07-22/. 118 Ballantyne J. (2022) ‘Uniper to Withdraw ECT Claim as Part of German Bailout’: https:// globalarbitrationreview.com/article/uniper-withdraw-ect-claim-part-of-german-bailout. 119 UNCTAD (2022) ‘Investment Dispute Settlement Navigator, Bulgaria’: https:// investmentpolicy.unctad.org/investment-dispute-settlement/country/30/bulgaria/respondent. 4 for renewables. 120 European Commission (2022) ‘Summary of the Commission’s Assessment of the Bulgarian Recovery and Resilience Plan’ https://ec.europa.eu/info/sites/default/files/bulgaria_rrp_summary_ en.pdf. 115

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given its focus on the mining sector and attempts to attract private investment in it.121 Indeed, in 2019, at least 19 foreign companies (based in the UK and Cyprus) undertaking mining activities in Bulgaria were identified by Greenpeace.122 In addition, US foreign investors could have access to ISDS through the US-Bulgaria BIT entered into force in 1994 or structure their investment in such a way to get access to the protections granted by the ECT to resist the clean energy transition, opening the field of foreign investors still wider.123 Bulgaria could therefore potentially face claims or threats from these investors— under the ECT or another investment treaty—which could substantially increase the costs of the clean energy transition or further delay it as already witnessed in France, Germany, and the Netherlands. Like the investors in these fellow EU member states and in most ISDS cases, foreign investors in coal energy in Bulgaria could allege expropriation. Indeed, their assets would be stranded with reserves left below the ground then entailing losses of future income.124 They would also be likely to invoke a breach of FET and of their legitimate expectations. This argument could in fact resonate in tribunals considering the change of strategy operated by Bulgaria over the past year, with the previous government not considering a coal phase-out until at least 50 years have passed.125 Given the number of potential claimants and their expectations when it comes to the monetary compensation that is due to them, transitioning to clean energy could be crippling to the Bulgarian economy and further impede its transition to green energy.126 As the German and Dutch examples have demonstrated, states may have to pay either substantial compensation to each fossil fuel operator or face arbitration with its own legal costs and uncertainty about the determinations of liability and financial compensation (usually higher in fossil fuel arbitrations).

121 Euracoal (2020) ‘Coal Industry Across Europe, 7th edition’: https://public.euracoal.eu/ download/Public-Archive/Library/Coal-industry-across-Europe/EURACOAL-Coal-industryacross-Europe-7th.pdf, p. 23. 122 Greenpeace Bulgaria (2018) ‘Behind the Curtains of Financial Mines’: https://www.greenpeace. org/static/planet4-bulgaria-stateless/2019/03/db06f7e3-the-financial-mines_en_short.pdf. 123 Tienhaara and Cotula (2020). See the practice of treaty shopping being advertised by law firms: Columbia Center on Sustainable Investment (2022) ‘Climate Action Needs Investment Governance, Not Investment Protection and Arbitration’: https://www.oecd.org/investment/investmentpolicy/OECD-investment-treaties-climate-change-consultation-responses.pdf, para. 12. 124 Indeed, these coal reserves would have produced energy for 60 more years: Euracoal (2020) ‘Coal Industry Across Europe, 7th edition’: https://public.euracoal.eu/download/Public-Archive/ Library/Coal-industry-across-Europe/EURACOAL-Coal-industry-across-Europe-7th.pdf. 125 Morris A. ‘As the EU Targets Steep Emissions Cuts, this Country Has a Coal Problem’. National Geographic 8 November 2021. https://www.nationalgeographic.com/environment/article/as-theeu-targets-steep-emissions-cuts-this-country-has-a-coal-problem. 126 Ember Climate (2022) ‘Bulgaria Falling Behind in the Electricity Transition’: https://emberclimate.org/app/uploads/2022/02/NECP-Factsheet-Bulgaria.pdf.

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4 Renewable Energy and the Investment Treaty Regime While fossil fuel companies have long dominated the landscape of ISDS, there has also been a boom in green, renewable, energy arbitrations over the past decade. Low-carbon ISDS cases now represent 36% of all energy arbitrations (compared to 60% involving the fossil fuel industry).127 As previously mentioned, to achieve the goals of the Paris Agreement and the “energy revolution”, private (alongside public) investments are needed.128 To promote the flow of private capital into renewable investment, states—in Europe in particular—have put in place financial incentives such as feed-in tariffs. Yet, given the popularity of these measures and their potential breach of EU law by constituting state aid, states such as Spain and the Czech Republic had to withdraw or substantially reduce these incentives.129 Unhappy with this move—which nevertheless does not impact the viability of the investment made based on these schemes but their profitability only130—Europe then also became a regional hotspot for ISDS cases in RE. Under the ECT, Spain has so far been the most popular respondent in cases involving the renewable industry with, to date, 51 arbitrations launched against it for changes in its incentive regime applicable to renewables.131 Other countries such as Italy (12), the Czech Republic (6), Romania (5), Bulgaria (4), Germany (2), and Ukraine (1) have also been sued but to a lesser extent.132 This section therefore focuses on the cases in Spain given the number of ISDS cases against it and the Czech Republic as a lower-income country in the EU.

4.1

Spain

In 2018 the Spanish government lifted a moratorium on renewables resulting in a boom in investment in such energy sources.133 The country has a statutory target of

127

Di Salvatore (2021), p. 10. Tienhaara and Downie (2018), p. 452. 129 Simões (2017). 130 Do JH, Eichberger FS, Ropia S, Singh A, Singh AH, Vakharia P, Viñuales JE, ‘OECD Public Consultation on Investment Treaties and Climate Change – Response Paper’: https://www.oecd. org/investment/investment-policy/OECD-investment-treaties-climate-change-consultationresponses.pdf. 131 ECT Secretariat (2022) ‘List of Cases’ https://www.energychartertreaty.org/fileadmin/ DocumentsMedia/Statistics/Chart_ECT_cases_-_1_June_2022.pdf. 132 ECT Secretariat (2022) ‘List of Cases’ https://www.energychartertreaty.org/fileadmin/ DocumentsMedia/Statistics/Chart_ECT_cases_-_1_June_2022.pdf. 133 Galloway H, ‘Why Spain’s Renewable Energy Boom Is so Controversial’. Euronews 21 June 2022. https://www.euronews.com/my-europe/2022/06/21/why-spains-renewable-energy-boom-isso-controversial. 128

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achieving at least 74% of the energy mix from renewable energy sources by 2030,134 recently amended up from 42%.135 Its intention is to generate 100% of its electricity from renewable sources by 2050 and 97% of its energy mix.136 In order to achieve this, investment in renewables by both domestic and foreign investors is essential, given that presently, fossil fuels are a dominant source of energy in the country.137

4.1.1

Response to Foreign Investors and the Threat of ISDS

European states—including Spain and the Czech Republic addressed below—have introduced incentive schemes to promote investment in RE. However, Spain later amended this scheme, which entailed a reduction of profits for investors and led to a wave of ISDS cases against it. Although Spain has won some ISDS cases in RE, it has so far lost in many others and is still facing ongoing claims.138 As a result, Spain has already paid €1.2 billion to its foreign investors and €101 million for the costs of arbitration and legal representation, while foreign investors in ongoing cases are cumulatively asking for around €3 billion compensation.139 While some foreign investors in RE were not granted any compensation in some of these green arbitrations,140 the ITR—its standards of investment protection and their interpretation by arbitral tribunals—did protect these investors in RE against unreasonable changes by the state. To do so, tribunals focused on the FET and whether Spain had breached an investors’ legitimate expectations.141 As is typical of ISDS however, this interpretation has so far been inconsistent even though these cases were based on the same substantive regime (i.e., Spanish incentive regime for RE and the ECT) and with similar claims and arguments put forward by the parties.142 One small group of arbitral tribunals considered that there were no breaches of FET since Spain made no specific commitments towards its foreign investors so they

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Climate Change and Energy Transition Bill. Law 7/2021 on climate change and energy transition. 136 IEA (2021) ‘Spain 2021 Energy Policy Review’: https://www.iea.org/reports/spain-2021. 137 IEA (2021) ‘Spain’s Extensive Policy Plans Set to Help Underpin a Successful Energy Transition Powered by Renewables and Efficiency - News’: https://www.iea.org/news/spain-s-extensivepolicy-plans-set-to-help-underpin-a-successful-energy-transition-powered-by-renewables-andefficiency. 138 Bárcena and Flues (2022). 139 Bárcena and Flues (2022). 140 E.g., SCC Case No. 062/2012, Charanne and Construction Investments v. Spain, Final Award, 21 January 2016. 141 E.g., PCA Case No. 2012-14, The PV Investors v. Spain, Final Award, 28 February 2020. ICSID Case No. ARB/13/30, RREEF v. Spain, Decision on Responsibility and on the Principles of Quantum, 30 November 2018. SCC Case No. 062/2012, Charanne and Construction Investments v. Spain, Final Award, 21 January 2016. 142 PCA Case No. 2012-14, The PV Investors v. Spain, Final Award, 28 February 2020. 135

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could not have had a legitimate expectation that the regulatory framework will remain unchanged for the whole life of their investment.143 Although this line of reasoning could be counted as a loss for these investors in RE, the reality is that these cases were not concerned with regulatory changes impacting on the viability of their investments, but their profitability—which had become excessive due to changes of circumstances.144 As such, despite not being awarded compensation, these investors still had a profitable investment, though not with excessive profits. Other tribunals instead found a breach of FET which required the payment of integral compensation. These cases were therefore a win for investors in RE and are illustrative of the full-fledged protection granted to them and their investments by the ITR. To justify this position, the tribunals found in Masdar and NextEra that Spain had given specific confirmation or assurances to their investors that the regime would remain unchanged; therefore, breaching their investors’ legitimate expectations when amending the incentive regime.145 Yet, in Eiser, the tribunal protected the RE investors only against changes that had a direct impact on the viability of the investment by “destroying its value” (and not only entailing a reduction of excessive profits).146 Finally, tribunals have also adopted a position between these two extremes.147 This interpretation safeguards the right of a state to regulate for the public interest in the face of changing circumstances while still ensuring that investments in RE are adequately protected. Tribunals endorsing this position recognise that although these investors in RE could not have the legitimate expectation that the incentive regime would remain unchanged for the lifespan of their plants, they still had a legitimate expectation that their investment would generate a “reasonable return”.148 With this approach, investors in RE still benefit from the protection granted by the ITR with tribunals ensuring that their investment is still profitable to the extent they envisaged at the time of their investment (should the Spanish amendments to the regime and changes of circumstances not have happened in the first place). At the same time, Spain’s responsibility is mitigated without frustrating its investors’ legitimate expectations.

143

SCC Case No. 062/2012, Charanne and Construction Investments v. Spain, Final Award, 21 January 2016. 144 Do JH, Eichberger FS, Ropia S, Singh A, Singh AH, Vakharia P, Viñuales JE, ‘OECD Public Consultation on Investment Treaties and Climate Change – Response Paper’: https://www.oecd. org/investment/investment-policy/OECD-investment-treaties-climate-change-consultationresponses.pdf. 145 ICSID Case No. ARB/14/1, Masdar v. Spain, Award, 16 May 2018. ICSID Case No. ARB/14/ 11, Nextera v. Spain, Award, 31 May 2019. 146 ICSID Case No. ARB/13/36, Eiser and Energia Solar v. Spain, Award, 4 May 2017, para. 387. 147 E.g., PCA Case No. 2012-14, The PV Investors v. Spain, Final Award, 28 February 2020. 148 ICSID Case No. ARB/13/30, RREEF v. Spain, Decision on Responsibility and on the Principles of Quantum, 30 November 2018, para. 517.

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Czech Republic

Like Bulgaria, the Czech Republic is reliant upon coal, oil and natural gas for its energy security.149 Consequently, it is presently at the stage of the energy transition where focus is placed upon the phase-out of coal, rather than scaling up the use of renewables which, in 2019, amounted to under 16% of energy consumption.150 Facilitating investment in low carbon energy is an essential element of the Czech Republic’s energy transition and to comply with EU renewable and climate targets.151

4.2.1

Response to Foreign Investors and the Threat of ISDS

The Czech Republic also amended its incentive regime for RE, which similarly entailed a reduction in investors’ returns on their investments. Compared to Spain however, the Czech Republic has mainly been successful in its green arbitrations, as only one case (out of six) found a breach of FET warranting the payment of due compensation.152 This quite consistent jurisprudence—which is not typical of ISDS—could however be explained by the fact that four cases involved the same tribunal members dealing with the same law and claims with awards given the same day. While one could think that the ITR may have failed to protect RE investors as they lost most of their cases, it appears this is not the case. The reasoning adopted by these five tribunals did protect investors in RE and their legitimate expectations, while allowing states to regulate in the public interest.153 Indeed, the Czech Republic had to change its incentive regime as it had proven too popular and excessively lucrative to investors given the longer lifespan for renewable plants and a reduction of their operating costs; and because it was in breach of EU state aid law and in the midst of the 2008 global economic crisis.154 Despite finding in favour of the Czech Republic however, tribunals noted that even with the amended incentive regime, the plants were “as profitable – and in fact more profitable – than envisaged when the

‘Czech Republic - Countries & Regions’ (IEA): https://www.iea.org/countries/czech-republic. The World Bank, ‘Renewable Energy Consumption (% of Total Final Energy Consumption), Czech Republic’: https://data.worldbank.org/indicator/EG.FEC.RNEW.ZS?locations=CZ. 151 IEA (2021) ‘Czech Republic 2021, Energy Policy Review’: https://www.iea.org/reports/czechrepublic-2021. 152 PCA Case No. 2013-35, Natland and others v. Czech Republic, Judgment of Swiss Federal Tribunal, 7 February 2020. 153 E.g., PCA Case No. 2014-21, Photovoltaik Knopf v. Czechia, Award, 15 May 2019. PCA Case No. 2014-22, ICW v. Czechia, Award, 15 May 2019. PCA Case No. 2014-21, Photovoltaik Knopf v. Czechia, Award, 15 May 2019. PCA Case No. 2014-20, Voltaic Network v. Czechia, Award, 15 May 2019. PCA Case No. 2014-19, Europa Nova v. Czechia, Award, 15 May 2019. 154 E.g., PCA Case No. 2014-21, Photovoltaik Knopf v. Czechia, Award, 15 May 2019. 149 150

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support system was created” (i.e., with profits above the return rate and payback well below the initially planned 15 years even with the changes).155 Therefore, although investors did lose “extreme” and “excessive” profitability, they were still making reasonable profits, which were even above what they had envisaged at the time of their investments.156 These RE cases brought against Spain and the Czech Republic illustrate that the ITR offers protection to investors in RE against changes unreasonably impacting their returns, in breach of specific insurances given to investors, or ultimately destroying the value of their investments. The ITR could therefore encourage the green energy transition; although further reforms are needed to reconcile the ITR and international climate commitments.

5 The Reform of the Investment Treaty Regime to Ensure the Clean Energy Transition From the discussion above, it is fair to say that the ITR has so far delayed and/or made the transition to green energy more costly.157 Although the ITR currently “discourages bold transitions to renewables” and rather “entrenches carbonintensive investments” due to its climate-blindness,158 several options are available for states willing to reform it in order facilitate the clean energy transition. The potential for ITR to help with the clean energy transition is however not unanimously accepted with, for example, Brauch calling for international investment governance without investment protections or ISDS,159 while Tienhaara and Downie question whether investment treaties do attract foreign direct investments in the first place.160 Given the fragmentation of the ITR with thousands of investment treaties and hundreds of ephemeral arbitral tribunals, it is nevertheless here to stay unless states decide to terminate all their treaties (which is unlikely) and considering the glacial pace of arbitral reform and the update of treaties.161 The ECT is in fact a prime example this situation. While modernising the ECT has been the path chosen by the 155

E.g., PCA Case No. 2014-21, Photovoltaik Knopf v. Czechia, Award, 15 May 2019, para. 490. PCA Case No. 2014-21, Photovoltaik Knopf v. Czechia, Award, 15 May 2019. 157 E.g., Fermeglia et al. (Forthcoming), p. 16, identifying ISDS cases as ‘an important factor in delaying the global efforts to address climate change’. 158 Bernasconi-Osterwalder and Brauch (2019), p. 4. 159 Columbia Center on Sustainable Investment (2022) ‘Climate Action Needs Investment Governance, Not Investment Protection and Arbitration’: https://www.oecd.org/investment/investmentpolicy/OECD-investment-treaties-climate-change-consultation-responses.pdf. 160 Tienhaara and Downie (2018). 161 Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf. 156

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EU, one alternative would have been termination followed by the negotiation of an entirely new treaty. Yet, for termination to occur, contracting parties must all agree unanimously.162 Despite a call for collective withdrawals by EU member states, unanimity to terminate the ECT is unlikely to be achieved, considering that Japan is hostile to any modernisation of the ECT at all.163 Reforming the ITR is therefore another option and academics and policymakers have already identified ways in which reformed investment treaties could protect domestic climate regulations, while encouraging investment in RE. For example, investment treaties—in particular, the ECT—could differentiate between highcarbon emitters investments (fossil fuels) and low-carbon emitters investments.164 In other words, broad standards of investment protection and access to ISDS would be unavailable to investors in fossil fuels, but still granted for investors in green energy. This differentiation would in turn send a strong message to investors in RE that their investments will be protected.165 Alternatively or concomitantly, states could introduce a carve-out clause denying access to ISDS for investors challenging “bona fide measures to address climate change”; meaning that investors would have to bring their cases before domestic courts instead.166 Should states be willing to adopt such provisions, these efforts are however likely to be undermined by the fragmentation of the ITR and the coexistence of old and new generation investment treaties. Aggrieved investors could still invoke the protection of an old generation treaty, which has more favourable terms than the reformed treaty and which simultaneously protects their investment due non-derogation clauses.167 As Atanasova notes, “even if the ECT is terminated or successfully reformed, there are 463 International Investment Agreements that would continue to provide substantially similar protection to investors in its absence”.168 The circumvention of a reformed investment treaty could also occur with investors invoking the Most-Favoured-Nation (MFN) treatment, which allows

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Brauch (2021). Brauch (2021). 164 Bernasconi-Osterwalder and Brauch (2019). Aaken van A, Broude T (2022) ‘Ways of Reforming International Investment Agreements to Make them More Compatible with Climate Change Goals’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf. 165 Bernasconi-Osterwalder and Brauch (2019). 166 Paine J (2022) ‘Submission to OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treaties-climatechange-consultation-responses.pdf, p. 179. 167 Atanasova D (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf. 168 Atanasova D (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’, p. 23: https://www.oecd.org/investment/investment-policy/OECD-investmenttreaties-climate-change-consultation-responses.pdf. 163

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for the importation of the most favourable investment protections among investment treaties concluded by their host state.169 Therefore, any meaningful reform of the ECT, or any investment treaty for that matter, should also be careful to consider existing old agreements and to not include non-derogation clauses nor broad MFN standards in their new texts, since these may impede their efforts to make the ITR more climate-friendly. Given the “agreement in principle” on the modernisation of the ECT released in June 2022, the climate-friendliness of the ITR is however not likely to be achieved anytime soon.170 Should this modernised text be adopted unanimously by the contracting parties of the ECT in November, it is still “falling short of pledges to make the trade and investment deal better suited to achieving international climate goals”.171 Existing investments in fossil fuels would still be protected—both substantially and procedurally with an access to ISDS—for another 10 years;172 thus, directly contradicting the need to urgently phase-out fossil fuels. Failing to significantly amend the ECT to assist the clean energy transition, states could instead withdraw. Some EU member states—which are currently facing ISDS cases or have faced the threat thereof—have already suggested a collective withdrawal or effectively withdrawn.173 A group of five claimants have also recently brought a case in the European Court of Human Rights against 12 Contracting Parties to the ECT.174 Basing their claim on the right to life (Article 2 ECHR) and right to respect of private and family life (Article 8 ECHR), they consider the ECT in breach of these and are asking for these states to withdraw from the ECT.175 Such withdrawal would however only be effective 20 years later owing to the sunset clause of the ECT.176 Nevertheless, should a collective withdrawal occur, this sunset clause could be bypassed to some extent. Brauch notes that withdrawing states could enter an inter se agreement as per Article 41 of the Vienna Convention of the Law of Treaties to deem the ECT not applicable between them.177 He even considers that the

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Brauch (2020). European Commission (2022) ‘Agreement in Principle Reached on Modernised Energy Charter Treaty’: https://policy.trade.ec.europa.eu/news/agreement-principle-reached-modernised-energycharter-treaty-2022-06-24_en. 171 Fermeglia et al. (Forthcoming), p. 2. 172 European Commission (2022) ‘Agreement in Principle Reached on Modernised Energy Charter Treaty’: https://policy.trade.ec.europa.eu/news/agreement-principle-reached-modernised-energycharter-treaty-2022-06-24_en. 173 Brauch (2021). 174 Rankin J. and Neslen A., ‘Young People Go to European Court to Stop Treaty that Aids Fossil Fuels Investors’. The Guardian, 21 June 2022. https://www.theguardian.com/environment/2022/ jun/21/young-people-go-to-european-court-to-stop-treaty-that-aids-fossil-fuel-investors. 175 Rankin J. and Neslen A., ‘Young People Go to European Court to Stop Treaty that Aids Fossil Fuels Investors’. The Guardian, 21 June 2022. https://www.theguardian.com/environment/2022/ jun/21/young-people-go-to-european-court-to-stop-treaty-that-aids-fossil-fuel-investors. 176 ECT, Article 47(3). 177 Brauch (2021). 170

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EU could adopt meaningful reforms of the ECT by the way of such an inter se agreement for relationships between its member states—with this agreement open to interested non-EU ECT parties—should a meaningful modernisation not be adopted: The modifying inter se agreement could phase out the treaty’s protections to fossil fuel investments, adopt refined investment provisions, and even exclude the applicability of certain substantive protections and the ISDS clause. . . for those states and investors from those states.178

While the EU has been a driver for the modernisation of the ECT given the need rapidly phase-out fossil fuels and scale-up RE, the reality is that it does fall short of these stated objectives. The option to withdraw collectively from the ECT and to enter an inter se agreement—to both bypass the sunset clause and adopt the meaningful and climate-friendly reforms highlighted above in a timely manner—is now more likely to be revived and attractive for EU member states. France and now reportedly Germany, the Netherlands, Spain, and Poland have asked the EC to consider a collective withdrawal.179 Should the entire EU bloc decline to proceed, these five countries could however still withdraw on their own—as Italy already did—and enter an inter se agreement between themselves (and Italy) which would contain a more climate-friendly ITR applicable to the investor-state relationships between them. The reform of the ITR is already—and the conclusion of an inter se agreement with a new ITR between withdrawing parties would still be—too slow given the urgency of the climate crisis. Therefore, quick interventions focusing on best practices in policymaking and arbitral decision-making need to be adopted, while states still try to negotiate new investment agreements or reform old ones. On the one hand, the green arbitrations outlined in Sect. 4 have demonstrated that states need to carefully draft their incentives, such as feed-in tariffs for RE investments, by allowing for flexibility in case of changes in circumstances.180 Indeed, as “the cost of renewable energy is continually declining”, there is a moment when feed-in tariffs require adjustments, are only needed “on a limited basis”, or even no longer needed at all.181 On the other hand, arbitrators should change the way they calculate the amount of compensation due to foreign investors so as to avoid the situations exemplified above, where states had to pay very generous compensation in order to adopt climate policies. Aisbett and Bonnitcha therefore suggested that “compensation for breach of an investment treaty should be the lesser of the investor’s loss and the host state’s gain from the host’s state not having had the new regulatory arrangements in place

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Brauch (2021), p. 5. Simon F., ‘Europe Edging Closer to Withdrawal from Energy Charter Treaty’. Euractiv, 17 May 2022. https://www.euractiv.com/section/energy/news/europe-edging-closer-to-withdrawal-fromenergy-charter-treaty/. 180 Simões (2017). 181 Tienhaara and Downie (2018), p. 457; Mendonça et al. (2010), p. xxiii. 179

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when the investment was made”.182 This new method to calculate compensation, should a host State be found liable, would then both address “under-investment due to fear of opportunistic actions” taken by the host state and regulatory chill.183 At the same time, it would ensure that investors are compensated for the amount they lost and invested, and not for the loss of future income; and that host states do not have their motives for adopting climate regulations questioned by private international arbitrators that may be biased and share different interests from governments.184 This quick and targeted change which does not require a reform of investment treaties, but of arbitral practice, would also have implications for both fossil fuels and green arbitrations. Considering the coal arbitrations brought against the Netherlands, Bonnitcha explains that with this new method it may be that the Netherlands would not have to pay anything even if found liable.185 While for green arbitrations against Spain, Aisbett and Bonnitcha note that by accounting for state behaviour (i.e., opportunistic or not) and the actual losses of an investor (i.e., not the loss of future income), it may well be the case that no compensation would be due.186 Several options are therefore available to stakeholders (e.g., states, policymakers, arbitrators) willing to make the ITR more climate friendly. As illustrated by the modernised text of the ECT, years of negotiations do not necessarily lead to any meaningful outcome but rather only contribute to further delaying the clean energy transition. The adoption of a combination of more quick and targeted interventions, taking the form of a change in the calculation of compensation and a collective withdrawal from the ECT with an inter se agreement between withdrawing parties, would thus be more likely to reconciliate the ITR with international climate commitments more significantly; and even more so, should the entire EU bloc collectively withdraw from the ECT as Brauch suggested.187

Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf, p. 13. 183 Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf, p. 13. 184 Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf, p. 13. 185 Bonnitcha J (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf. 186 Aisbett E (2022) ‘Submission to the OECD Public Consultation on Investment Treaties and Climate Change’: https://www.oecd.org/investment/investment-policy/OECD-investment-treatiesclimate-change-consultation-responses.pdf. 187 Brauch (2021). 182

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6 Conclusion The fossil fuel industry is already the most active user of ISDS with the amount of compensation awarded in fossil fuel arbitrations usually five times higher than in non-fossil fuel arbitrations.188 ITR is therefore making the clean energy transition more costly. While these higher costs could be covered by Germany and the Netherlands without difficulties given their economy, this will prove more challenging in eastern European states, such as Bulgaria, which are poorer and heavily reliant on coal. On the other hand, this chapter has also revealed that the ITR does protect investments in RE—while safeguarding a state’s right to regulate in the public interest—by considering the wave of cases against Spain and the Czech Republic for amending their incentive schemes for RE. To fully reconciliate the ITR with international climate commitments—by not making fossil fuel phase-out more costly and by encouraging foreign investments in RE—the ITR needs to be significantly reformed. Although there is now an “agreement in principle” on the modernisation of the ECT, it fails to achieve such reconciliation. Furthermore, there is also no certainty that the modernised text of the ECT will be unanimously adopted by its 53 contracting parties. Yet, without any meaningful reform, many of the problems identified in this chapter regarding the decarbonisation of the energy sector, and the detrimental outcome on climate policy and the clean energy transition, will remain. As Ortino aptly puts it, investment law currently ‘is untenable. . . [the] law needs to improve dramatically both in terms of clarity and in terms of its ability to guarantee the host state’s legitimate right to regulate in the public interest.’189

References Bárcena L, Flues F (2022) From solar dream to legal nightmare, how financial investors, law firms and arbitrators are profiting from the investment arbitration boom in Spain. Transnational Institute and PowerShift Berge TL, Berger A (2021) Do Investor-State dispute settlement cases influence domestic environmental regulation? The role of respondent state bureaucratic capacity. J Int Dispute Settlement 12:1–41 Bernasconi-Osterwalder N, Brauch MD (2019) Redesigning the Energy Charter Treaty to advance the low-carbon transition. Transnatl Dispute Manag 16(1):1–28 Boute A (2012) Combatting climate change through investment arbitration. Fordham Int Law J 35: 613–664 Brauch MD (2021) Should the European Union fix, leave or kill the Energy Charter Treaty? Columbia Center on Sustainable Investment Staff Publications. 1–8

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Brauch MD (2020) Reforming international investment law for climate change goals. In: Mehling M, Van Asselt H (eds) Research handbook on climate finance and investment law. Edward Elgar Di Salvatore L (2021) Investor-State disputes in the fossil fuels industry. IISD Report Fermeglia M, Higham C, Silverman-Roati K, Setzer J (Forthcoming) Mapping climate-related investment arbitrations Fisher E, Scotford E, Barritt E (2017) The legally disruptive nature of climate change. Mod Law Rev 80(2):173–201 Hagen A, Jaakola N, Vogt A (2019) The interplay between expectations and climate policy: compensation for stranded assets. IAEE Energy Forum. Fourth Quarter 2019:29–31 Hansen TA (2022) Stranded assets and reduced profits: Analyzing the economic underpinnings of the fossil fuel industry’s resistance to climate stabilization. Renew Sustain Energy Rev 158 (112144):1–14 Johnson L, Sachs L, Lobel N (2019) Aligning international investment agreements with the sustainable development goals. Columbia J Transnatl Law 58(1):58–120 Kotzé LJ, Kim RE (2019) Earth system law: the juridical dimensions of Earth system governance. Earth Syst Gov 1:1–12 Levin K, Cashore B, Bernstein S, Auld G (2012) Overcoming the tragedy of super wicked problems: constraining our future selves to ameliorate global climate change. Policy Sci 45: 123–152 Marley JJ (2014) The environmental endangerment finding in international investment disputes. Int Law Polit 46:1003–1040 McGlade C, Ekins P (2015) The geographical distribution of fossil fuels unused when limiting global warming to 2°C. Nature 517:187–190 Mendonça M, Jacobs D, Sovacool BK, (2010) Powering the green economy: the feed-in tariff handbook. Earthscan Mercure JF, Salas P, Vercoulen P, Semieniuk G, Lam A, Pollitt H, Holden PB, Vakilifard N, Chewpreecha U, Edwards NR, Viñuales JE (2021) Reframing incentives for climate policy action. Nat Energy 6:1133–1143 Moon G (2021) Arrested ambition? Foreign investor protections, stabilization clauses and fossilfuelled power generation in developing countries. Rev Eur Comp Int Environ Law 30(3): 313–326 Ortino F (2019) The origins and evolution of investment treaty standards: stability, value, and reasonableness. Oxford University Press Prasad A, Loukoianova E, Feng AX, Oman W (2022) IMF staff climate notes – mobilizing private climate financing in emerging market and developing economies. International Monetary Fund Prislan V (2012) Non-investment obligations in investment treaty arbitration – towards a greater role for states. In: Baetens F (ed) Investment law within international law: an integrationist perspective. Cambridge University Press Sachs LE, Johnson L, Merill E (2020) Environmental injustice: how treaties undermine human rights related to the environment. La Revue des Juristes de Science Po 18:90–100 Samples T (2019) Winning and losing in Investor-State dispute settlement. Am Bus Law J 56(1): 115–175 Schultz T, Dupont C (2015) Investment arbitration: promoting the rule of law or over-empowering investors? A quantitative empirical study. Eur J Int Law 25(4):1147–1168 Simões FD (2017) When green incentives go pale: investment arbitration and renewable energy policymaking. Denver J Int Law Policy 45(2):251–285 Thiessen PV (2022) Reforming the energy charter treaty for sustainability? J Energy Resour Law 40 (4):465–489 Tienhaara K (2018) Regulatory chill in a warming world: the threat to climate policy posed by Investor-State dispute settlement. Transnatl Environ Law 7(2):229–250

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Tienhaara K, Cotula L (2020) Raising the cost of climate action? Investor-State dispute settlement and compensation for stranded fossil fuels assets. International Institute for Environment and Development UK Tienhaara K, Downie C (2018) Risky business? The Energy Charter Treaty, renewable energy, and Investor-State disputes. Glob Gov 24:451–471 Tienhaara K, Thrasher R, Simmons BA, Gallagher KP (2022) Investor-State disputes threaten the global green energy transition. Science 376(6594):701–703 Van Asselt H (2021) Governing fossil fuel production in the age of climate disruption: towards an international law of ‘leaving it in the ground’. Earth Syst Gov 9(100118):1–9 Viñuales J (2015) The environment breaks into investment disputes. In: Bungenberg M et al (eds) International investment law: a handbook. CH Beck, Hart, Nomos Viñuales J (2016) Foreign investment and the environment in international law: the current state of play. Cambridge Centre for Environment, Energy and Natural Resource Governance (C-EENRG). 2016(1):1–42 Welsby D, Price J, Pye S, Ekins P (2021) Unextractable fossil fuels in a 1.5°C world. Nature 597:230–234

Myriam Gicquello is a Lecturer in Mediation and Alternative Dispute Resolution at Newcastle Law School, Newcastle University. Emily Webster is an Assistant Professor in Environmental and Climate Law at the Department of Land Economy, University of Cambridge and an Official Fellow in Law at Queens’ College. She is a Fellow of C-EENRG, a member of the Hughes Hall Centre for Climate Engagement, the IUCN World Commission on Environmental Law and a Research Fellow of the Earth System Governance network.

Making the Energy Charter Treaty Climate-Friendly: An (Almost) Impossible Leap Mattia Colli Vignarelli

Contents 1 Prologue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Can the ECT Become Climate Friendly? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 The Clash Between the ECT and Climate Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 The ‘Modernised’ ECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Trapped in a Dead End? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 The Project of Investment Law and the ECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 The Strategy of Withdrawal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract This article provides a critical assessment of the ‘modernisation’ process of the Energy Charter Treaty (ECT). First, the research frames the ECT reform as a means for resolving the clash between the treaty and climate action, that cannot be effectively managed through conflicts rules. Consequently, the text of the ‘modernised’ ECT is analysed, with particular attention to the ‘flexibility mechanism’ for the optional progressive carve out of fossil-fuel investments, which is supposed to represent the key tool to make the ECT climate-friendly. The research shows that even this mechanism would ensure fossil-fuel investments protection at the crucial stage of energy transition. Therefore, the hypothesis of a withdrawal of the EU and its Member States is considered. Before mentioning the potential legal hurdles of this strategy, the research aims at understanding its impact on the political economy of investment law. Hence, the ‘geopolitical’ and ‘neoliberal’ drivers of the treaty are analysed through the notion of ‘institutional project’. Notwithstanding the

This author wishes to thank Prof. Annamaria Viterbo, Prof. Stefano Saluzzo and Dr. Gustavo Minervini for their invaluable advice and suggestions. M. Colli Vignarelli (✉) University of Turin, Turin, Italy e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 267–294, https://doi.org/10.1007/8165_2022_102, Published online: 11 January 2023

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unclear legal consequences of withdrawal, its symbolic value goes far beyond the ECT alone, certifying an unprecedented setback in the project of investment law.

1 Prologue The topic of this paper is at the very least a ‘topical’ one. When the manuscript was first concluded, in September 2022, an agreement in principle on the ‘modernisation’ of the ECT had been reached. Since then, many EU Member States declared their dissatisfaction with the resulting text, for the reasons highlighted in the first part of this work. Consequently (as of 23 November 2022), one after the other, Germany, France, Luxemburg, Spain, the Netherlands, Poland and Slovenia announced their intention to withdraw from the Treaty. What was described in this paper as an ‘hypothesis’ is becoming a reality. Therefore, the paper was updated to take into account developments until the 23rd of November, the day after the failure of the Conference of the Parties of the ECT which should have adopted the agreement. The discussion has been postponed to mid-April 2023, and it is hard to predict what will happen. In any case, this contribution provides a ‘legal back-story’ of what is occurring these days: the apparent unravelling of the most important international investment treaty.

2 Introduction During the European Council of 25 and 26 June 1990, the Heads of States or Governments of EU Member States were discussing the economic situation of a collapsing Soviet Union, when the then Dutch Prime Minister Ruud Lubbers— apparently surprising his interlocutors1—came up with a Memorandum titled ‘European Energy Community’. The aim was to kick-start a new season in energy cooperation between the Soviet Union and Western Europe in the aftermath of the post-Cold War era. It was the first step towards the Energy Charter Treaty (ECT), which was finalized in 1994 and entered into force in 1998.2 Today, the ECT counts 53 Contracting parties, consisting of 51 States plus the European Union and the EURATOM.3 1

See Lubbers (1996). Energy Charter Treaty (ECT), entered into force on 16 April 1998, 2080 UNTS 100. 3 Afghanistan, Albania, Armenia, Austria, Azerbaijan, Belarus (which applies the ECT provisionally, pending ratification), Belgium, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, European Union and Euratom, Finland, France, Georgia, Germany, Greece, Hungary, Iceland, Ireland, Japan, Jordan, Kazakhstan, Kyrgyzstan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Moldova, Mongolia, Montenegro, The Netherlands, North Macedonia, Poland, 2

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Over the years, the ECT has been under intense scrutiny and growing criticism, being described as an obstacle to climate action.4 Almost 25 years after the entry into force of the treaty, its Contracting parties have gone through negotiations for reform, with the EU leading the attempts to update its provisions. An agreement in principle on ‘modernisation’ has been reached on 24 June 2022. Since then, several EU Members States5 have announced their intention to withdraw from the Treaty, expressing their dissatisfaction with the outcome of the process. Against this background, this article provides a critical assessment of the reformed ECT and highlights the legal challenges surrounding the hypothesis of withdrawal. The research is divided in two main parts. The first part contends that the law of treaties is not sufficient to resolve the clash between climate action and the ECT. Indeed, ‘modernisation’ represents an attempt to reduce this tension. Consequently, the most relevant amendments to the ECT are analysed. After a brief review of those relating to standards of treatment and sustainable development, particular attention is devoted to the ‘flexibility mechanism’, i.e. an optional instrument to progressively carve out fossil fuel investment protection. This is supposed to represent the key legal tool to reach the goal of making the ECT climate-friendly. However, the research shows that even this amendment is not able to align the treaty with its expected results. The second part considers the hypothesis of withdrawal. Before mentioning the potential legal hurdles of this strategy, it seems necessary to analyse its deep-rooted impact on the political economy of investment law. Hence, the driving forces of the treaty are analysed through the notion of an ‘institutional project’.6 International investment law maintains that the internationalisation of substantive standards and the judicialisation of dispute resolution are capable of moving international economic relations from the fragile and ‘subjective’ level of politics to the stable and ‘objective’ level of law, reaching the goal of ‘depoliticisation’. However, this narrative may underestimate the distributive choices at the basis of the regime. Faced with the existential threat of climate change, a deep paradigm shift might be necessary.

Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, Tajikistan, Turkey, Turkmenistan, Ukraine, United Kingdom, Uzbekistan, Yemen. Moreover, Australia, Norway and Russia were signatory but did not ratify the treaty. Finally, Italy was also a Member State, but withdrew in 2015. 4 See e.g. End fossil fuel protection, available at http://www.endfossilprotection.org/ (visited 27 June 2022). 5 To date (23 November 2022) France, Germany, Luxemburg, Spain, the Netherlands, Poland and Slovenia. Italy has already withdrawn. 6 Koskenniemi (2009), p. 9. See also Crawford and Koskenniemi (2012), pp. 14–20.

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3 Can the ECT Become Climate Friendly? This section tries to answer the question of whether the reformed ECT, as it emerged from the ‘modernisation’ process, can “reflect climate change and clean energy transition goals and contribute to the achievement of the objectives of the Paris Agreement”.7 First, the research highlights the clash between the ECT and climate action. Accordingly, it investigates whether the Paris Agreement and the ECT can be deemed to entail a conflict of norms as per Article 30 of the Vienna Convention of the Law of Treaties (VCLT). In the second place, it looks for any interpretative tool to exclude measures taken to combat climate change from investment arbitration and possible liability under the current ECT. The analysis concludes that climate action is undoubtedly subordinate to the ECT standards. Against this background, the reformed ECT has been portrayed by the European Commission as being able to end this clash.8 However, the analysis of the ‘modernised’ treaty shows that this result is still not on the horizon.

3.1

The Clash Between the ECT and Climate Action

The current decade clearly represents a turning point in history. Indeed, “[t]he cumulative scientific evidence is unequivocal: Climate change is a threat to human well-being and planetary health. Any further delay in concerted anticipatory global action on adaptation and mitigation will miss a brief and rapidly closing window of opportunity to secure a liveable and sustainable future for all”.9 In this context, the Intergovernmental Panel on Climate Change (IPCC)10 recently pointed out the historical indifference of energy governance towards climate mitigation. Addressing the need to realign existing instruments to climate commitments, the ECT is cited as a problematic example, recognising that “a great deal of

7

Council Decision 10745/19 ADD 1. In the Commission’s words, the promise became reality: “[T]he modernised ECT [. . .] provides legal certainty and ensures a high level of investment protection while reflecting clean energy transition goals and contributing to the achievement of the objectives of the Paris Agreement”. See https://policy.trade.ec.europa.eu/news/agreement-principle-reached-modernised-energy-chartertreaty-2022-06-24_en (last accessed 31 August 2022). 9 Pörtner H O et al (eds., 2022), Summary for Policymakers in Pörtner H O et al (eds.) Climate Change 2022: Impacts, Adaptation, and Vulnerability. Contribution of Working Group II to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change. IPCC, p. 35, https:// www.ipcc.ch/report/ar6/wg2/downloads/report/IPCC_AR6_WGII_SummaryForPolicymakers.pdf (last accessed 13 June 2022). 10 The IPCC was established in 1988 by the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP) to assess “the scientific, technical and socioeconomic information relevant for the understanding of the risk of human-induced climate change”. 8

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[international energy governance] is still concerned with promoting further development of fossil fuels”.11 The IPCC points to a clash which has been apparent for quite a considerable period of time: the ECT is proving to be an obstacle to climate action.12 Indeed, there is clear evidence that if State parties to the Paris Agreement13 want to meet the climate change goals on which they agreed,14 they should act throughout the fossil fuel supply chain. This requires measures such as “removing fossil fuel subsidies; downscaling or terminating fossil fuel extraction projects; and restricting the development of infrastructure to transport fossil fuels”.15 Such measures would be potentially subject to investment arbitration as provided by Article 26 ECT. They might be scrutinized, as a way of example, under Article 10 ECT and could be found in violation of the Fair and Equitable Treatment (FET) standard,16 or declared expropriatory under Article 13 ECT, with investors being awarded compensations amounting to the ‘fair market value’ of the assets,17 probably far higher than they would under domestic law.18 The question in the concrete case might become: how to qualify a law approved by a Contracting Party of the ECT which imposes the termination of fossil fuel

The IPCC states that “[a] large number of bilateral and multilateral agreements, including the 1994 Energy Charter Treaty, include provisions for using a system of investor-state dispute settlement (ISDS) designed to protect the interests of investors in energy projects from national policies that could lead their assets to be stranded. Numerous scholars have pointed to ISDS being able to be used by fossil-fuel companies to block national legislation aimed at phasing out the use of their assets”. See Patt et al (eds., 2022), Final Draft of Chapter XIV, in Shukla et al (eds.) Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change. IPCC, p. 81, https://report. ipcc.ch/ar6wg3/pdf/IPCC_AR6_WGIII_FinalDraft_Chapter14.pdf (last accessed 13 June 2022). 12 For scholarship on the discrepancy between the investment regime and climate change mitigation commitments see among others Tienhaara and Downie (2018); Tienhaara et al. (2022). 13 Conference of the Parties, Adoption of the Paris Agreement. UN Doc. FCCC/CP/2015/L.9/Rev/1, 12 December 2015. 14 Article 4 of the Paris Agreement establishes the goal of “[h]olding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”. 15 See Tienhaara and Cotula (2020), p. 8. Recent studies find that the value of fossil fuel infrastructure protected by the ECT is EUR 344.6 billion in the EU, the UK and Switzerland. See Moldenhauer and Schmidt (2021), ECT data analysis: Results and Methods, 23 February 2021, https://www.investigate-europe.eu/en/2021/ect-data/ (last accessed 13 June 2022). 16 Which under the ECT expressly includes an obligation of regulatory stability, protecting in the broader possible way the ‘legitimate expectations’ of the Investor. (See Article 10 ECT). 17 “[. . .] compensation shall amount to the fair market value of the Investment expropriated at the time immediately before the Expropriation or impending Expropriation became known in such a way as to affect the value of the Investment”, Article 13(1) ECT. 18 For a detailed analysis of potential violations of ECT standards by States in achieving the energy transition, see Tienhaara and Cotula (2020). 11

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extraction activities covering also existing projects?19 This question requires to explore the legal arguments on the interactions between the two agreements. The first issue to address is whether the Paris Agreement and the ECT might give rise to a conflict of norms as per Article 30 of the Vienna Convention on the Law of Treaties (VCLT).

3.1.1

Excluding a Conflict of Norms

A conflict of norms arises when the provisions of an earlier treaty and a later treaty concern the same subject-matter and are incompatible, i.e. the fulfilment of the obligation under one treaty affects the fulfilment of the obligation of another in a concrete situation.20 When it is impossible to harmonise the two treaties and the earlier one is not explicitly or implicitly terminated (or suspended),21 Article 30 VCLT enters the picture, providing that the earlier treaty remains applicable only to the extent that its provisions are compatible with those of the later treaty.22 In the present case, the ECT—the earlier treaty—would apply only to the extent that its provisions are compatible with the Paris Agreement, the later treaty.23 However, the hypothesis of an investment tribunal finding the two agreements in conflict is at least remote.24 The Paris Agreement does not oblige State parties to adopt specific measures negatively impacting on the investment sector. It is based on a goal setting approach, containing ‘soft’ obligations which leave to States the

19

An investment tribunal in a most recent award (in the case Rockhopper Italia S.p.A., Rockhopper Mediterranean Ltd, and Rockhopper Exploration Plc v. Italian Republic, ICSID Case No. ARB/17/ 14), had an answer to a similar question: the measure violates the ECT standards of treatment and shall be compensated. See https://www.theguardian.com/business/2022/aug/24/oil-firm-rockhop per-wins-210m-payout-after-being-banned-from-drilling (last accessed 31 August 2022). 20 See Koskenniemi (2006); Conforti (2011), p. 188; Von der Decken (2018a), p. 549. 21 The relevant provisions here are Article 30(3) and Article 30(4) VCLT, read in conjunction with Article 59 VCLT. See Sadat-Akhavi (2003), pp. 70 ff. 22 Specifically, Article 30(3) applies to the cases in which all the parties of the later treaty are parties to the previous one, while Article 30(4) to the cases in which the parties to the later treaty do not include all the parties to the earlier one. This latter is the situation in which the relationship between the Paris Agreement and the ECT falls, considering that Yemen is a Contracting party of the ECT and not of the Paris Agreement. 23 Except in the relations with Yemen, which is not a party of the Paris Agreement. In that case, according to Article 30(4) VCLT, only the ECT would apply. 24 Investment tribunals usually do not even hold that the EU and the applicable intra-EU investment agreement share the same subject matter. See e.g. Achmea BV v The Slovak Republic, UNCITRAL, PCA Case No 2008-13 (formerly Eureko B.V. v The Slovak Republic), Decision on Jurisdiction, Arbitrability and Suspension, 26 October 2010, para. 283; Jan Oostergetel and Theodora Laurentius v. The Slovak Republic, UNCITRAL, Decision on Jurisdiction, 30 April 2010, para. 104; Electrabel S.A. v. Republic of Hungary, ICSID Case No. ARB/07/19, Award (25 November 2015), paras 4.174–4.176.

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determination of their own plans.25 The ECT, for its part, does not prohibit such measures, unless they violate the standards of treatment.26 Moreover, the formulation of the ECT standards leaves wide margin for interpretation in the concrete case, making it extremely difficult to assert that it is impossible to fulfil simultaneously the obligations deriving from the two treaties.27

3.1.2

The Results of Treaty Interpretation: ECT First

Provided that, under the law of treaties, the ECT and the Paris Agreement apply simultaneously, it is necessary to discuss whether other interpretative tools might suggest to an investment tribunal to consider the Paris Agreement in the interpretation of ECT standards—e.g. the FET standard provided by Article 10(1) ECT and the rules on expropriation established by Article 13 ECT—and with what consequences. First of all, the Paris Agreement is indirectly recalled by Article 19 ECT. This provision establishes that “[i]n pursuit of sustainable development and taking into account its obligations under those international agreements concerning the environment to which it is Party, each Contracting Party shall strive to minimise in an economically efficient manner harmful Environmental Impacts” [emphasis added]. Indeed, pursuant to Article 31(1) VCLT, a tribunal is called to determine “the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose”. According to Article 31(2) VCLT, the context includes the text of the treaty, its preamble and annexes. Therefore, a contextual interpretation of Part III ECT might suggest taking into account the Paris Agreement goals via Article 19(1) ECT.28 However, the latter provision does not seem to strengthen environmental and climate obligations, but to circumscribe their acceptability. According to this provision, the Contracting parties are called upon to fulfil their obligations under environmental agreements ‘in an economically efficient’ manner. Consequently, even if a Tribunal were to consider Article 19 ECT pertinent in evaluating the conduct of a State, a test on ‘economic efficiency’ would delimit the boundaries within which climate action is acceptable. Even if there is no significant case law on this

See Bernasconi-Osterwalder and Brauch (2019), p. 9. The only ‘hard’ provisions are the procedural obligations to report the nationally determined contributions (NDCs) every 5 years and to register these with the United Nations Framework Convention on Climate Change (UNFCCC) Secretariat. 26 However, the mere possibility of this happening could be concerning. See below on ‘regulatory chill’. 27 On the other hand, the very wording of Article 30 VCLT seems to suggest that ultimate choice on which obligation to fulfil falls on the State, with all the consequence in terms of responsibility. See Mus (1998), pp. 227 ff; Saluzzo (2018), p. 103. 28 On Article 19, see Baltag (2019), p. 8. 25

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provision,29 this test would arguably subordinate the legitimacy of a measure affecting fossil fuel assets to the standards provided by the ECT.30 Therefore, Article 19 ECT does not seem helpful in safeguarding regulatory measures adopted to comply with the Paris Agreement. At the same time, the ECT Preamble recalls “the United Nations Framework Convention on Climate Change, the Convention on Long-Range Transboundary Air Pollution and its protocols, and other international environmental agreements with energy-related aspects”, recognising “the increasingly urgent need for measures to protect the environment, including the decommissioning of energy installations and waste disposal, and for internationally-agreed objectives and criteria for these purposes”. This reference—added to that of Article 19 ECT—might confirm the relevance of Article 31(3)(c) VCLT as a useful interpretative tool, leading a tribunal to consider the Paris Agreement in evaluating the conduct of the respondent State.31 According to this provision, any “relevant rules of international law applicable in the relations between the parties”, together with the context, has to be taken into account in the interpretation of a treaty. This sets out the principle of ‘systemic integration’,32 often described as a powerful means to assure the unity of the international legal order,33 a ‘master key’ to the house of international law.34 A more frequent use of this principle in investment arbitration is often regarded by the doctrine as a possible way for successfully cross-fertilising investment law with other sectors of international law.35 So far the provision has been deemed to operate “not at the level of individual investors but at the interstate level”. not affecting the obligations of the States towards an investor. (See Blusun S.A., Jean-Pierre Lecorcier and Michael Stein v. Italian Republic, ICSID Case No. ARB/14/3, Award of 27 December 2016, para. 274). Given that the obligations under Article 19 ECT only apply between the parties and do not directly affect investors, the article could be disregarded in evaluating the responsibility of a Contracting Party for a possible violation of the standards of treatment. The Tribunal seems to implicitly indicate that, on the contrary, the standards of treatment pertain to the category of “direct rights of individuals”, which is however far from uncontroversial. See e.g. Reinisch and Mansour Fallah (2022), p. 18. 30 See also Hobér (2020), pp. 351–352 “Contracting Parties shall, in pursuit of sustainable development, strive to minimize harmful environmental effects within or outside their respective Areas of all operations in the energy sector, while acting in a cost-effective manner”. 31 At least when the respondent State and the State in which the applicant investor is incorporated are both parties to the Paris Agreement, e.g. always except in the case of Yemen. 32 See ex multis McLachlan (2005), pp. 279–320. 33 See e.g. Dupuy (2002), p. 456. 34 Koskenniemi (2006), p. 211. 35 For a clear endorsement of the use of systemic integration to reduce the isolation of investment law see e.g. Schill and Djanic (2018), p. 45. This principle has been applied in the famous Urbaser v. Argentina case to construct investor’s obligations through the rules of the Universal Declaration of Human Rights (UNDHR) and the International Covenant on Economic, Social and Cultural Rights (ICESCR). See Urbaser S.A. and Consorcio de Aguas Bilbao Bizkaia, Bilbao Biskaia Ur Partzuergoa v. The Argentine Republic, ICSID Case No. ARB/07/26, Award of 6 December 2016, para. 1992: “[. . .] it can thus be retained that the BIT does not represent, in the view of the 29

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Therefore, in the event that a State adopts measures affecting investments covered by the ECT in order to fulfil its obligations under the Paris Agreement, a tribunal might resort to systemic integration. However, as underlined above, the tribunal would not find in this treaty any obligation concerning the investment sector. More in detail, it would not find anything suggesting specific deference to measures taken to combat climate change.36 Rather, the tribunal might look at the UNFCCC, from which the Paris Agreement originates,37 which provides at Article 3(4) that “[m] easures taken to combat climate change, including unilateral ones, should not constitute a means of arbitrary or unjustifiable discrimination or a disguised restriction on international trade [emphasis added]”.38 Even if this provision refers to international trade, there is no apparent reason to exclude its relevance for investment law in the context of systemic integration. Therefore, an investment tribunal might conclude that a proper harmonisation of the two treaties confirms that measures taken to reach the Paris Agreement’s goals should comply with the ECT standards. Even systemic integration would not be helpful in clearly safeguarding a State’s regulatory powers with regard to climate action. Finally, a ‘pragmatic’ solution may be to consider a measure affecting fossil fuel assets a purely domestic one. Accordingly, an investment tribunal should ‘incorporate’ environmental consideration in the interpretation of ECT standards.39 This might grant a particular deference to environmental measures,40 including those related to climate action.

Contracting parties and its clear text, a set of rules defined in isolation without consideration given to rules of international law external to its own rules”. However, on the impossibility and indesirability of entrusting the balancing between public and private interests to investment arbitration, see Davitti (2020), p. 353. 36 Some sort of deference should be always accorded. Its threshold, however, is not clear. See e.g. TECO Guatemala Holdings, LLC v. Republic of Guatemala, ICSID Case No. ARB/10/17, Award of 19 December 2013, para. 493: “although the role of an international tribunal is not to second-guess or to review decisions that have been made genuinely and in good faith by a sovereign in the normal exercise of its powers, it is up to an international arbitral tribunal to sanction decisions that amount to an abuse of power, are arbitrary, or are taken in manifest disregard of the applicable legal rules and in breach of due process in regulatory matters.” The margin of discretion of the tribunal seems immense. 37 The Paris Agreement was adopted during the 21st Conference of the Parties to the UNFCCC (COP21). See also the Preamble of the Paris Agreements, which recalls “the objectives of the Convention and [its] principles”. 38 United Nations Framework Convention on Climate Change, 9 May 1992, 1771 UNTS 107. 39 This ‘meanstreaming’ of environmental consideration is increasingly adopted by investment tribunals. See Dupuy and Viñuales (2018), pp. 461–469. 40 See, for instance, William Ralph Clayton, William Richard Clayton, Douglas Clayton, Daniel Clayton, and Bilcon of Delaware, Inc. v. Government of Canada, Permanent Court of Arbitration (PCA) Case No. 2009-04, Award on Jurisdiction and Liability of 17 March 2015, paras. 595–601.

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As a general remark, relying only on the ‘environmental sensibility’ of arbitrators seems highly risky, as the safeguard of climate action may ultimately depend on the composition of the tribunal.41 Moreover, the very wording of ECT provisions seems to discourage this approach, embedding a sort of presumption about environmental measures as ‘creeping protectionism’. Apart from the already cited Article 19 ECT, a prominent example is Article 24 ECT. Indeed, it is at least arguable that measures stranding fossil fuel assets could fall under the scope of Article 24(2)(i) ECT, which establishes that “[t]he provisions of this Treaty [. . .] shall not preclude any Contracting Party from adopting or enforcing any [m]easure [. . .] necessary to protect human, animal or plant life or health”.42 Article 24 ECT constitute a general exception clearly inspired by Articles XX and XXI of the General Agreement on Tariffs and Trade (GATT),43 at first glance recognising the regulatory powers of the Contracting parties. However, its adaptation to the ECT resulted in puzzling limitations. First, according to Article 24 (1) ECT, the exception does not apply in the case of expropriation.44 Moreover, Article 24(2)(b) excludes that measures ‘necessary to protect human, animal or plant life or health’ may derogate from the standards of treatment provided by Part III ECT.45 The general exception does not help in safeguarding a State’s regulatory powers in this matter, where measures related to climate action and resulting in fossil fuel stranded assets could fall.

3.2

The ‘Modernised’ ECT

The previous analysis presented the legal arguments on the basis of which regulatory measures taken to comply with the Paris Agreement are subject to the ECT standards of treatment. Measures affecting fossil fuel assets are not excluded from the scrutiny of investment arbitration and possible liability. Whether this is acceptable in the face of the climate emergency is another matter entirely.

41

See the conclusions on the analysis on the case law of investment tribunals dealing with environmental matters in Sands et al. (2018), p. 915. 42 Actually, there is no case law on Article 24 ECT, probably for the limited scope of application of the provision. See Hobér (2020), p. 390. 43 Bamberger (1996), p. 22. 44 Also, under Article 24(1) the exception does not apply to Article 12 (Compensation for losses) and Article 29 (Interim Provisions on Trade-Related Matters). 45 The formulation of Article 24(2) is very tricky. It provides that the regulatory exception does not apply to the provisions “referred to in paragraph (1)” (i.e. expropriation, compensation for losses and interim provisions on trade-related matters) and to those of “Part III of the treaty” only “with respect to subparagraph (i)” (i.e. measures necessary to protect human, animal or plant life or health).

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That the answer may be negative is suggested by the well-known phenomenon of ‘regulatory chill’. Growing evidence suggests that the mere risk of investment arbitration is able to slow and chill regulatory action.46 Therefore, the risk of having to compensate fossil fuel assets could induce ECT Contracting parties to slow down the measures taken to combat climate change. Indeed, the ECT embraces the concept of ‘neutrality’. Former ECT’s secretary general Urban Rusnák explained that “the [ECT] is neutral. It protects all energy investments, fossil fuels, renewable, nuclear”.47 However, energy policy should not be ‘neutral’: according to the best available science, new fossil-fuel investments should be discouraged and existing ones should be terminated in the next few years.48 Therefore, considering the phenomenon of regulatory chill, the mere possibility of fossil-fuel investment litigation may be per se problematic. It is precisely in this challenging context that the EU has decided to lead the efforts to amend the ECT. Indeed, the “growing perception that the ECT does not sufficiently meet today’s climate policy commitments”49 inevitably prompted the EU to take an ambitious target: “[t]he Modernised ECT should reflect climate change and clean energy transition goals and contribute to the achievement of the objectives of the Paris Agreement”.50 The first EU proposal was sent to the ECT Secretariat in May 2020. In January 2021, an additional submission was released.51 After 15 rounds of negotiations, the parties reached an Agreement in Principle.52

46 The literature on regulatory chill is extensive. See, among others, Tienhaara (2011); Cotula (2014); Van Harten and Scott (2016); Schram et al. (2018). 47 See Backman C (2020), Interview: A new Energy Charter Treaty as a complement to the Paris Agreement. Borderlex, 18 June 2020, https://www.energycharter.org/fileadmin/DocumentsMedia/ Other_Publications/A_new_Energy_Charter_Treaty_as_a_complement_to_the_Paris_Agreement. pdf (last accessed 13 June 2022). However, it should be underlined that the treaty does not protect all energy investments. Some technologies, especially hydrogen, are not covered by the treaty, see Maynard and Ason (2019); Keay-Bright (2019). 48 The urgency of climate action is reflected in the extremely limited remaining ‘global carbon budget’ in a 1.5 °C scenario. This concept represents the total amount of CO2 that can still be emitted in the future while limiting global warming to a given temperature target. See Matthews et al. (2020). 49 See https://policy.trade.ec.europa.eu/news/commission-presents-eu-proposal-modernisingenergy-charter-treaty-2020-05-27_en (last accessed 8 September 2022). 50 Council Decision 10745/19 ADD 1. 51 The text proposal is available at https://policy.trade.ec.europa.eu/news/commission-presents-euproposal-modernising-energy-charter-treaty-2020-05-27_en (last accessed 8 September 2022) and the additional submission at https://trade.ec.europa.eu/doclib/docs/2021/february/tradoc_159436. pdf (last accessed 8 September 2022). 52 See the Public Communication explaining the main changes contained in the agreement in principle, Energy Charter Conference approved at its ad hoc meeting held on 24 June 2022, available at https://www.energycharter.org/fileadmin/DocumentsMedia/CCDECS/2022/ CCDEC202210.pdf (last accessed 8 September 2022).

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The reformed ECT largely reflects the Investment Chapter of the EU-Canada Comprehensive Economic and Trade Agreement (CETA),53 although with some significant differences.54

3.2.1

Standards, Exceptions and the ‘Disconnection Clause’

With regard to the provisions on investment protection, the most relevant amendments aim at clarifying the kinds of assets covered55 and restricting the content of the standards of treatment. Article 10 ECT is completely re-written essentially importing the CETA wording, with the aim of excluding the ‘umbrella clause’ and narrowing the FET standard, inter alia trying to limit the catch-all concept of ‘legitimate expectations’.56 Moreover, various exceptions and clarifications are included with the aim of extending the parties’ regulatory space.57 Among these exceptions, the new Article 24(3) excludes the application of Articles 7, 26, 27 and 29 among members of the same Regional Economic Integration Organisation. Therefore, ECT provisions on Transit, State-to-State Dispute Settlement and—most importantly—Investor-State Dispute Settlement, will no longer apply in intra-EU relations. This amendment represents an explicit recognition of the so called ‘disconnection clause’ for intra-EU investment disputes, marking a breaking point in international investment law.58 Indeed, not only the ECT is the most litigated investment treaty,59 but almost 60% of known ECT cases are intra-EU.60 The disconnection clause will undoubtedly dramatically reduce the role of investment arbitration in the years to come, even if this tool will remain in force in extra-EU relations.61 53

Comprehensive Economic and Trade Agreement (CETA) between Canada, of the one part, and the European Union and its Member States, of the other part, OJ L 11, 14.1.2017, p. 23–1079. On the impact of CETA investment chapter see e.g. Pantaleo (2017); Overduin (2021). For a discussion on the role of the CETA on the legitimacy crisis of investment arbitration see Dionysiou (2021). For a comprehensive and multi-point analysis see Mbengue and Schacherer (2019). 54 The following analysis is based on a ‘leaked’ text, available here: https://www.bilaterals.org/ IMG/pdf/reformed_ect_text.pdf (last accessed 23 November 2022). 55 The new Article 1 is supposed to exclude (as with CETA) the so-called ‘mailbox companies’ from protection. 56 Similarly, Article 13 (Expropriation) is amended according to the CETA wording. 57 The most relevant amendments make Article 24 applicable to all ECT provisions and add a new article (essentially imported from CETA) on the ‘right to regulate’. 58 See e.g. https://borderlex.net/2022/09/19/comment-will-successful-revision-talks-save-theenergy-charter-treaty/ (last accessed 19 September 2022). 59 With more than 140 known cases. See below at Sect. 3.1 for further discussion. 60 As once explained by the former ECT General Counsel Graham Coop, the treaty has become “to a very large extent [. . .] an intra-UE investment protection treaty” See Coop (2014), p. 518. 61 With concrete consequences discussed below, at Sect. 3.2. However, according to the new Annex NPT, Japan will not apply Part III with respect to European fossil-fuel investments and investors, while—according to the new Annex IA-NI—Switzerland and Turkey will not give their consent to

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Sustainable Development, the Fossil-Fuel ‘Carve-Out’ and Its Limits

In addition to the above, the ECT reform introduces a number of provisions specifically covering sustainable development. The amended Article 19 reaffirms the right of each party to regulate on sustainable development issues, while providing for the obligation not to reduce the level of environmental and labour protection. It includes an obligation to “strive” to ensure high environmental and labour standards.62 Also, it obliges parties to take measures to protect the environment and to improve labour conditions in a transparent manner, and to approve legislations on environmental impact assessment.63 Moreover, a new article concerns ‘Climate change and clean energy transition’, recalling the UNFCCC and the Paris Agreement goals, imposing an obligation to implement the Parties’ climate commitments and to promote various types of climate change policies. These provisions can be deemed an application of the current Trade and Sustainable Development (TSD) strategy of the EU.64 However, in this case a stronger language is adopted, probably in an attempt to mitigate possible criticism on their effectiveness.65 Finally, Article 27 ECT (Settlement of disputes between Contracting Parties) is amended to cover also disputes on the interpretation of climate change provisions, and a new Article is added to specifically cover the resolution of disputes on the

international arbitration in disputes related to an investment in their Area by European fossil-fuel investors (in general, as provided by the complex Annexes-system established by the reformed ECT “by an Investor of another Contracting Party regarding Energy Materials and Products excluded by the latter in Annex NI”). 62 The relevant environmental and labour conventions are recalled, as well as the UN Guiding Principles on Business and Human Rights. 63 However, the above mentioned reference to ‘economic efficiency’ is maintained and reinforced with a new comma which provides that: “The Contracting Parties shall not implement their respective environmental and labour laws in a manner that would constitute a disguised restriction on trade or investment in energy between the Contracting Parties or an unjustifiable or arbitrary discrimination against other Contracting Parties”. See the new Article 19(4). 64 Since its 2009 FTA with South Korea, the EU has included TSD Chapters in its trade agreements, committing the parties to ratify and implement International Labour Organisation (ILO) conventions and Multilateral Environmental Agreements (MEAs), and not to lower environmental and labour standards. In the current TSD Chapters (with Central-America, Colombia, Peru, Georgia, Moldova and Ukraine) neither enforceable dispute settlement procedures nor financial sanctions for non-compliance are provided. More recently, the EU-Japan Economic Partnership Agreement included commitments to ratify and implement the Paris Agreement, while the EU-Canada Comprehensive Economic Trade Agreement (CETA) contained three different chapters covering sustainable development, labour and environment. See Communication COM(2021) 497 final from the Commission of 18 February 2021 on Trade Policy Review—An Open, Sustainable and Assertive Trade Policy. 65 See Harrison et al. (2019); Van 't Wout (2021).

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interpretation and application of Sustainable Development Provisions between Contracting parties.66 The purpose of these amendments, taken together, is to strengthen the sustainable development framework of the ECT. This is supposed to increase the degree of deference to be accorded to climate change regulatory measures.67 However, despite welcomed, these provisions do not address the core issue. Investment arbitration would continue to be granted to fossil-fuel investors. As far as extra-EU relations are concerned, measures affecting fossil fuel assets can still be subject to investment arbitration. In view of the ‘regulatory chill’, it is reasonable to conclude that these amendments alone would not be able to align the ECT to climate action. To counter this criticism, a new optional ‘flexibility mechanism’ for the progressive phase-out of fossil fuel investment protection is included. The analysis of this amendment requires a clarification on the concept of ‘Investment’ under the ECT. The current ECT embraces the broadest possible definition of ‘Investment’. Under the treaty, the notion covers both foreign direct investment and portfolio investments, protecting “every kind of asset, owned or controlled directly or indirectly by an Investor”, including (but not limited to) those listed in Article 1 (6) ECT.68 However, the ECT is a sectorial agreement in the energy field. Therefore, this broad definition concerns assets “associated with an Economic Activity in the Energy Sector”, which according to Article 1(5) ECT, is an “economic activity concerning the exploration, extraction, refining, production, storage, land transport, transmission, distribution, trade, marketing, or sale of Energy Materials and Products”.69 Therefore, to assess the scope of application of the ECT, one has to look at the list of Energy Materials and Products provided by Annex EM.70 If we agree that the outcome of the ECT reform should be excluding fossil fuel from investment protection, the only credible starting point—apart from restricting the types of assets covered71—is amending the definition of investment or the scope

66

The new Article 28bis establishes a conciliatory procedure that leads to a non-binding public report. Based on this report, the Conference is bound to discuss “actions and measures to be implemented by the Contracting Parties party to the dispute”. Consequently, each party to the dispute has the obligation to inform the Secretariat of its implementation of recommended actions or measures. 67 Especially through the ‘pragmatic’ approach, but arguably also via systemic integration. However, see Sect. 3.1.2 above. 68 As above mentioned, this definition is amended in the reformed ECT. 69 “Except those included in Annex NI, or concerning the distribution of heat to multiple premises”. See Article 1(5) ECT. 70 As disciplined by Article 1(4). These Materials and Products are divided into three main categories: (a) nuclear energy; (b) coal, natural gas, petroleum and petroleum products, electrical energy; and (c) other energy. 71 As the ‘modernised’ ECT does, both amending the definition of Investment and of Investor.

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of investment protection to achieve this result.72 The reformed ECT provides a ‘flexibility mechanism’ to move in this direction, but is definitely too weak. Indeed, the ‘modernised’ treaty allows a Contracting party to exclude fossil-fuel investment protection and arbitration in its territory, based on a Conference decision.73 This means that fossil fuels protection will still be granted as a rule, and might be exceptionally carved out. To date, the EU and UK decided to use the mechanism, maintaining the protection of fossil fuel investments existing at the date of the entry into force of the relevant provisions—i.e. 90 days after the ratification of threefourths of the Contracting Parties—for other 10 years.74 This amendment is clearly in contrast with scientific evidence urging that, to limit the temperature increase to 1.5 °C, global emissions must peak by 2025, fall from 2019 levels by 43% by 2030 and by 84% by 2050.75 Actually, the new ECT will provide fossil fuels investors with the tool of investment arbitration precisely in the crucial phase of energy transition, in contrast with the announced EU goals in pursuing the ECT reform. All considered, the most relevant instrument for an ‘evolution’ of the clash between the ECT and climate action might end up being the aforementioned disconnection clause, per se motivated by another conflict, i.e. between EU law and investment arbitration.76 This stems from the simple fact that—in the absence of intra-EU arbitrations—the number of arbitrations should decrease sharply. In conclusion, the ‘modernisation’ process failed to make the ECT climate friendly. The treaty will raise the cost of energy transition and chill climate action in the years to come. A solution for the substantial clash between the ECT and climate action seems not on the horizon.

72

See the analysis of Bernasconi-Osterwalder and Brauch (2019). The mechanism is far from linear, and it is not necessary in this contribution to outline its complex operation. See the amended Article 1 and Article 26, the related reformed Annex NI and new Annexes NPT and IA-NI, and the new article concerning the ‘non application of part III to certain investments’. 74 To be precise, the UK excluded the protection of existing investment regarding a number of Energy Materials and Products—coal, lignite, peat—after 01 October 2024 (or after the date of entry into force of the amendments if later). 75 Pat et al (eds. 2022), Summary for Policymakers. in Shukla et al (eds.) Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change. IPCC, p. 21, available at https://www.ipcc.ch/ report/ar6/wg3/downloads/report/IPCC_AR6_WGIII_SPM.pdf (last accessed 13 June 2022). 76 Which is outside the scope of this work. It will be briefly mentioned below, from the perspective of the political economy of international investment law. For discussions from a doctrinal perspective, see e.g. Declève and Van Damme (2021). For a recent monography on the topic both from the perspective of international law and EU law, see De Boeck (2022). 73

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4 Trapped in a Dead End? The ‘modernised’ ECT is still inadequate if compared to the objectives of the Paris Agreement and the scientific evidence on climate change. Making the ECT climate friendly seems out of reach. As a consequence, the possibility of withdrawal has been raised within EU institutions.77 During the weeks following the end of negotiations, many EU Member States expressed their dissatisfaction with the outcome of negotiations, announcing their intention to withdraw from the Treaty. As a result, the Conference of the Parties to the ECT postponed the discussion on the agreement in principle.78 Before delving into the merit of the strategy of withdrawal and its possible legal obstacles, it seems necessary to analyse the reasons that might explain both such a ‘radical’ choice and its concrete significance for the future of the political economy of international investment law. Beyond the argument on regulatory chill, the substantial clash between the ECT and climate action might be assessed by framing the treaty under the notion of ‘institutional project’, offering food for thoughts on the axiological distance between investment law and climate action. According to Martti Koskenniemi, today “the world of legal practice is being sliced up in institutional projects that cater for special audiences with special interests and special ethos”.79 Arguably, this is the most material consequence of the so-called ‘fragmentation of international law’.80 Hereinafter, the notion of institutional project is applied to the ECT to describe the two driving forces of the treaty: the ‘geopolitical’ and ‘neoliberal’ drivers.

77

See for instance, before the end of the negotiation process, the position expressed by Bernd Lange, Chairman of the Trade Committee of the European Parliament, see https://www.fr.de/ meinung/gastbeitraege/die-eu-muss-die-energiecharta-reformieren-90477891.html (last accessed 13 June 2022). Moreover, a letter dated 8 September 2020—signed by 139 European and national parliamentarians—urged the EU Commission to withdraw (available at https://www.ernesturtasun. eu/ecologia/statement-the-modernisation-of-the-energy-charter-treaty/). Even after the end of the process, these voices have not ceased, see e.g. https://www.investigate-europe.eu/en/2022/ectecocide-treaty-puts-member-states-and-eu-commission-at-odds/. 78 The Energy Charter Conference met online on 22 November 2023—with “more than 33 Contracting Parties” attending (i.e. almost 20 Parties defecting)—and postponed the discussion to mid-April. See CCDEC 2022 32 NOT, Decision of The Energy Charter Conference on ‘Preliminary draft schedule of planned and proposed Energy Charter Meetings and Activities for 2023’. 79 Koskenniemi (2009), p. 9. See also Crawford and Koskenniemi (2012), pp. 14–20. 80 The debate on the fragmentation of international law is boundless, and—according to Martineau (2009)—characterised by opposing and mutual exclusive narratives. However, among many contributions on this debate, see Simma (1985); Sands (1998). As a ‘classic’ starting point for reflections on the issue see Koskenniemi (2006). Recently, see for instance Peters (2017).

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The Project of Investment Law and the ECT

The institutional project of investment law can be summarised as the depoliticisation of the economy through internationalisation and judicialisation.81 Even if its most striking success came after the end of the Cold War, its contemporary foundations lie in the neoliberal response to the Third-World countries attempts to reshape international law in the post-colonial period82 and to the welfarist Keynesian economics of post-war decades.83 Indeed, investment law and neoliberalism are strictly connected.84 In 1986, Ibrahim Shihata, the then General Counsel of the World Bank, proclaimed one of the clearest formulations of this project. He argued that investor-State arbitration provided “a forum for conflict resolution in a framework which carefully balances the interests and requirements of all the parties involved, and attempts in particular to “depoliticize” the settlement of investment disputes”.85 International investment law maintains that the internationalisation of substantive standards and the judicialisation of dispute resolution are capable of moving international economic relations from the fragile and ‘subjective’ level of politics to the stable and ‘objective’ level of law, reaching the goal of ‘depoliticisation’. However, this narrative may underestimate the role of power relations and distributive choices.86 As observed by David Schneidermann, “[i]t might be more accurate to characterize the system [of investment law and arbitration] as not depoliticized but decentralized – power is conveyed to investors and ultimately to the coterie of investment lawyers and arbitrators that populate its institutions and

81

Tzouvala (2020), p. 38. Miles (2013), pp. 78–100. 83 Tzouvala (2020), p. 43. The definition of ‘neoliberalism’ here is adopted from Ntina Tzouvala: ‘a model of capitalist accumulation that arose as a response to the Keynesian state and to 19th century laissez-faire liberalism and [. . .] rests upon the idea of generalized competition and state intervention for the construction, guarantee and expansion of these competitive relations in an ever increasing sphere of social co-existence, including the structure and functions of the state itself.’ See Tzouvala (2016), pp. 120–121. 84 See Sornarajah (2015), p. 10. Historically, the creation of ‘free markets’ has not been a peaceful process. According to Polanyi (2001), p. 257: “Economic history reveals that the emergence of national markets was in no way the result of gradual and spontaneous emancipation of the economic sphere from governmental control. On the contrary, the market has been the outcome of a conscious and often violent intervention on the part of the government, which imposed the market organization of society for noneconomic ends”. While ‘liberalisation’ is intuitively supposed to mean unimpeded trade and investment, the main focus of neoliberal theorists has been instead market protection. See Slobodian (2018), pp. 5–8. In this context, according to Pistor (2019), p. 19 “States often do not, in fact need not, control the legal coding process itself. [. . .] But states provide the legal tools that lawyers use; and they offer their law enforcement apparatus to enforce the capital that lawyers have crafted”. 85 Shihata (1986), p. 4. But this narrative is widespread. See e.g. Vandevelde (1988), p. 533; Franck (2009), pp. 437–438; Schill and Djanic (2018), p. 33. 86 Perrone (2020), p. 119. 82

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pronounce on the meaning of its norms”.87 The project of investment law introduces a lever to unbalance power relations in favour of private investors, confining other actors—the Global South, local communities, the environment and future generations—to the periphery. Therefore, investment law can be described as the project of promoting and isolating discursive patterns of ‘investment protection’,88 necessarily at the expense of other interests. A key question to grasp the scale of the clash between the ECT and climate action is whether the treaty is in any way particular to this landscape. The ECT was negotiated in the first half of the nineties on the basis of the European Energy Charter, a non-binding political declaration89 approved at the Hague Conference of 16 and 17 December 1991. The treaty was finalised in 1994, and entered into force in 1998. In the intentions of its promoters, the agreement would have overcome political divisions between Western Europe, Russia and the former Soviet Republics and reduced dependence on Russian energy resources for both Western and Eastern European countries.90 The main driver of the process that would lead to the ECT— however clearly ‘soaked’ with the neoliberal esprit du temps—was geopolitical. Almost 30 years after the signing of the ECT, the geopolitical driver is still echoed in the narrative surrounding the treaty. This narrative extends the regional perspective embraced by the European Council in 1990, but still reflects the idea that the ECT is more than a simple investment agreement in the energy sector. It would be, on the contrary, an instrument of multilateralism promoting energy security by means of an “efficient energy market”.91 However, the years following the adoption of the treaty demonstrated the failure of the geopolitical driver, both in its original regional version and its ‘extended’ one. First, the most significant setback is probably Russia’s decision not to ratify the treaty. After signing it on 17 December 1994, Russia officially confirmed that it did not intend to ratify the ECT on 17 April 2009.92 Second, international cooperation in the energy field was largely developed independently from the treaty. From a 87

Schneiderman (2011), p. 714. This was particularly clear in older cases. See e.g. Compañia del Desarrollo de Santa Elena S.A. v. Republic of Costa Rica, ICSID Case No. ARB/96/1 (“Expropriatory environmental measures—no matter how laudable and beneficial to society as a whole—are, in this respect, similar to any other expropriatory measures that a state may take in order to implement its policies”, Award, para. 72) However, the same result can be observed in recent times. See e.g. Eco Oro Minerals Corp. v. Republic of Colombia, ICSID Case No. ARB/16/41. 89 European Energy Charter (signed 17 December 1991). 90 See Hobér (2020), p. 14. 91 See European Energy Charter, Title I. 92 See Russian Federation, International Energy Charter. Moreover, it is useful to recall the missed approval of a protocol on energy transit. Indeed, in 1999 the Energy Charter Conference decided to agree on more specific rules on energy transit than those in Article 7 ECT, negotiating a separate Transit Protocol. However, negotiations were first suspended in 2003, resumed in 2007, entrusted to the Trade and Transit Group in 2009 and finally repealed by the Conference in 2011. See Stănescu (2018), p. 100. 88

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European perspective, the ECT currently overlaps with many other instruments specifically covering energy cooperation between the EU and Eastern Europe, Caucasus and Central Asian countries.93 Moreover, global energy governance remains highly fragmented,94 and the role of the ECT has become quite small. Third, the European energy supply today suffers both insecurity95 and lack of diversification.96 More generally, the entire world is falling short on reliable energy supplies.97 The ECT has proved to be of little practical impact as far as the geopolitical driver is concerned. All the above does not mean that the neoliberal driver suffered the same destiny of the geopolitical one. Rather, it is still consolidating today. Indeed, the legal coding of Part III (Investment promotion and protection) and Part V (Dispute Settlement) ECT represented an extraordinary effective tool for investment arbitration in the energy sector. As underlined above, the ECT is by far the most litigated treaty, with more than 140 known cases.98 Moreover, departing from the mostly regional perspective implied by the original geopolitical driver,99 the ECT is trying to expand globally. This purpose was assumed from the ‘Policy on Expansion, Outreach and Consolidation’ (CONEXO) lunched in 2009,100 and reached its peak with the adoption of the International Energy Charter in 2015. The Charter was signed by 90 States and International Organisations.101 Against this backdrop, two related conclusions may be drawn. First, the narrative on the uniqueness of the treaty is extremely fragile. The ECT, far from representing the ‘European energy community’ envisaged by Ruud Lubbers or the multilateral forum for global energy cooperation described today, is essentially a geographically

93

The EU signed Memoranda of Understandings (MoUs) in the energy sector with Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan. Also, it promoted multilateral forums such as the INOGATE programme and the EU4 Energy Programme, The establishment in 2005 of the Energy Community with Albania, Bosnia and Herzegovina, Kosovo, North Macedonia, Georgia, Moldova, Montenegro, Serbia and Ukraine can be also cited. 94 Sovacool and Florini (2012) identify at least 42 institutions involved in global energy governance. 95 See e.g. the analysis of Popkostova (2022). 96 According to the European Commission, in 2021 the EU imported more than 40% of its total gas consumption, 27% of oil imports and 46% of coal imports from Russia. See COM(2022) 108 final of 8 March 2022, p. 1. 97 Birol F (2022), What does the current global energy crisis mean for energy investment?. International Energy Agency (IEA), 13 May 2022, https://www.iea.org/commentaries/what-doesthe-current-global-energy-crisis-mean-for-energy-investment (last accessed 13 June 2022). 98 Followed by the terminated NAFTA (72 cases). 99 However, Australia and Japan are founding members. Seemingly, the idea of ‘expanding’ investment protection even at the cost of regional cooperation was somehow already present. The geopolitical driver was prevalent, but not exclusive. 100 See CCDEC 201203—Approval of Final Draft of the “Policy on Consolidation, Expansion and Outreach” (CONEXO). 101 After Russian termination of provisional application, Afghanistan (2013), Montenegro (2015) Yemen and Jordan (2018) acceded the Treaty. However, Italy withdrew in 2015.

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broad investment treaty, one of the most significant tools of investment law. As such—and this is the second conclusion—the ECT is unconcerned with climate action. This relates less to the provisions of the individual treaty and more to the axiological premises of its underlying institutional project. Therefore, the symbolic value of ‘modernisation’ goes far beyond the ECT alone. The EU involvement in the ECT reform has not simply been an effort of legal engineering. Rather, it represents a test bench for the idea of saving the planet from climate catastrophe while keeping the neoliberal project of investment law intact, which is probably at the heart of all EU external action when dealing with this regime.102 The very inclusion of the ‘disconnection clause’ can be considered in continuity with this strategy. On the one side, it aims to solve the tensions between the EU regime and the investment law project; on the other, it safeguards and strengthens it in external relations. The (eventual) withdrawal of the EU—regardless of its legal consequences— would certify an unprecedented setback in the institutional project of investment law, which the EU itself contributed to build and still contributes to sustain. However, the axiological distance between investment law and climate action seems hard to bridge. Due to the decisions of several EU Member States, the hypothesis of withdrawal is becoming a reality.

4.2

The Strategy of Withdrawal

The strategy of withdrawal presents several legal obstacles. According to Article 47 ECT “at any time after five years from the date on which this Treaty has entered into force for a Contracting Party, [. . .] Contracting Party may give written notification to the Depositary of its withdrawal from the Treaty”, which takes effect one year after. Moreover, under Article 47(3) ECT, the provisions of the treaty would apply to existing investments for a period of 20 years from the date in which withdrawal takes effect. At a first glance, given this ‘sunset clause’, withdrawal seems totally incompatible with the dramatically narrow timeframe available to avoid climate catastrophe. Hence, this hypothesis has been recently articulated in more precise terms as a two-steps strategy. To begin with, the EU and its Member States will have to conclude an inter se agreement under Article 41 VCLT, “to neutralize the effect of the ECT’s survival clause as between themselves”.103 Only as a second step, withdrawal will be exercised. The idea is that, in this way, withdrawal would immediately take effect

102

On the novelty approach actually see e.g. Titi (2015); contra Paparinskis (2015). See Brauch M D (2021), Should the European Union fix, leave or kill the Energy Charter Treaty?. Blogdroiteuropéen, https://blogdroiteuropeen.com/2021/02/09/should-the-european-

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at least among EU Member States themselves, without prejudice to the application of the sunset clause in extra-UE disputes. However, there are at least two open questions that have to be addressed with respect to this strategy. The first relates to the admissibility of inter se modifications under the ECT. Article 41 VCLT provides that modification is admitted if provided for by the treaty or not prohibited, subject to certain conditions which are discussed below. Indeed, the ECT is silent on modification. Therefore, an inter se agreement seems to be possible. However, it could be argued that, since inter se modification is a particular type of successive treaty concerning the same subject matter of the previous treaty,104 the non-derogation clause of Article 16 ECT would apply. Article 16 ECT provides that, when the Contracting parties enter into a subsequent agreement whose terms concern the subject matter of Part III or Part V of the Treaty, the most favourable provisions to the investment or the investor apply.105 This would make the unmodified ECT prevail in the concrete case, de facto ‘neutralizing the neutralization’ of the sunset clause.106 The second point concerns the two cumulative conditions set out by Article 41 VCLT. According to Article 41(b)(i) and Article 41(b)(ii) VCLT respectively, modification is admitted if it “does not affect the enjoyment by the other parties of their rights under the treaty or the performance of their obligations” and it does not “relate to a provision, derogation from which is incompatible with the effective execution of the object and purpose of the treaty as a whole”. In determining whether these two conditions are met, a distinction between treaties imposing obligations of a reciprocal nature or obligations owed to all the parties might play a decisive role.107 The majority of international obligations are reciprocal in nature, and even a multilateral agreement may well give rise to “a bundle of interwoven bilateral relationships dominated by the principle of reciprocity”.108 Instead, according to the ILC, the obligations owed to all the parties to a regime, or erga omnes partes obligations, derive from an international regime in the

union-fix-leave-or-kill-the-energy-charter-treaty-by-martin-dietrich-brauch/ (last accessed 13 June 2022) See also https://voelkerrechtsblog.org/de/mission-impossible/ (last accessed 13 June 2022). 104 See e.g. Villiger (2009), p. 537. However, Article 30(4) VCLT (an inter se modification theoretically falls within the scope of this provision) is without prejudice to Article 41. Therefore, if the conditions set out by Article 41 are met, Article 30(4) seems to be of no relevance. See Von der Decken (2018b), p. 779; Aust (2013), p. 242. 105 See Article 16 ECT. This article is abrogated in the reformed treaty. 106 So far, Article 41 has been discussed by investment tribunals dealing with the argument that EU law has led to an inter se modification of the ECT between EU member states. See e.g. BayWa r.e. Renewable Energy GmbH and BayWa r.e. Asset Holding GmbH v. Spain, ICSID Case No. ARB/15/16, para. 276. Probably, the application of Article 16 might be explicitly excluded in the modification agreement. However, the same argumentative pattern might be reproduced, providing a significant tool to make the ‘sanctity of the treaty’ prevail. 107 See e.g. Capotorti (1971), p. 509; Pauwelyn (2001), p. 549; Von der Decken (2018b), p. 782. 108 Sicilianos (2002), p. 1133.

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maintenance and implementation of which all the States parties have a common legal interest.109 Therefore, the two conditions of Article 41 VCLT are strictly connected: if the obligation is bilateral or reciprocal in nature, a modification does not affect the enjoyment of other parties’ rights, and the effective execution of the object and purpose of the treaty is reasonably not undermined.110 Moreover, Art. 41(2)(b) (ii) VCLT refers to the object and purpose of the treaty “as a whole”. Therefore, “modifications relating to single and less important aspects of the object and purpose of the treaty are to be considered as permissible”.111 However, both the nature of obligations enshrined in the ECT and the ‘object and purpose’ of the treaty are endlessly debatable, leading to conflicting and irreconcilable positions. The ECT obligations may be well identified as reciprocal112 enabling an inter se agreement to exclude the sunset clause. However, it is also possible to argue that the ‘object and purpose of the ECT as a whole’ implies integral obligations,113 or even that investors have ‘acquired rights’ under the ECT, that cannot be subsequently modified or extinguished by the States.114 Therefore, refraining from more detailed conclusions on the feasibility of this strategy, the option of an inter se agreement followed by withdrawal certainly seems a ‘legal minefield’ from which it is not easy to emerge unscathed.

109 This latter category comprises both ‘interdependent’ and ‘integral’ obligations. The former are those whose mutual respect among all parties is the indispensable condition of the legal system they establish, e.g. in a disarmament convention. The latter transcend the sphere of the bilateral relations of the States parties, promoting collective or extra-state interests, e.g. in a human rights convention. Sicilianos (2002), pp. 1134–1135. 110 See Von der Decken (2018b), p. 783. 111 Von der Decken (2018b), p. 783. 112 This is the position of the Court of Justice of the European Union, see CJEU, case C-741/19, République de Moldavie v Komstroy LLC, ECLI:EU:C:2021:655, para. 64. 113 In this direction the tribunal in BayWa r.e. Renewable Energy GmbH and BayWa r.e. Asset Holding GmbH v Spain, ICSID Case no. ARB/15/16, Decision on Jurisdiction, Liability and Directions on Quantum of 2 December 2019, para. 276: “it is very doubtful whether the abrogation inter se of the ECT as between EU Member States is compatible ‘with the effective execution of the object and purpose of the [ECT] as a whole’”. 114 Article 70(1)(b) VCLT provides that the termination of a treaty “does not affect any right, obligation or legal situation of the parties created through the execution of the treaty prior to its termination”. However, this provision does not refer to the rights of (private) individuals, and the doctrine of acquired rights does not seem to have a clear basis in international law. See e.g. Sornarajah (2010), p. 419; Voon et al. (2014), p. 470. See also Reinisch and Mansour Fallah (2022), pp. 15–19.

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5 Conclusion In its empirical study on investment arbitration, Gus Van Harten concluded that: “in the context of arbitrator resolutions of contested jurisdictional issues, there is tentative support for expectations of systemic bias arising from the interests of arbitrators in light of the system’s asymmetrical claims structure and the absence of conventional markers of judicial independence”.115 This suggests that the issue of withdrawal might be often framed in the most investor-friendly way.116 However, it remains that the ‘modernised’ ECT seems inadequate compared to the long-term objectives of the Paris Agreement and the scientific evidence on climate change. According to several EU Member States, the ‘push’ for a coordinated withdrawal seems worthwhile, even at the cost of engaging with the associated legal risks.117 Even assuming the feasibility of the strategy of withdrawal, the efforts to resolve the conflict between investment law and climate action ‘at the root’ would not be exhausted. First, the vast network of investment agreements currently in place would remain out there. Indeed, the investment law regime would offer many alternatives for fossil fuel investment arbitration.118 Second, extra-EU disputes would be possible for 20 years from the date of entry into force of withdrawal. Accordingly, the Commission suggested that accepting the ‘modernised’ ECT should be considered a better option.119 Nevertheless, and without considering the uncertainty as to when a reformed text might actually come into force, the impact of withdrawal (both uncoordinated or coordinated) on the political economy of investment law cannot be overestimated. Indeed, the decision of several EU Member States to withdraw—whether the whole

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Van Harten (2012), p. 252. Referring to mutual termination of investment agreements, see Voon et al. (2014), p. 473. 117 However, as of 23 November 2023 the unilateral withdrawal of France, Germany, Spain, the Netherlands, Poland and Slovenia seems the only option concretely on the table. It is hard to predict whether the Commission will shift its political stance and lead the (however legally uncertain) efforts towards a coordinated withdrawal. 118 There are 463 investment agreements currently overlapping with the ECT (See UNCTAD Investment Agreement Navigator). These agreement would still apply. See see e.g. Atanasova (2022), p. 23: “Maintaining the focus on the ECT alone in the circumstances significantly reduces the accuracy of the impact assessment that the investment regime can have on the regulatory activity of the Contracting Parties to it. [. . .] [E]ven if the ECT is terminated or successfully reformed, there are 463 IIAs that would continue to provide substantially similar protection to investors in its absence”. 119 With reference to the new ‘flexibility mechanism’, the Commission states that “[t]his phasing out of protection for fossil fuel investments will take place within a shorter timeframe than in the case of a withdrawal from the ECT, for both existing and new investments: existing fossil fuel investments will be phased out after 10 years under modernised rules (instead of 20 years under current rules)” see https://policy.trade.ec.europa.eu/news/agreement-principle-reached-modernised-energy-char ter-treaty-2022-06-24_en (last accessed 21 September 2022). 116

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EU follows or not—has already fundamentally undermined the (already crumbling) legitimacy both of the treaty and of the whole investment regime. Be as it may, our house is on fire. Climate change requires unprecedented action in the next few years. New distributive choices at the basis of the whole international investment regime are required, and a deeper paradigm shift might be needed. The interests of those who have been neglected so far must be considered, especially the Global South, local communities and future generations.120 This means to a large extent addressing the detrimental relationship between fossil fuel exploitation, the investment law project and climate change mitigation.

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Sands P (1998) Treaty, custom and the cross-fertilization of international law. Yale Hum Rights Dev Law J 1:85–105 Sands P, Pill J, Fabra A, Mackenzie R (2018) Principles of international environmental law. Cambridge University Press, Cambridge Schill SW, Djanic V (2018) Wherefore Art Thou? Towards a public interest-based justification of international investment law. ICSID Rev 33(1):29–55 Schneiderman D (2011) Revisiting the depoliticization of investment disputes. In: Sauvant KP (ed) Yearbook on international investment law and policy. Oxford University Press, pp 693–714 Schram A, Friel S, Van Duzer AJ, Ruckert A, Labonté R (2018) Internalisation of international investment agreements in public policymaking: developing a conceptual framework of regulatory chill. Glob Policy 9:193–202 Shihata I (1986) Toward greater depoliticization of investment disputes: the roles of ICSID and MIGA. ICSID Rev 1:1–12 Sicilianos LA (2002) The classification of obligations and the multilateral dimension of the relations of international responsibility. Eur J Int Law 13(5):1127–1145 Simma B (1985) Self-contained regimes. Netherlands Yearb Int Law 16:111–136 Slobodian Q (2018) Globalists. The end of empire and the birth of neoliberalism. Harvard University Press, Cambridge Sornarajah M (2010) The international law on foreign investment, 3rd edn. Cambridge University Press, Cambridge Sornarajah M (2015) Resistance and change in the international law on foreign investment. Cambridge University Press, Cambridge Sovacool BK, Florini A (2012) Examining the complications of global energy governance. J Energy Nat Resour Law 30(3):235–263 Stănescu CG (2018) Article 7. Transit. In: Leal-Arcas R (ed) Commentary on the Energy Charter Treaty. Elgar commentaries. Edward Elgar, Cheltenham, pp 95–113 Tienhaara K (2011) Regulatory chill and the threat of arbitration: a view from political science. In: Brown C, Miles K (eds) Evolution in investment treaty law and arbitration. Cambridge University Press, Cambridge, pp 606–628 Tienhaara K, Cotula L (2020) Raising the cost of climate action? Investor-state dispute settlement and compensation for stranded fossil fuel assets. IIED, London Tienhaara K, Downie C (2018) Risky business? The energy charter treaty, renewable energy, and investor-state disputes. Glob Gov 24(3):451–471 Tienhaara K, Thrasher R, Simmons BA, Gallagher KP (2022) Investor-state disputes threaten the global green energy transition. Science 376(6594):701–703 Titi C (2015) International investment law and the European Union: towards a new generation of international investment agreements. Eur J Int Law 26(3):639–661 Tzouvala N (2016) Chronicle of a death foretold? Thinking about sovereignty, expertise and neoliberalism in the light of Brexit. German Law J 17:117–124 Tzouvala N (2020) The Ordo-Liberal origins of modern international investment law: constructing competition on a global scale. In: Haskell J, Rasulov A (eds) New voices and new perspectives in international economic law, European yearbook of international economic law. Springer, Cham, pp 37–54 Van Harten G (2012) Arbitrator behaviour in asymmetrical adjudication: an empirical study of investment treaty arbitration. Osgoode Hall Law J 50(1):211–268 Van Harten G, Scott DN (2016) Investment treaties and the internal vetting of regulatory proposals: a case study from Canada. Osgoode Legal Studies research paper no. 26/2016, York University, York Van 't Wout D (2021) The enforceability of the trade and sustainable development chapters of the European Union’s free trade agreements. Asia Eur J 20:81–90 Vandevelde KJ (1988) The BIT program: a fifteen-year appraisal. Proc ASIL Annu Meeting 82: 532–540

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Villiger ME (2009) Commentary on the 1969 Vienna Convention on the law of treaties. Brill/ Nijhoff, Leiden Von der Decken K (2018a) Article 30. Application of successive treaties relating to the same subject matter. In: Dörr O, Schmalenbach K (eds) Vienna Convention on the law of treaties: a commentary, 2nd edn. Springer, Heidelberg, pp 539–558 Von der Decken K (2018b) Article 41. Agreements to modify multilateral treaties between certain of the parties only. In: Dörr O, Schmalenbach K (eds) Vienna Convention on the law of treaties: a commentary, 2nd edn. Springer, Heidelberg, pp 777–790 Voon T, Mitchell AD, Munro J (2014) Parting ways: the impact of mutual termination of investment treaties on investor rights. ICSID Rev 29(2):451–473

Mattia Colli Vignarelli is a PhD Student in International Law at the University of Turin. He holds a Master’s Degree in Law from the University of Eastern Piedmont. His research focuses on international investment law, energy transition and climate change. His research interests include international investment law, international environmental law and theories of international law.

Making Finance Flows Consistent with the Aims of the Paris Agreement: Roles, Obligations, and Limitations of the EU Banking Sector and Its Regulatory and Supervisory Institutions Gudrun Zagel and Dieter Huber

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Setting the Scene: International Climate Law and the EU Banking Sector . . . . . . . . . . . . . . . . 2.1 The UNFCCC Regime . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The Paris Agreement and the Banking Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 EU Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Selected International Initiatives Promoting Greening Financial Systems . . . . . . . . . . 3 Examining the Status Quo: The EU Banking Sector Activities and Climate Change . . . . . 3.1 General Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Private Banking Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 EU Banking Supervisory Authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Central Banks: The Example of ECB and ESCB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Exploring the Way Forward: Potential Policies and Measures in the Banking Sector Contributing to Achieving the Goals of the PA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract While linkages of the banking sector to climate change are manifold, the Paris Agreement (PA) merely generally refers to the financial sector in Article 2(1) (c). Subsequent Conferences of the Parties recognise the importance of private financial flows for climate change mitigation and adaptation. The EU banking sector Views expressed in this paper are the authors’ and do not necessarily reflect those of the OeNB or the Eurosystem. G. Zagel (✉) Paris Lodron University Salzburg, Department of Fundamentals of Law, International and European Law, Salzburg, Austria e-mail: [email protected] D. Huber Oesterreichische Nationalbank, Vienna, Austria e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 295–344, https://doi.org/10.1007/8165_2022_95, Published online: 27 December 2022

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has increasingly faced criticism for not adequately addressing the climate change impacts of its activities. Controversy exists on how to integrate climate change into the banking sector activities effectively and how to adapt the regulatory framework accordingly. The article discusses the potential roles and responsibilities of the private banking sector, banking supervisory authorities, and central banks in the EU regarding climate change mitigation and adaptation. It assesses whether and how these actors already contribute to the PA objectives and EU climate goals and which impediments and alternative options exist when pursuing these goals. On this behalf, it examines the EU’s obligations under the PA and the EU implementing measures regarding the banking sector. It discusses how the activities, tasks, and mandates of the different actors and the related regulatory framework may impact the achievement of the PA objectives. Finally, it proposes measures the EU banking sector may undertake but also points out necessary policy decisions to be adopted by the EU legislators to ensure the EU banking sector’s optimal contribution to achieving the PA objectives.

1 Introduction Climate change is a common concern of humankind,1 and there are increasing signs of its impact.2 To prevent temperature rise to levels that make our planet uninhabitable, the Paris Agreement (PA) aims to “. . .reach the global peaking of greenhouse gas emissions as soon as possible[. . .] and to undertake rapid reductions thereafter. . .”.3 Governments set their nationally determined contributions (NDCs) to implement the PA goals4 and gradually adopt legislation to reduce greenhouse gases (GHGs) and ultimately become climate-neutral. Also, many enterprises make efforts to either implement climate measures voluntarily or based on legislative changes in their host states. At the same time, NGOs increasingly bring climate claims against states and private actors before national and international courts, which have shown varying activism regarding climate change policies, as Urgenda or Milleudefensie v Royal Dutch Shell show.5 However, a debate on the linkages between the banking sector and climate change has emerged only recently. The banking sector’s nexus to climate change is manifold. Examples include whether banks impact climate change by financing climate-affecting industries or

1

Glasgow Climate Pact, Decision 1/CMA.3, 31.11.2021, FCCC/PA/CMA/2021/10/Add.1, preamble, 6th recital. 2 Intergovernmental Panel on Climate Change (IPCC) (2022), Climate Change 2022—Impacts, Adaptation and Vulnerabilities, IPCC Switzerland, at https://www.ipcc.ch/report/ar6/wg2/. 3 Article 4(1) Paris Agreement (PA), 12.12.2015, 3156 UNTS No. I-54113. 4 At https://unfccc.int/NDCREG. 5 See Kahl and Weller (2021).

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mitigation projects, whether risks stemming from climate change result in financial stability risks, or how supervisory activities and monetary policy should consider climate change. Points of controversy include modifying the monetary policy framework, particularly the central banks’ asset purchase programs, introducing regulatory measures to support environmentally beneficial bank lending activities or penalties for financing harmful projects. Furthermore, the banks’ management, shareholders, and creditors are developing analytical tools to identify business opportunities and manage climate-related risks. The PA addresses the activities of the private banking sector only indirectly. Articles 2(1)(a) and (b) require parties to adopt climate change mitigation and adaptation measures, Article 2(1)(c) intends to “make finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”. The good-faith implementation of Article 2 PA requires exploring the climate impacts of all economic sectors. Given the central function of the banking sector for financing the economy and its transition to climate neutrality, this includes examining and addressing the connection between the banking sector and climate change, as indicated by the decisions of the Conference of Parties (COP),6 the European Union’s (EU) NDCs,7 and the European Green Deal,8 which includes a sustainable finance component. Furthermore, the EU members’ national energy and climate plans complement the EU’s NDCs9 and provide implementation measures related to the banking sector.10 Yet, a comprehensive picture of the impact of the banking sector on climate change is still missing, and the role of the banking sector in implementing the PA objectives remains controversial. The question of how the banking sector should contribute to mitigating climate change has recently reached the courts. In 2021, the non-profit organisation ClientEarth brought the first climate-related case against the Banque Nationale de Belgique (BNB) before Belgian courts.11 ClientEarth challenged the corporate sector purchase program (CSPP)12 of the European Central Bank (ECB) 6

See e.g., for COP26, https://ukcop26.org/wp-content/uploads/2021/11/COP26-Presidency-Out comes-The-Climate-Pact.pdf. 7 Update of the NDC of the European Union and its Member States, 07.12.2020, at https://unfccc. int/sites/default/files/NDC/2022-06/EU_NDC_Submission_December%202020.pdf. 8 The European Green Deal, Communication from the Commission, 11.12.2019, COM (2019) 640 final. 9 See https://ec.europa.eu/info/energy-climate-change-environment/implementation-eu-countries/ energy-and-climate-governance-and-reporting/national-energy-and-climate-plans_en. 10 Cf. An EU-wide Assessment of the National Energy and Climate Plans, 17.09.2022, COM(2020) 564 final, p. 13. 11 Solana (2021), pp. 51–54. 12 Decision (EU) 2016/948 of the European Central Bank of 1 June 2016 on the Implementation of the Corporate Sector Purchase Programme (ECB/2016/16). This decision was taken to strengthen the passthrough of the Eurosystem’s asset purchases to the financing conditions of the real economy, and to provide further monetary policy accommodation and contribute to a return of inflation rates to levels below, but close to, 2% over the medium term. Under the CSPP specified Eurosystem central banks may purchase, inter alia, eligible corporate bonds from eligible

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implemented by the BNB for ignoring the climate impact of the companies whose securities the BNB purchases. The Belgian court rejected the application in the first instance, and ClientEarth appealed the decision hoping for a preliminary ruling from the ECJ on whether the ECB’s CSPP complies with the ECB’s obligations under the EU Treaties and the EU Charter of Fundamental Rights.13 In a separate proceeding, ClientEarth filed suit in the EU General Court against the European Investment Bank (EIB) and obtained a favourable decision that required the EIB to review an EIB Board of Directors resolution approving the financing of a biomass power generation plant on its climate impacts.14 Further climate litigation against financial actors is conceivable, which raises the question of how the EU banking sector, its regulatory and supervisory institutions, and central banks can and should contribute to achieving the PA goals and the EU’s objective of climate neutrality by 2050. Beyond the climate-specific aspects of the cases, the issues at stake also touch on the delineation of central bank mandates and the legal limits for the ECB, e.g., when designing asset purchase programs within its monetary policy mandate.15 This article analyses the potential roles and responsibilities of the private banking sector, banking supervisory authorities, and central banks in the EU regarding climate change mitigation and adaptation. Specifically, it assesses whether and how these actors already contribute to the PA objectives and EU climate goals and which impediments and alternative options exist when pursuing these goals. It will not discuss the issues of sustainable finance, bank regulation, and central banking comprehensively but rather point to noteworthy aspects and identify common conceptions and limitations. First, the article examines the PA obligations of the

counterparties in the primary and secondary markets, under specific conditions (Article 1). The eligibility criteria for the purchase of corporate bonds are outlined in Article 2, for the assessment of the credit quality requirements only credit assessment information provided by an external credit agency accepted by the Eurosystem is taken into account. For an explanation of the CSPP see, e.g., ECB (2016), The Corporate Bond Market and the ECB’s Corporate Sector Purchase Program, ECB Economic Bulletin 5/2016, pp. 20–24, at Economic Bulletin Issue No. 5/2016 (June 2016) (europa. eu). 13 Linklaters Sustainable Futures, Does the ECB’s Quantitative Easing Programme Fuel Climate Change? NGO ClientEarth Goes Back to Court after the Dismissal of its Claims, 17.02.2022, at https://sustainablefutures.linklaters.com/post/102hj1q/does-the-ecbs-quantitative-easingprogramme-fuel-climate-change-ngo-clientearth; see also ClientEarth, Questions on Legality of ECB Lending Remain after Climate Case Ruling, Press Release, 03.12.2021, at https://www. clientearth.org/latest/press-office/press/questions-on-legality-of-ecb-lending-remain-after-climatecase-ruling/. ClientEarth withdrew its appeal after the ECB updated its policy to integrate climate change concerns into its CSPP, see ClientEarth Communications, 29.11.2022, https://www. clientearth.org/latest/latest-updates/news/we-re-withdrawing-our-lawsuit-against-the-belgiannational-bank/. 14 General Court, Case T-9/19, ClientEarth v EIB, Judgement of the General Court, 27.01.2021, ECLI:EU:T:2021:42, appealed on 06.04.2021, C-223/21 P; for a discussion see Grantham Research Institute on Climate Change and the Environment (ClientEarth v. European Investment Bank—European Union—Climate Change Laws of the World (climate-laws.org). 15 On this question see the CJEU, Case C-493/17, Weiss and Others, ECLI:EU:C:2018:1000, para. 71, referring to CJEU, Case C-62/14, Gauweiler and Others, ECLI:EU:C:2015:400, para. 66.

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EU and its Member States (MS) and the implementing measures adopted by the EU and the MS with a specific focus on the banking sector. Second, it discusses the roles of selected financial actors, the legal and regulatory frameworks they operate in, and how their activities, tasks, and mandates may impact the PA objectives as implemented in the EU’s NDCs. Third, it explores conceivable measures that could contribute to achieving the PA obligations and the EU NDCs while respecting the division of tasks between the relevant actors. The conclusions assess the existing regulatory framework for banking in light of the challenges of climate change and point out feasible ways forward.

2 Setting the Scene: International Climate Law and the EU Banking Sector 2.1

The UNFCCC Regime

Although science has discovered the linkages between human activities and global warming at the end of the nineteenth century,16 and the Intergovernmental Panel on Climate Change (IPCC) has published climate reports since 1988,17 a global legal answer to climate change only came in 1992 with the adoption of the UN Framework Convention on Climate Change (UNFCCC).18 The objective of the UNFCCC is the “stabilisation of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system (Article 2 UNFCCC). Besides the general obligations to monitor climate change through establishing inventories of GHGs (Article 4 UNFCCC), the UNFCCC provided the framework for negotiating further instruments in the annual Conferences of the Parties (Articles 7 and 17 UNFCCC).19 The 1997 Kyoto Protocol (KP) established binding targets of GHG reductions, several mechanisms to achieve this goal, and a reporting and monitoring system, albeit only for Annex I parties, i.e. developed countries, and only for a limited period.20 While the COPs failed to agree to extend the KP beyond 2012, the increasingly alarming reports of the IPCC resulted in the adoption of the 2015 Paris Agreement on Climate Change, which provides today’s international legal framework for tackling climate change.21

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Arrhenius (1896). Reports—IPCC. 18 UN Framework Convention on Climate Change (UNFCCC), 9.5.1992, 1771 UNTS No. I-30822, p. 107. 19 For details see Bodansky (2017), pp. 130–141 with further references. 20 Kyoto Protocol to the UN Framework Convention on Climate Change, 11.12.1997, 2303 UNTS No. 30882, p. 162; for details see Bodansky (2017), pp. 160–208 with further references. 21 For a survey see Bodansky (2017), pp. 209–257; Van Calster and Reins (2021). 17

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Despite initial criticism of the weak obligations enshrined in the PA, the rapid entry into force and the ambitious implementing activities of the PA parties—also driven by the more and more tangible impacts of climate change worldwide—show the contribution of the PA to encourage steps to mitigate and adapt to climate change.22 The PA regime requires all states to contribute to limiting the rise of temperatures to 2/1.5° (Article 2.1 PA).23 In addition to climate change mitigation, parties must also adopt measures to adapt to climate change and provide financial means for their realisation (Articles 2(1)(b) and (c)).24 In contrast to the KP with fixed GHG reduction obligations, the PA pursues a bottom-up approach that permits all parties to determine how and to what extent to contribute to achieving the 2/1.5° objectives.25 Following Article 4(2) PA, the parties establish their NDCs that typically set a peak year for GHG emissions, interim reduction goals, a date for climate neutrality, and how the different sectors of the economy and society contribute to achieving this goal.26 In addition, parties establish a long-term strategy (Article 4(19) PA). Controversial is to what extent the PA provisions and the NDCs are binding obligations under public international law.27 As the KP exemplified, binding obligations do not ensure compliance.28 Introducing NDCs aimed at facilitating understanding of the intended contributions to enable coordination; therefore, there was no intention to make the NDCs legally binding.29 Moreover, the UNFCCC parties feared that legally binding NDCs could scare away certain key players from joining the PA.30 To facilitate the participation of as many states as possible, the 2015 Paris COP agreed to make the PA a legally binding agreement, but with provisions that have different degrees of legal bindingness.31 Article 2 PA establishes the objectives of the PA. While not binding, the objectives inform the interpretation of the other provisions of the PA.32 Concerning

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E.g. Update of the NDC of the European Union and its Member States, 07.12.2020, at https:// unfccc.int/sites/default/files/NDC/2022-06/EU_NDC_Submission_December%202020.pdf, paras. 1–8. 23 For details see Van Calster and Reins (2021), pp. 79–81. 24 Van Calster and Reins (2021), pp. 82–85. 25 Van Calster and Reins (2021), pp. 97–98. 26 Cf. UNFCCC Secretariat, Nationally Determined Contributions under the Paris Agreement, Synthesis Report by the Secretariat, 17.9.2021, FCCC/PA/CMA/2021/8, pp. 12–42; see also Van Calster and Reins (2021), pp. 120–124. 27 For a debate see Bodansky (2017), pp. 210–212; Van Calster and Reins (2021), p. 99, paras. 313–314; Voigt (2016). 28 For a discussion of this argument see Green (2014), pp. 15–19. 29 See Warsaw ADP decision, UNFCCC Decision 1/CP.19, Further Advancing the Durban Platform, FCCC/CP/2012/10/Add.11, paras. 2(b) and (c); see also Green (2014), p. 23; Van Calster and Reins (2021), p. 99. 30 See Green (2014), p. 23; Van Calster and Reins (2021), para. 3.14. 31 Bodansky (2017), pp. 19 and 213–214; see also Voigt (2016); critical Van Calster and Reins (2021). 32 Cf. Article 31 Vienna Convention on the Law of Treaties (VCLT), 23.5.1969, 1155 UNTS No. 18232, p. 331; see also Van Calster and Reins (2021), pp. 78, paras. 2.13 and 2.14.

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the obligation to establish NDCs, there is consensus that the NDCs are obligations of conduct,33 i.e. they are binding not regarding their outcome but regarding their procedure.34 However, the procedural rules are rigorous,35 and de facto prevent parties from not submitting or disregarding the NDCs: The PA requires the parties to prepare, communicate, and maintain NDCs.36 The parties must resubmit NDCs every 5 years, representing a progression.37 The NDCs are publicly registered, and parties shall account for them.38 To ensure the effective implementation of the selfimposed commitments, the parties established a monitoring mechanism administered by the COP and the UNFCCC Secretariat.39 As a result, while the NDCs are not obligations of result, they can be seen as de facto obligations that come with intense political pressure to comply.40 When preparing their NDCs, the PA parties must follow the relevant rules of international law. Following Article 26 of the Vienna Convention on the Law of Treaties (VCLT), treaty obligations must be implemented in good faith, i.e. through measures that give effect to the treaty’s purpose.41 NDCs fulfil this obligation if they effectively contribute to the objectives of climate change mitigation, adaptation, and release of financial means. As achieving the PA objectives requires the participation of all sectors of the economy and society,42 a good faith preparation of the NDCs also requires the parties to address the potential role of the banking sector. Furthermore, as an obligation of conduct, the preparation of the NDCs must meet a due diligence standard.43 This standard requires states to “adopt reasonable and appropriate regulatory and enforcement measures to curb GHG emissions from activities under their jurisdiction”.44 Also, international environmental law establishes due

33

Voigt (2016), p. 18. Van Calster and Reins (2021), p. 99, para. 3.14; see also Green (2014); Rajamani (2016), pp. 497–502. 35 For details see Van Calster and Reins (2021), pp. 113–124; Voigt (2016), p. 18. 36 Article 4(2) PA. 37 Articles 4(3) and (9) PA. 38 Articles 4(12) and (13) PA. 39 See Articles 6, 13–15 PA; for details see Rajamani (2016), pp. 502–505; Bodansky (2017), pp. 19–20. 40 Cf. Van Calster and Reins (2021), pp. 124–128. 41 See Orakhelashvili (2019), p. 265; see also ILC Final Report, II YBILC 1966, p. 219; see also PA, preamble, 4th recital. 42 Cf. PA, preamble, 14th and 15th recital; see also UN, 2030 Agenda for Sustainable Development, A/RES/70/1, SDG No. 13. 43 Van Calster and Reins (2021), p. 126, para. 4.49; Bodansky (2017), pp. 42f and 45; Voigt (2016), p. 19. 44 Bodansky (2017), p. 45. 34

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diligence obligations. The preventive principle requires states to take due diligence measures to prevent environmental harm.45 The precautionary principle46 expressly mentioned in Article 3.3 UNFCCC requires states to take precautionary measures to anticipate, prevent or minimise the causes of environmental harm and mitigate its adverse effects, even if there is no full scientific certainty. Both principles constitute customary international law and require states to take a proactive stance in preparing their NDCs, which arguably also involves examining the linkages between the banking sector and climate change.

2.2

The Paris Agreement and the Banking Sector

Although the PA does not explicitly address the banking sector, the sector plays an essential role in realising the PA objectives. Financing climate change mitigation and adaptation has been a central issue in the UNFCCC since its inception. The initial focus of the financial provisions in the UNFCCC47 was to provide financial means from developed country parties to developing country parties for climate change mitigation and adaptation. The debates of the COPs and the UNFCCC Standing Committee on Finance48 under these provisions circled the questions of financial assistance, creating climate-related funds, and specifying eligible projects for financing or the amount of funding.49 The source of funds contemplated were merely public funds.50 Only later, the COPs considered a “wide variety of sources”.51 The 2007 Bali Action Plan52 provides a wide range of measures regarding the banking sector and private investment to facilitate climate mitigation and adaptation. Subsequent COPs pursued this path, the latest prominent examples being the 2021 Glasgow Climate Pact and the 2022 Sharm el-Sheik Implementation Plan.53 Also, Article 9 PA reflects this broader approach by expanding the financial commitments

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1992 Rio Declaration on Environment and Development, A/Conf.151/26/Rev.1 (Vol. 1), Annex, Principle 2; see for details Boyle and Redgwell (2021), pp. 152–170, in particular pp. 163–167. 46 1992 Rio Declaration on Environment and Development, A/Conf.151/26/Rev.1 (Vol. 1), Annex, Principle 15; see for details Boyle and Redgwell (2021), pp. 170–183; Bodansky (2017), pp. 41–44. 47 See Articles 4.3, 4.4, and 11 UNFCCC, and Article 2(1)(c) PA. 48 Standing Committee on Finance (SCF) | UNFCCC. 49 Bodansky (2017), pp. 137–140; for the KP: Article 11 KP, Bodansky (2017), p. 179. 50 Bodansky (2017), p. 139. 51 Bodansky (2017), p. 140, referring to Decision 2/CP.15, Copenhagen Accord, 30.03.2010, FCCC/CP/2009/11/Add.1, para. 8; see also Decision 1/CP.21, Adoption of the Paris Agreement, 29.01.2016, FCCC/CP/1015/10/Add. 1, para. 53. 52 Decision 1/CP.13, Bali Action Plan, 14.03.2007, FCCC/CP/2007/6/Add.1*, para. 1(e). 53 Glasgow Climate Pact, Decision 1/CMA.3, 31.11.2021, FCCC/PA/CMA/2021/10/Add.1; Sharm el-Sheikh Implementation Plan, Revised draft decision, FCCC/CP/2022/L.19, at https://unfccc.int/ sites/default/files/resource/cp2022_L19_adv.pdf.

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from developed countries to voluntary contributions of developing countries and other donors. The vital role of private capital and financial markets in climate finance makes the international banking system a central actor in realising climate change mitigation and adaptation measures by providing financial means and a stable framework for climate finance transactions. Therefore, in light of the potential impacts of the banking sector on climate finance, the effective and due diligence implementation of the PA objectives requires considering the role of the banking sector when drafting the NDCs. In this context, the questions are manifold: Are banks obliged to consider climate impacts in their financing and investment operations? To what extent do banks have to integrate climate considerations in their risk evaluation and disclose such risks, thus ensuring financial stability? Does climate change have an impact on financial stability, and what is the actual role of banking supervisory institutions when considering the effects of climate risks on the resilience of the financial sector? And lastly, how does climate change affect the objective of central banks to ensure price stability, and to what extent should they take climate considerations into account when designing their operations? Many NDCs address the performance of the financial and banking sector generally under Article 2(1)(c) PA. They have recently also included the impacts of the private financing sector on climate change. Most NDCs stress the importance of private investment and finance complementing public finances to realise the PA objectives and pledge to develop adequate regulatory frameworks. They report the activities of private banks, central banks and supervisory authorities relating to climate change.54 Likewise, although private climate finance is only a small part of the overall financial flows,55 the NDCs consider it essential to ensure consistency of financial flows and capital stock as a whole with the long-term goals of the PA, specifically those set out in Article 2.56 As a result, NDCs also comprise the banking sector, and the PA parties have undertaken several commitments.

54

UNFCCC Secretariat, Synthesis Report for the Technical Assessment Component of the First Global Stocktake, 20.04.2022, at https://unfccc.int/sites/default/files/resource/GST_SR_23d_MOI. pdf, paras. 5(iv) and (v), 7, and 147. 55 Cf. UNFCCC Secretariat, Synthesis Report for the Technical Assessment Component of the First Global Stocktake, 20.04.2022, at https://unfccc.int/sites/default/files/resource/GST_SR_23d_MOI. pdf, Figure 4 at p. 27. 56 UNFCCC Secretariat, Synthesis Report for the Technical Assessment Component of the First Global Stocktake, 20.04.2022, at https://unfccc.int/sites/default/files/resource/GST_SR_23d_MOI. pdf, para. 71.

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EU Implementation

The EU and its MS are PA parties and implement their obligations jointly, depending on the distribution of powers.57 This principle also applies to any measures adopted regarding the banking sector. The EU submitted the first NDCs on 6 March 2015, followed by the second submission in 2020.58 In addition, the EU presented its longterm strategy on 6 March 2020,59 which states that it will reduce emissions by 55% by 2030 and be climate-neutral in 2050. Also, the MS submitted such strategies, e.g., Austria submitted it for the period through to 2050 in December 2019.60 The European Green Deal61 and the MS’ National Integrated Climate and Energy Plans62 implement the EU’s NDCs.63 The European Green Deal, in conjunction with specific emissions reduction targets and strategies, aims to make the economy sustainable and climate-neutral by 2050 with intermediate emissions reduction targets. The European Climate Law sets a legally binding net-zero GHG emissions target by 2050.64 The EU institutions and the MS are bound to take the necessary measures at the EU and national levels to meet the target. The European Green Deal covers a wide range of measures addressing all sectors of the economy. To implement the European Green Deal, the EU legislators have developed a comprehensive legislative framework

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Regulation (EU) 2018/1999 on the Governance of the Energy Union and Climate Action, OJ 2018 L 328/1; see also Declaration by the Union Made in accordance with Article 20(3) PA, at https://unfccc.int/files/focus/ndc_registry/application/pdf/xxvii-7d_european_union_ndc.pdf. 58 See UNFCCC, NDC Registry, at https://www4.unfccc.int/sites/NDCStaging/pages/Party.aspx? party=EUU. 59 Cf. Article 4(19) PA; the EU’s submission is available at https://unfccc.int/sites/default/files/ resource/HR-03-06-2020%20EU%20Submission%20on%20Long%20term%20strategy.pdf, see also Regulation (EU) 2018/1999 on the Governance of the Energy Union and Climate Action, OJ 2018 L 328/1, Article 15. 60 Republic of Austria, Federal Ministry of Sustainability and Tourism, Long-Term Strategy 2050— Austria, Vienna, December 2019, at https://unfccc.int/sites/default/files/resource/LTS1_Austria. pdf. 61 European Green Deal, Communication from the Commission, 11.12.2019, COM (2019) 640 final. 62 The plans of the EU members are available at https://energy.ec.europa.eu/topics/energy-strategy/ national-energy-and-climate-plans-necps_en. 63 Cf. Regulation (EU) 2018/1999 on the Governance of the Energy Union and Climate Action, OJ 2018 L 328/1, Article 3: Integrated National Energy Plans; Article 7: required finances and investments. 64 Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021 Establishing the Framework for Achieving Climate Neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (“European Climate Law”), OJ L 243, 9.7.2021, pp. 1–17.

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addressing all sectors of the economy and identified measures to implement the EU’s obligations under the PA.65 Regarding the banking and financial sector, the ECOFIN Council emphasised that making swift progress towards achieving the long-term goals of the PA includes “making finance flows – public and private – consistent with a pathway towards low GHG emissions and climate-resilient development”.66 It also highlighted the need to significantly enhance the mobilisation of private finance to help implement the PA.67 Likewise, the integrated national climate and energy plans of the MS include measures to mainstream climate change into the financial and banking sector.68 The European Commission took several actions following the Report of the European Commission’s High-Level Expert Group on Sustainable Finance.69 Essential instruments include the 2018 “Action Plan: Financing Sustainable Growth”,70 setting out an EU strategy on sustainable finance, and the 2021 “Renewed Strategy on Sustainable Finance”,71 which includes measures to increase private investment in sustainable projects, activities to support the actions set out in the European Green Deal, and managing and integrating climate and environmental risks in the financial system. The main objectives of these proposals are reorienting capital flows towards sustainable investment, managing financial risks stemming from climate change, and fostering transparency and long-term considerations in financial and economic activity. To implement these strategy papers, the EU has adopted several legislative acts addressing different aspects of the banking sector’s operations and their linkages to climate change, a prominent example being the Taxonomy Regulation.72

65

At https://ec.europa.eu/info/files/communication-european-green-deal_en. ECOFIN Council, ECOFIN Council Conclusions on Climate Finance, Press Release, 5.10.2021, at https://www.consilium.europa.eu/de/press/press-releases/2021/10/05/ecofin-council-conclu sions-on-climate-finance/, para. 2. 67 ECOFIN Council, ECOFIN Council Conclusions on Climate Finance, Press Release, 5.10.2021, at https://www.consilium.europa.eu/de/press/press-releases/2021/10/05/ecofin-council-conclu sions-on-climate-finance/, para. 3. 68 E.g. Republic of Austria, Federal Ministry of Sustainability and Tourism, Long-Term Strategy 2050—Austria, Vienna, December 2019, at https://unfccc.int/sites/default/files/resource/LTS1_ Austria.pdf, pp. 72–74 and 79; see also UNFCCC Secretariat, Synthesis Report for the Technical Assessment Component of the First Global Stocktake, 20.04.2022, at https://unfccc.int/sites/ default/files/resource/GST_SR_23d_MOI.pdf. 69 Report of the European Commission’s High-Level Expert Group on Sustainable Finance, 31.01.2018, at https://ec.europa.eu/info/publications/180131-sustainable-finance-report_en. 70 Action Plan: Financing Sustainable Growth, Communication from the Commission, 8.3.2018, COM(2018) 97 final, at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:5201 8DC0097&from=EN. 71 Strategy for Financing the Transition to a Sustainable Economy, Communication from the Commission, 6.7.2021, COM(2021) 390 final, at https://eur-lex.europa.eu/legal-content/EN/ TXT/?uri=CELEX:52021DC0390. 72 Regulation (EU) 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), OJ 2020 L 198/13, pp. 13–43. 66

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Similarly, the ECB and the European Banking Authority (EBA) have adopted relevant policy instruments, including the ECB Guide on climate-related and environmental risks,73 the ECB Action Plan and Roadmap,74 and the EBA Report on management and supervision of environmental, social, and governance-related (ESG) risks for credit institutions and investment firms.75 The ECB and other relevant EU institutions also cooperate internationally on these questions.

2.4

Selected International Initiatives Promoting Greening Financial Systems

Numerous international initiatives are promoting greening financial systems or financial instruments that address funding needs for climate change. Despite being voluntary and non-binding, the results of these cooperations influence the EU regulatory framework for banks. Many initiatives have been operative even before the PA entered into force.76 There are two types of initiatives: private initiatives, including encouraging voluntary commitments on climate action,77 setting market standards for sustainability reporting,78 green bonds79 or carbon accounting,80 and public initiatives fostering the integration of climate risk considerations in the

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ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf. 74 ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy, Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ ecb.pr210708_1~f104919225.en.html. The ECB has decided on a comprehensive action plan and a roadmap to further incorporate climate change considerations into its policy framework. 75 EBA, EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), EBA/REP/2021/18, at https://www.eba.europa.eu/sites/default/docu ments/files/document_library/Publications/Reports/2021/1015656/EBA%20Report%20on%20 ESG%20risks%20management%20and%20supervision.pdf. 76 UNFCCC Standing Committee on Finance, Report of the Standing Committee on Finance. Addendum. Mapping of available information relevant to Article 2, paragraph 1(c), of the Paris Agreement, including its reference to article 9 thereof (2022), FCCC/PA/CMA/2022/7/Add.4, pp. 5–13, at https://unfccc.int/documents/620484. 77 E.g., Glasgow Financial Alliance for Net Zero, Financial Institution Net-zero Transition Plans (2022), at https://assets.bbhub.io/company/sites/63/2022/06/GFANZ_Recommendations-and-Guid ance-on-Net-zero-Transition-Plans-for-the-Financial-Sector_June2022.pdf. 78 E.g., the Global Reporting Initiative, at https://www.globalreporting.org/ and the International Sustainability Standards Board (ISSB), at https://www.ifrs.org/groups/international-sustainabilitystandards-board/. 79 E.g., International Capital Markets Association, Green Bond Principles (June 2021), at https:// www.icmagroup.org/assets/documents/Sustainable-finance/2021-updates/Green-Bond-PrinciplesJune-2021-140621.pdf. 80 E.g., the Partnership for Carbon Accounting Financials, at https://carbonaccountingfinancials. com/.

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financial sector. Examples of the latter include the Task Force on Climate-related Financial Disclosures (TCFD) created by the G20 Financial Stability Board,81 the FSB Roadmap for Addressing Climate-Related Financial Risks,82 the Network of Central Banks and Supervisors for Greening the Financial System (NGFS),83 the Basel Committee on Banking Supervision (BCBS),84 and the International Platform on Sustainable Finance (IPSF).85 All activities are relevant to Article 2(1)(c) PA by seeking to enhance the financial system’s role in managing risks or mobilising capital for green and low-carbon investments. To this end, they define and promote best practices or conduct analytical work on green finance.86 A common theme is that financial markets need clear, high-quality information on the impacts of climate change for an efficient allocation of capital, to scale up green finance, and to ensure better risk management.87 Therefore, many initiatives seek to enhance reporting of climate-related financial information88 or improve the comparability and interoperability of taxonomies for sustainable economic activities.89 The NGFS also published a guide for banking supervisors on how to integrate climaterelated and environmental risks into their supervisory frameworks,90 work on

81

Task Force on Climate-related Financial Disclosures, at https://www.fsb-tcfd.org/. Financial Stability Board, FSB Roadmap for Addressing Climate-Related Financial Risks (2021), at https://www.fsb.org/wp-content/uploads/P070721-2.pdf. 83 Network of Central Banks and Supervisors for Greening the Financial System, at https://www. ngfs.net/en. 84 Basel Committee on Banking Supervision, Principles for the Effective Management and Supervision of Climate-related Financial Risk (June 2022), at https://www.bis.org/bcbs/publ/d532.pdf. 85 For information on the IPSF’s activities see International Platform on Sustainable Finance, Annual Report (2022), at https://finance.ec.europa.eu/system/files/2022-11/221109-ipsf-annualreport_en.pdf. 86 Joint Statement by the Founding Members of the Central Banks and Supervisors Network for Greening the Financial System (12.12.2017), at https://www.banque-france.fr/sites/default/files/ medias/documents/joint_statement_-_greening_the_financial_system_-_final.pdf. 87 See., e.g., Task Force on Climate-related Financial Disclosures, at https://www.fsb-tcfd.org/. 88 As one among many publications of the NGFS see, e.g., Network of Central Banks and Supervisors for Greening the Financial System, Enhancing market transparency in green and transition finance (April 2022), at https://www.ngfs.net/sites/default/files/medias/documents/ enhancing_market_transparency_in_green_and_transition_finance.pdf. 89 International Platform on Sustainable Finance, Annual Report (November 2021), p. 8, at https:// ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/docu ments/211104-ipsf-annual-report_en.pdf. 90 Network of Central Banks and Supervisors for Greening the Financial System, Progress Report on the Guide for Supervisors (October 2021), at https://www.ngfs.net/sites/default/files/ media/2021/11/08/progress_report_on_the_guide_for_supervisors.pdf. 82

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climate scenario analysis,91 and on ways to approach the problem of data gaps.92 These initiatives provide input for regulatory and supervisory agencies worldwide and promote international convergence and compatible frameworks. For example, the TCFD disclosure framework features prominently in the supervisory ECB Guide on climate-related and environmental risk93 and forms part of the supervisory expectations for major European banks. International initiatives also address the linkage between central banks and climate change. The NGFS guide on how central banks could disclose climaterelated information advances the idea that if central banks, without prejudice to their mandates, decided to disclose information on their climate-related exposures, related risk management strategies, and governance arrangements, other market participants would follow suit.94 The NGFS also outlined options for adapting central bank operations to climate change in a separate report.95 Policymakers refer to the reports. For instance, the European Parliament (EP) explicitly requested the ECB “to build on the nine options assessed by the NGFS for central banks to factor climate-related risks into their operational framework on credit operations, collateral and asset purchases”.96 Subsequently, the ECB decided to incorporate climate change considerations into its policy framework and roadmap97 that reflect some options outlined by the NGFS.

91

Network of Central Banks and Supervisors for Greening the Financial System, NGFS Climate Scenarios for Central Banks and Supervisors (June 2021), at https://www.ngfs.net/sites/default/ files/media/2021/08/27/ngfs_climate_scenarios_phase2_june2021.pdf. 92 Network of Central Banks and Supervisors for Greening the Financial System, Progress Report on Bridging Data Gaps (May 2021), at https://www.ngfs.net/sites/default/files/medias/documents/ progress_report_on_bridging_data_gaps.pdf. 93 ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf, pp. 48–50. 94 Network of Central Banks and Supervisors for Greening the Financial System, Guide on Climaterelated Disclosure for Central Banks (December 2021), at https://www.ngfs.net/sites/default/files/ medias/documents/guide_on_climate-related_disclosure_for_central_banks.pdf. 95 Network of Central Banks and Supervisors for Greening the Financial System, Adapting Central Bank Operations to a Hotter World: Reviewing Some Options (March 2021), at https://www.ngfs. net/sites/default/files/media/2021/06/17/ngfs_monetary_policy_operations_final.pdf. 96 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html. 97 ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy, Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ ecb.pr210708_1~f104919225.en.html.

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3 Examining the Status Quo: The EU Banking Sector Activities and Climate Change 3.1

General Remarks

Climate finance to mitigate and adapt to climate change has been one of the most controversial questions in the UNFCCC negotiations. Relevant actors for climate finance include governments, development finance institutions, central banks and regulators, multilateral finance institutions, climate funds, and private sector actors, including corporations, private banks, and investors.98 For instance, the EIB is one of the most prominent global financiers of climate action and environmental sustainability.99 However, while most financial means to address climate change come from public sources, private finance has become increasingly relevant to implementing the PA goals.100 Private financial actors, including stock exchanges, investors, and private sector banks, had considered climate change and developed climate-related financial instruments and regulations even before the PA entered into force.101 However, the PA sharpened the attention.102 Yet, regulating private climate finance differs substantially from public funding. In contrast to the administration of public means, which allows states to influence spending and direct it to climate policy purposes, the regulatory framework of the private banking sector focuses on financial stability and the management of financial risks. Preventing climate change, however, is not at the centre of these rules. Therefore, this article restricts its focus on private sector banks, banking supervisory authorities, and central banks to explore commonalities of their evolving roles and shared obstacles when considering climate considerations. The regulatory framework of the banking sector primarily focuses on granting financial stability. In this context, climate change has been characterised as the

98

UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), p. 3, at https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-% 20Summary%20-%20WEB.pdf. 99 EIB Group, EIB Group Climate Bank Roadmap 2021–2025 (November 2020), p. 5, at https:// www.eib.org/attachments/thematic/eib_group_climate_bank_roadmap_en.pdf. 100 Cf. UNFCCC Secretariat, Synthesis Report for the Technical Assessment Component of the First Global Stocktake, 20.04.2022, at https://unfccc.int/sites/default/files/resource/GST_SR_23d_ MOI.pdf, Figure 4 at p. 27. 101 UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), p. 13, at https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-% 20Summary%20-%20WEB.pdf. 102 UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), p. 13, at https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-% 20Summary%20-%20WEB.pdf.

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“Tragedy of the Horizon”, as its impacts will transpire beyond the traditional time horizons of corporations and institutions, such as regular business cycles, political cycles, monetary policy, and observation periods for financial stability purposes.103 This time inconsistency leads to several problems: For instance, it could delay the transition to a more carbon-neutral economy by only allowing for short-term planning, an abrupt correction of market perceptions could destabilise the financial system, and market players might not be willing to finance the transition to a carbon-neutral economy in the absence of incentives and clear commitments from policymakers.104 Civil society has pressured the financial sector, including central banks, for their perceived inaction on climate change. Critics argue, inter alia, that banks provide financing to companies in GHG-intensive sectors without adequately assessing the risks, thus ignoring the problem of stranded fossil-based assets.105 Scholars argue106 that through this failure, financial institutions ignore negative externalities, provide financing to environmentally detrimental companies too cheaply, and, as a result, accelerate climate change. Put differently, allocating resources based on an incomplete analysis of expected risks and returns would lead to over-investing in environmentally harmful assets and under-investing in projects that would benefit the environment. According to this view, public authorities, regulators, and central banks should correct this analysis, thus reallocating financial flows in favour of sustainable investments.107 In light of this criticism, the following sections will analyse whether and to what extent the current regulatory framework for banking and its actors’ practices is suitable to address the challenges of climate change. It will further discuss whether the existing attempts to integrate climate change into this legal framework are adequate to reconcile the interests of financial stability and climate change.

103 Carney M, Governor of the Bank of England and Chairman of the Financial Stability Board, Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, Speech at Lloyd’s of London, 29.09.2015, at https://www.bis.org/review/r151009a.pdf. 104 Gourdel et al. (2022), Chapter 7.2.; the authors highlight the key role of investors’ anticipation of the impact of the carbon tax for smoothing the transition in the economy and finance. 105 The non-profit thinktank Carbontracker understands stranded assets as those assets that at some time prior to the end of their economic life are no longer able to earn an economic return as a result of changes associated with the transition to a low-carbon economy, e.g., lower than anticipated demand or prices. This leads to the assets being worth less than expected as a result of changes associated with the energy transition, see https://carbontracker.org/terms/stranded-assets/. 106 Scialom (2021), p. 197. 107 Explained in more detail in Scialom (2021), pp. 197–198.

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Private Banking Sector The EU Prudential Regulatory Framework for Activities of Private Banks and Climate Change

The EU’s private banking system consists of numerous actors and stakeholders interacting in multidimensional ways. Private sector banks provide various services, including loans, investment banking, asset management, and payment services. They cooperate with their customers, other actors in the financial market, supervisory authorities, and central banks. Based on the legislative and regulatory framework adopted by the EU, national legislators, and regulatory agencies, the banks’ competent corporate body devises business strategies and takes individual business decisions resulting in the allocation of financial resources within the economy. To ensure the stability of the financial system, the legislation provides for strict regulation of taking up and pursuing a banking business in the EU. The regulatory framework primarily aims at ensuring the solvency of banks, the safety of bank deposits, trust in the banking system, and the protection of public funds. Climate change mitigation and adaptation, e.g. through limiting the GHG emissions of corporations by limiting the banks’ financing, is not part of the objectives of the current prudential framework. The Capital Requirements Directive (CRD)108 and the Capital Requirements Regulation (CRR)109 form the legal core governing banking activities, the supervisory framework, and the prudential rules for banks.110 EBA’s regulatory and technical standards,111 adopted by the EU Commission, complement this framework. Banking supervisory authorities may also supplement the general requirements with individual measures to address a bank’s specific risk profile, risk

108 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on Access to the Activity of Credit Institutions and the Prudential Supervision of Credit Institutions and Investment Firms, OJ 2013 L 176/338, as amended. 109 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on Prudential Requirements for Credit Institutions and Investment Firms, OJ L 176/1, as amended. The CRR and CRD complement each other. The CRR represents the directly appliable body of rules maximally harmonized within the EU, the provisions of the CRD in general need to be transposed by MS into national law. 110 Depending on the specific activities undertaken, additional regulatory frameworks may apply, e.g., in the area of asset management, securities etc. 111 Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 Establishing a European Supervisory Authority (European Banking Authority), as amended, OJ 2010 L 331/12, Article 8(1)(a). Regulatory technical standards (RTS) in accordance with Article 290 TFEU need to be distinguished from implementing technical standards (ITS) in accordance with Article 291 TFEU. In the area of banking regulation, RTS serve to ensure the consistent harmonization of this area of the financial market. They must be “technical”, hence may not contain strategic decisions or policy choices, their content is limited by the legislative act on which they are based. ITS serve to determine the conditions of application of certain legislative acts. They must also be of a technical nature and may not contain strategic decisions or policy choices. See also Article 10–14 and 15 EBA Regulation; for details on the EBA Regulation see below.

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management, and capital planning. They base such measures on the ongoing supervisory review of each bank.112 Disclosure requirements seek to promote market discipline and play a central role in monitoring a bank’s prudential metrics.113 Depending on the legal form of a bank and its specific activities, the relevant corporate law provisions114 and rules on disclosure, including the Accounting directive,115 the Non-Financial Reporting Directive (NFRD),116 the European Commission’s Guidelines on Non-Financial Reporting,117 the Taxonomy Regulation118 and the Sustainable Finance Disclosure Regulation (SFDR)119 apply. The rules on disclosure, inter alia, aim to improve the information value on climate-related risks,120 the environmental performance of assets and economic activities of financial and non-financial undertakings, and the 112

Article 97 CRD. Basel Committee on Banking Supervision, Disclosure Requirements (2019), para. 10.1, at https://www.bis.org/basel_framework/standard/DIS.htm?type=all. 114 E.g., the law on stock corporations. 115 Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the Annual Financial Statements, Consolidated Financial Statements and Related Reports of Certain Types of Undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC, OJ (2013) L 182/19. 116 Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards Disclosure of Non-financial and Diversity Information by Certain Large Undertakings and Groups, OJ 2014 L 330/1. 117 European Commission, Communication from the Commission—Guidelines on Non-financial Reporting: Supplement on Reporting Climate-related Information, OJ 2019 C 209/1. The Guidelines express the expectation to publish, inter alia, meaningful information and key metrics on climate-related and environmental risks. 118 Regulation (EU) 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), OJ 2020 L 198/13. The EU Commission adopted a delegated act to further specify the content, methodology, and presentation of the information to be disclosed, see Commission Delegated Regulation supplementing Regulation (EU) 2020/852 of the European Parliament and of the Council by Specifying the Content and Presentation of Information to be Disclosed by Undertakings Subject to Articles 19a or 29a of Directive 2013/34/EU Concerning Environmentally Sustainable Economic Activities, and Specifying the Methodology to Comply with that Disclosure Obligation, 06.07.2021, C(2021) 4987 final, at https://ec.europa.eu/finance/docs/level-2-measures/taxonomyregulation-delegated-act-2021-4987_en.pdf. 119 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on Sustainability-related Disclosures in the Financial Services Sector, OJ 2019 L 317/1, to be read in conjunction with the Regulation (EU) 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), OJ 2020 L 198/13. The SFDR obliges manufacturers of financial products and financial advisers including banks to disclose the “principal adverse impacts” that investment decisions have on sustainability factors and the sustainability characteristics of financial products. 120 Climate risks can be viewed as a subset of ESG risk. The EBA defines ESG risks as “risks of any negative financial impact on the institution stemming from the current or prospective impacts of ESG factors on its counterparties or invested assets”, see EBA, EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), EBA/REP/2021/18, at https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/ 113

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extent to which financial products are environmentally sustainable and address adverse effects and sustainability impacts.121 In the EU, taxonomy-related reporting serves as a basis for various future initiatives in sustainable finance, e.g., the EU Green Bond Standard.122 Furthermore, large banks with securities admitted to trading on a regulated market must disclose certain information on ESG risks and mitigating actions supporting the transition to a carbon-neutral economy and adaptation to climate change.123 These regulations aim to disclose a bank’s business characteristics and risk profile to supervisors and market participants and increase transparency to steer consumers and corporates toward climate change action, as envisaged by Articles 12 and 13 PA.124 However, data gaps persist, and methodologies to quantify climate risk are still evolving. Disclosure obligations largely build on data provided by the corporate sector and aim at providing a picture of individual banks’ risk situation and information to what extent their activities are associated with environmentally sustainable economic activities. The EU legislators are currently establishing a coherent framework for an integrated “green” financial market

Reports/2021/1015656/EBA%20Report%20on%20ESG%20risks%20management%20and%20 supervision.pdf, p. 23. 121 Under Article 8 Taxonomy Regulation large undertakings that are required to publish non-financial information pursuant to the Non-Financial Reporting Directive (NFRD) have to disclose information to the public on how and to what extent their activities are associated with environmentally sustainable (“taxonomy-aligned”) economic activities. 122 European Commission, Proposal for a Regulation of the European Parliament and the Council on European Green Bonds, 6.7.2022, COM(2021) 391 final, at https://eur-lex.europa.eu/legalcontent/EN/TXT/?uri=CELEX%3A52021PC0391. 123 Article 449a CRR, Article 98(8) CRD. The information required is further detailed in EBA Implementing Technical Standards (ITS) on Disclosures on Environmental, Social and Governance (ESG) Risks, in: EBA, Final Report, Final Draft Implementing Technical Standards on Prudential Disclosures on ESG Risks in accordance with Article 449a CRR, 24.01.2022, EBA/ITS/2022/01, at EBA draft ITS on Pillar 3 disclosures on ESG risks.pdf (europa.eu). The information shall be provided staggered over time. It includes comparable quantitative disclosures on climate-changerelated risks, as well as information on exposures towards carbon-related assets and assets subject to chronic and acute climate change events, furthermore, quantitative disclosures on banks’ mitigating actions supporting their counterparties in the transition to a GHG-neutral economy and in the adaptation to climate change. In addition, a Green Asset Ratio (GAR), which identifies the banks’ assets financing activities that are environmentally sustainable according to the EU taxonomy must be disclosed. On related EBA activities see below. 124 Article 431 CRR.

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consisting of clear definitions125 and a harmonised disclosure framework126 to enable investors to identify sustainable investment opportunities and risks. To ensure the safe and prudent management of climate-related risks, banks should consider these risks as financial risks127 when formulating and implementing their business strategy, governance, and risk management frameworks and disclosing related information.128 However, being an institution-specific assessment, it is primarily the responsibility of the disclosing bank to decide whether physical or transition risks arising from climate change129 are significant. Supervisors expect banks to document the information underlying this assessment.130 Scholars criticise the prudential supervisory framework for banks and the current notion of risk for not expressly capturing risks originating outside financial markets, as is the case for climate change with no historical record.131 Extrapolating historical data in such cases does not suffice to assess future climate-related risks.132 Also, current assessment methodologies may not sufficiently capture risks because climate risks manifest over a longer time horizon than traditional financial risks.133 Some scholars argue that regulators should act more cautiously and impose higher risk 125

As provided by the Taxonomy Regulation and related technical standards. As provided for by the NFRD, the Taxonomy Regulation, prudential regulation, the Corporate Sustainability Reporting Directive (CSRD) (Directive of the European Parliament and of the Council amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting, PE-CONS 35/22, at https:// data.consilium.europa.eu/doc/document/PE-35-2022-INIT/en/pdf), the work done by the European Financial Reporting Advisory Group (EFRAG), at https://www.efrag.org/ and, for financial products, the SFDR. 127 Existing risk categories include, e.g., credit, market, operational, reputational, legal and liquidity risks. 128 For a list of provisions of particular relevance in that respect and EBA Guidelines specifying these provisions see ECB, Guide on Climate-related and Environmental Risks (2020), at https:// www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf, p. 8 and below. 129 For a discussion of these categories see, e.g., EBA, EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), EBA/REP/2021/18, at https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/ Reports/2021/1015656/EBA%20Report%20on%20ESG%20risks%20management%20and%20 supervision.pdf, pp. 35–43. Physical risks arise from the physical effects of climate change and environmental degradation. Transition risks arise out of the uncertain timing of the adjustment to an GHG-neutral economy. A bank’s business model, operating environment, and risk profile determine whether such risks are relevant and influence the resulting regulatory requirements. In its report, the EBA provides steer on supervisory expectations, sets out common definitions of ESG risks and their transmission channels, and identifies evaluation methods that are needed for effective risk management. 130 ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf, p. 23. 131 Le Quang and Scialom (2021), pp. 3–7. 132 Bolton et al. (2020), pp. 21–22. 133 Coelho and Restoy (2022), pp. 4 and 7. 126

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weights on GHG-intensive exposures to reorient financial flows from environmentally detrimental to “green” exposures and account for the perceived higher risk of, e.g., loans to GHG-intensive sectors. This approach could make it less attractive for banks to finance companies in these sectors.134 However, following the NGFS, there is still limited empirical evidence of ex-post green/non-green risk differentials. Therefore conducting such analysis is not straightforward given persistent methodological and data-related challenges.135 As the prudential regulation focuses on mitigating banks’ financial risk, treating “green” exposures more leniently from a bank regulatory perspective could be potentially counterproductive for financial stability.136 Another example of the lack of directly connecting the supervisory framework with climate change objectives is the CRR, which provides for preferential treatment of exposures related to certain infrastructure projects.137 While this rule aims to reduce own funds requirements for banks “in order to encourage private and public investments in infrastructure projects”,138 the provision stops short of linking the preferential treatment to the environmental objective of the project. Hence, the objectives of the prudential regulatory framework (stability of banks and the financial system) are not commingled with matters of environmental or economic policy (encouraging investments in sustainable projects). Some scholars have proposed stronger interventions of the supervisory authorities beyond addressing the financial risks to banks, e.g., through a policy of credit guidance to channel financing towards priority sectors forcing banks to withdraw from less sustainable sectors progressively. Such policy would, however, require a

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Le Quang and Scialom (2021), p. 14. Network for Greening the Financial System, Capturing Risk Differentials from Climate-related Risks: A Progress Report (May 2022), at https://www.ngfs.net/sites/default/files/medias/ documents/capturing_risk_differentials_from_climate-related_risks.pdf, and Network for Greening the Financial System, A Status Report on Financial Institutions’ Experiences from Working with Green, Non-green and Brown Financial Assets and a Potential Risk Differential (May 2020), at https://www.ngfs.net/sites/default/files/medias/documents/ngfs_status_report.pdf. The EBA also follows a cautious stance on adjustment factors for green and non-green exposures, see EBA, The Role of Environmental Risks in the Prudential Framework, Discussion Paper, 02.05.2022, EBA/DP/2022/02, at https://www.eba.europa.eu/sites/default/documents/files/document_library/ Publications/Discussions/2022/Discussion%20paper%20on%20the%20role%20of%20environ mental%20risk%20in%20the%20prudential%20framework/1031947/Discussion%20paper%20on %20role%20of%20ESG%20risks%20in%20prudential%20framework.pdf, p. 45. 136 Coelho and Restoy (2022), p. 6. 137 According to Article 501a CCR, such exposures shall entail reduced own funds requirements provided that they comply with a list of criteria including that the obligor has carried out an assessment whether the assets being financed contribute to the environmental objectives of climate change mitigation or adaption. However, a verification of this assessment is not required. 138 Recital 61 of Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the Leverage Ratio, the Net Stable Funding Ratio, Requirements for Own Funds and Eligible Liabilities, Counterparty Credit Risk, Market Risk, Exposures to Central Counterparties, Exposures to Collective Investment Undertakings, Large Exposures, Reporting and Disclosure Requirements, and Regulation (EU) No 648/2012, OJ 2019 L 150/1. 135

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redefinition of the role of banks and finance.139 A recent review of climate-related financial policies shows that, while several climate-related risk management and supervisory measures exist,140 the G20 countries have not adopted any macroprudential measure concerning capital requirements, leverage ratios, or liquidity requirements relating to climate risk.141 According to an ECB/ESRB Project Team on Climate Risk Monitoring, the selection, design and calibration of macroprudential policy measures to address climate risk still requires more work.142 To sum up, the bank regulatory framework contributes to an orderly transition to a more carbon-neutral economy by requiring financial actors to identify and manage climate-related financial risks adequately. Currently,143 banks must consider climate-related risks primarily in terms of financial risks to the bank itself, i.e., how climate change constitutes a financial risk a bank must consider when lending money and taking investment decisions. Banks have certain obligations to identify, quantify, manage and disclose potential risks arising to the bank, but the full integration of climate-related information into the supervisory reporting framework will be a long-term undertaking. If the relevant conditions are met, authorities may impose requirements to address risks not covered adequately.144 However, this regulatory framework captures the identification and assessment of the negative impacts a bank’s financing activities may have on climate change primarily indirectly. As a result, the current regulatory framework lacks express regulatory limits to financing environmentally detrimental projects, as long as a bank complies with procedural, organisational and general prudential requirements, and the bank’s overall resilience is not endangered. Discussions about adjusting the framework mainly focus on correcting possible deficiencies to address the risks of climate change for banks fully.145 However, the corporate sector and financial markets need to interconnect to reorient capital flows towards a more GHG-neutral economy. Legislators increasingly consider this interlinkage by coordinating disclosure requirements for both sectors and requiring forward-looking corporate transition planning towards GHG neutrality to enable banks and investors to assess the transition readiness of their counterparties and allocate funding accordingly. Furthermore, shifting financial flows towards climate-neutral adaptive investments

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Le Quang and Scialom (2021), p. 16, with further references. Measures include climate risk-related stress-testing and disclosure requirements. 141 Cited in D’Orazio and Popoyan (2022), p. 107. 142 ECB/ESRB Project Team on Climate Risk Monitoring, The Macroprudential Challenge of Climate Change (July 2022), at https://www.esrb.europa.eu/pub/pdf/reports/esrb.ecb.climate_ report202207~622b791878.en.pdf?5654a61b8a5f9bcc779c001b051e8168, p. 115. 143 EU legislators currently negotiate amendments, see European Commission, Banking Package 2021: New EU Rules to Strengthen Banks’ Resilience and Better Prepare for the Future, Press Release, 27.10.2021, at https://ec.europa.eu/commission/presscorner/detail/en/IP_21_5401. 144 Article 104 CRD. 145 Coelho and Restoy (2022), p. 2. 140

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requires clearer additional public interventions, including leveraging the role that public policy and public finance can play.146

3.2.2

Activities of the Private Banking Sector and Climate Change

As a credit provider and investment manager, the banking sector is essential for achieving the long-term goals of the PA by facilitating the reallocation of resources required for economic transformation.147 While banks may have a pivotal role in implementing climate change policies,148 their investment decisions and financial advice may also cause or contribute to adverse effects on the environment.149 Also, banks may face risks arising from climate change, and even though projections of climate losses are uncertain,150 climate risks may affect a bank’s profitability.151 Therefore, the European banking sector can significantly impact climate change, and climate change can impact the European banking sector. For that reason, the European banking sector should play its part in helping achieve climate targets and manage the financial risks of climate change.152 The two goals are connected in that a delayed or disorderly transition to a low-carbon economy would increase

146 Council of the EU, ECOFIN Council Conclusions on Climate Finance, Press Release 727/21, 05.10.2021, at https://www.consilium.europa.eu/de/press/press-releases/2021/10/05/ecofin-coun cil-conclusions-on-climate-finance/pdf. 147 Coelho and Restoy (2022), p. 2. 148 Reghezza et al. (2021), p. 19. 149 Commission Delegated Regulation supplementing Regulation (EU) 2019/2088 of the European Parliament and of the Council with regard to Regulatory Technical Standards Specifying the Details of the Content and Presentation of the Information in relation to the Principle of ‘Do No Significant Harm’, Specifying the Content, Methodologies and Presentation of Information in relation to Sustainability Indicators and Adverse Sustainability Impacts, and the Content and Presentation of the Information in relation to the Promotion of Environmental or Social Characteristics and Sustainable Investment Objectives in Precontractual Documents, on Websites and in Periodic Reports, 06.04.2022, C(2022) 1931 final, at https://ec.europa.eu/finance/docs/level-2-measures/ C_2022_1931_1_EN_ACT_part1_v6%20(1).pdf, p. 2. 150 Bank of England, Results of the 2021 Climate Biennial Exploratory Scenario (CBES) (published 24.05.2022), at https://www.bankofengland.co.uk/stress-testing/2022/results-of-the-2021-climatebiennial-exploratory-scenario, p. 4. 151 As an example, see, e.g., the exploration of the financial risks posed by climate change for the largest UK banks and insurers (published 24.05.2022), at https://www.bankofengland.co.uk/stresstesting/2022/results-of-the-2021-climate-biennial-exploratory-scenario, p. 12. 152 Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions, Action Plan: Financing Sustainable Growth, 08.03.2018, COM(2018) 97 final, at https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52018DC0097& from=EN, pp. 1–2.

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risks to the global economy and the financial system.153 This twofold relevance of risks154 can be described in more detail as follows: First, banks can have an impact on climate change, for example—negatively—through their GHG emissions, by providing a loan to a counterparty with environmentally detrimental business activities or—positively—by financing “green” projects. Second, climate change can impact banks, for example, through physical effects of climate change on their premises or—to an even larger extent—through financing companies that are affected by physical risks or the implementation of policies aimed at promoting the transition to an environmentally sustainable economy. Such climate policies could, in turn, affect the debtor’s risk profile and indirectly the bank’s balance sheet.155 The financial system needs to be sound and resilient to contribute to a smooth transition to a low-carbon economy and mitigate potentially disruptive impacts.156 One way to analyse its resilience is to survey data on banks’ direct exposures to GHG-intensive sectors. For instance, according to the International Energy Agency (IEA), the energy sector is the largest source of GHG emissions. Following the IEA’s “net-zero pathway”,157 states should not approve the development of new oil and gas fields. Financing projects deviating from a sector-specific pathway may increase risks for banks. Following a study of the EBA, European banks appear to have limited direct exposures to GHG-intensive sectors, but concentrated exposures in a few sectors and firms exist.158 The climate impact could be significant for banks

153 Knot K, Propelling a Graceful Transition: The Role of the Financial System, Speech, 01.06.2022, at https://www.dnb.nl/en/general-news/2022/speech-klaas-knot-propelling-a-gracefultransition-the-role-of-the-financial-system/. 154 Frequently called the “double materiality”. According to one definition, the “double materiality perspective” means that entities need to consider how sustainability issues affect their business and their own impact on people and the environment, see European Commission, Questions and Answers: Corporate Sustainability Reporting Directive Proposal, 21.04.2021, at https://ec.europa. eu/commission/presscorner/detail/en/QANDA_21_1806. 155 EBA, EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), EBA/REP/2021/18, at https://www.eba.europa.eu/sites/default/docu ments/files/document_library/Publications/Reports/2021/1015656/EBA%20Report%20on%20 ESG%20risks%20management%20and%20supervision.pdf, pp. 29–30. 156 EBA, Mapping Climate Risk: Main Findings from the EU-wide Pilot Exercise, Report, 21.05.2021, EBA/Rep/2021/11, at https://www.eba.europa.eu/sites/default/documents/files/docu ment_library/Publications/Reports/2021/1001589/Mapping%20Climate%20Risk%20-%20Main% 20findings%20from%20the%20EU-wide%20pilot%20exercise%20on%20climate%20risk. pdf, p. 6. 157 International Energy Agency, Net Zero by 2050 A Roadmap for the Global Energy Sector (Revised version, October 2021), at https://iea.blob.core.windows.net/assets/deebef5d-0c34-45399d0c-10b13d840027/NetZeroby2050-ARoadmapfortheGlobalEnergySector_CORR.pdf, p. 21. 158 EBA, Mapping Climate Risk: Main Findings from the EU-wide Pilot Exercise, Report, 21.05.2021, EBA/Rep/2021/11, at https://www.eba.europa.eu/sites/default/documents/files/docu ment_library/Publications/Reports/2021/1001589/Mapping%20Climate%20Risk%20-%20Main% 20findings%20from%20the%20EU-wide%20pilot%20exercise%20on%20climate%20risk. pdf, p. 7.

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highly exposed to climate risks, either with portfolios concentrated in certain economic sectors or specific geographical areas.159 But also, financing innovative energy and transportation ventures may entail specific financial risks, if projects are in a nascent stage or build on government policies to become economically viable. Banks and investors must satisfy fiduciary duty and due diligence requirements and should not finance such projects without due regard to potential losses. Hence, banks depend to a certain extent on predictable government policies to redirect financing. Establishing a forum for dialogue with actors from financial institutions, administrative bodies, science, and civil society helps anchor climate considerations in the core business of banks. A prominent example of such dialogue is the Glasgow Financial Alliance for Net Zero (GFANZ), a voluntary global coalition of financial institutions aiming to accelerate the transition to a net-zero economy.160 Its members commit to using science-based guidelines to reach net-zero emissions across all emissions scopes by 2050, setting 2030 interim targets, publishing a transition strategy, and transparent reporting and accounting on progress against those targets.161 Against the background of enhanced supervisory and public scrutiny of banks’ activities, such alliances should be established on a sound basis and not misleading. In climate change litigation, alleged breaches of disclosure obligations and deficient decisionmaking processes within banks feature most prominently.162 Also, in the context of growing demand for ESG investments and rapidly evolving markets, there is an increasing risk of “greenwashing”.163 While the GFANZ alliance intends to address such practices by establishing certain standards, it has also been criticised for not adhering to stricter benchmarks.164 As discussed above, bank regulatory and supervisory expectations have risen steadily.165 Banks are expected to disclose meaningful information to market participants on how they adapt their business strategies and their current performance 159

Alogoskoufis et al. (2021), p. 69. GFANZ was launched in April 2021 by Mark Carney, UN Special Envoy for Climate Action and Finance and the UK Prime Minister’s Finance Advisor for COP26, in collaboration with the UN’s Race to Zero and the COP26 Presidency. It acts as a forum for addressing pan-financial sector challenges associated with the net-zero transition. 161 The Glasgow Financial Alliance for Net Zero—Our Progress and Plan towards a Net-zero Global Economy (November 2021), at https://assets.bbhub.io/company/sites/63/2021/11/ GFANZ-Progress-Report.pdf, p. 11. 162 Solana (2021) identified eight different types of climate-related claims, pp. 56–57. 163 Greenwashing can be described as misleadingly attributing to an entity, a financial instrument, product or service certain sustainability-related characteristics that do not (to this extent) exist (e.g., mislabeling as “environmentally friendly” or underreporting of certain exposures). 164 Stand.Earth, 90+ Groups Criticize Carney’s Green Finance Alliances as Greenwashing Ahead of COP26, Press Release, 07.10.2021, at https://www.stand.earth/latest/climate-finance/canada%E2% 80%99s-banks-and-fossil-fuels/90-groups-criticize-carney%E2%80%99s-green-finance. 165 See above in Sect. 3.2.1. and, e.g., ECB, Guide on Climate-related and Environmental Risks (2020), at h ttp s://www.b an kingsupervision.eu rop a.eu/ecb/pub/pdf/ssm.20 2011 finalguideonclimate-relatedandenvironmentalrisks~58213f6564.en.pdf. 160

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against climate-related portfolio metrics, especially when banks commit to contributing to climate-related goals.166 Conveying the risk profile comprehensively and truthfully also limits reputational and litigation risks. A valuable instrument for identifying environmentally sustainable economic activities and investment opportunities is the Taxonomy Regulation, which requires undertakings to provide information to what extent their activities qualify as environmentally sustainable.167 For banks, this information is helpful as they process the obtained corporate data to produce their own ratios of sustainable activities. However, gaps remain because smaller undertakings are not obliged to disclose information under the Taxonomy Regulation. To conclude, there is evidence that, following the PA, European banks reallocated credit away from polluting firms.168 While banks’ transparency and addressing climate risks are drivers to reallocate capital flows to sustainable corporations and projects, this may not suffice to close the sustainable investment gap. Some banks apply strategies to exclude or divest from environmentally detrimental activities. Such strategies potentially reduce banks’ risks and may have an indirect beneficial climate impact as financing conditions for harmful activities become more expensive due to the limited supply of finance. However, measuring this effect and assessing its impact on GHG emissions remains challenging, as actual emissions reductions depend on decisions in the real economy. Also, the UNFCCC Standing Committee on Finance considers that “measuring the effective role of financial actors, in the context of Article 2(1)(c), is notable as a topic of debate among initiatives, including to which metrics are most important as indicators of success.”169

166

ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf, expectation 13.3. Institutions are encouraged to contribute to climate-related goals and are also expected to provide comprehensive and meaningful information on it. 167 Regulation (EU) 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), OJ 2020 L 198/13, Article 8. 168 Reghezza et al. (2021), p. 18. 169 UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), at https:// unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-%20Sum mary%20-%20WEB.pdf, p. 14.

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321

EU Banking Supervisory Authorities The Role and Tasks of Banking Supervisory Authorities and Climate Change

The European System of Financial Supervision (ESFS) comprises, inter alia, the European Systemic Risk Board (ESRB),170 the EBA, national supervisory authorities, and the ECB.171 The main objective of the ESFS is to ensure the adequate implementation of the rules applicable to the financial sector to preserve financial stability, confidence in the financial system as a whole, and customer and consumer protection in financial services.172 EU MS designate competent authorities that monitor the activities of banks to assess compliance with the prudential requirements.173 For some of the MS, the ECB exercises the supervisory tasks within the framework of the Single Supervisory Mechanism (SSM) consisting of the ECB and national competent authorities.174 When carrying out its tasks, exercising its supervisory powers, and adopting related guidelines, recommendations, and decisions under the SSM, the ECB operates under primary and secondary EU law.175 As a supervisory body, the ECB shall pursue only the objectives set by the SSM Regulation. This function is distinct

The ESRB is responsible for the macroprudential oversight of the EU financial system and the prevention and mitigation of systemic risk. The ESRB, therefore, has a broad remit, covering banks, insurers, asset managers, shadow banks, financial market infrastructures, and other financial institutions and markets, see https://www.esrb.europa.eu/about/background/html/index.en.html. 171 Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 Establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC, OJ 2010 L 331/12 (EBA Regulation), Article 2. The supervisory authorities for insurance and occupational pensions institutions (EIOPA) and for the supervision of securities and markets (ESMA) and a joint committee are also part of the ESFS. However, in line with the focus of this article, their roles will not be illustrated. 172 Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 Establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC, OJ 2010 L 331/12, Article 2. 173 Article 4 CRD. 174 Council Regulation (EU) No 1024/2013 of 15 October 2013 Conferring Specific Tasks on the European Central Bank Concerning Policies relating to the Prudential Supervision of Credit Institutions (SSM Regulation), OJ 2013 L 287/63, Article 1. To the extent that supervisory powers fall within the scope of the supervisory tasks conferred on the ECB, the ECB is considered the competent authority for participating SSM MS. This is generally the case for so-called significant institutions of a certain size, importance for the economy or cross-border activities. For so-called less significant banks, national banking supervisory authorities remain competent authorities (Article 6 (4) SSM Regulation). 175 Recitals 32 and 34, and Article 4(3) SSM Regulation. 170

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from the ECB’s monetary policy functions or other tasks.176 Furthermore, given the globalisation of banking services and the increased importance of international standards, the SSM Regulation requires the ECB to carry out its functions in respect of international standards and in close cooperation with supervisors outside the EU.177 A central mandate of the EBA is to contribute to creating a single rulebook for financial services in the EU. Its scope of action has been amended to the effect that it should consider sustainable bank business models and the integration of ESG factors, provided that such actions are necessary to ensure the effective application of the prudential regulatory framework.178 It shall develop common methodologies for assessing the environmental risk effects on the financial stability of banks. Also, the EBA’s stress-testing methodologies to assess the resilience of financial institutions shall consider potential risks stemming from adverse environmental developments.179 Furthermore, the EBA shall put in place a monitoring system to assess material ESG-related risks, taking the PA into account.180 To sum up, in line with the focus of the prudential regulatory framework for banks, the tasks of supervisory authorities are geared towards financial stability. There is only a limited legal basis to require banks to reallocate capital flows to environmentally sustainable corporations or contribute to reducing emissions in the real economy. Still, when evaluating individual banks’ risk profiles and the financial system’s resilience, bank supervisors are empowered to consider potential financial risks for banks resulting from business models that involve high exposures to GHG-intensive sectors or climate-related physical risks. A stable data basis, methodologies, and metrics for such analyses are still evolving. Prudential disclosure requirements and disclosure obligations outside the bank supervisory framework are intertwined and go beyond a pure financial risk view. They also require banks to, e.g., disclose information on their activities in sectors or assets that may highly contribute to climate change. The Green Asset Ratio (GAR)181 as a PA-aligned indicator will, once operational, help supervisors and investors identify the extent 176

Recital 65 and Articles 25(1) and (2) SSM Regulation; for further discussion of these tasks see below Sect. 3.3. 177 Recital 80 and Article 8 SSM Regulation; cf. also infra Sect. 2.4. 178 Article 1(3) EBA Regulation; see also Articles 8(1)(f) and 8(1a) EBA Regulation. The EBA is tasked, in consultation with the ESRB, with developing criteria, inter alia, for the identification and measurement of potential environmental-related systemic risk. Banks that may pose a systemic risk shall be subject to strengthened supervision (Article 23(1) EBA Regulation). 179 Article 32(2)(a) and (e) EBA Regulation. 180 Article 29(1)(f) EBA Regulation. 181 The Green Asset Ratio shows the proportion of assets that are environmentally sustainable and contribute substantially to the objectives of climate change adaptation or mitigation, or that enable another activity to substantially contribute to those objectives (EBA, Final Report, Final Draft Implementing Standards on Prudential Disclosures on ESG Risks in accordance with Article 449a CRR (24.01.2022), EBA/ITS/2022/01, at https://www.eba.europa.eu/sites/default/documents/files/ document_library/Publications/Draft%20Technical%20Standards/2022/1026171/EBA%20draft% 20ITS%20on%20Pillar%203%20disclosures%20on%20ESG%20risks.pdf).

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banks are financing activities consistent with the PA goals. These disclosure obligations may also have repercussions on the way banks conduct their business in that they induce them to seek taxonomy-aligned exposures.

3.3.2

Activities of EU Banking Supervisory Authorities and Climate Change

Supervisory authorities have already used their powers in climate-related contexts, albeit mainly by focusing on climate risks that constitute potential financial risks. Exposure to climate-related and environmental risks is among the SSM’s strategic priorities for 2022–2024.182 Still, some supervisory authorities have also used tools to measure the climate goal alignment of their financial sectors. An example is the 2° ii Paris Agreement Capital Transition Assessment (PACTA).183 However, there is generally little activity regarding analysing the actual environmental impact of loans provided to customers of varying environmental records.184 The ECB and ESRB have explored how to measure the impact of climate change risks on financial stability.185 The study contributes substantially to the PA objective to enhance capacity building and dissemination of climate-relevant information.186 Following this analysis, climate shocks appear inevitable, and the severity of disruptions to the economy depends on timely and rigorous mitigating action. Exploratory scenario analysis shows that “physical risk losses – particularly for high-emitting firms – would become dominant in around 15 years in the event of an insufficiently orderly climate transition”.187 While data gaps constrain a fully representative analysis, so far, asset prices do not appear to reflect climate risks fully.188 The ECB also undertook an economy-wide climate stress test and climate policy scenario analysis to assess the resilience of corporations and euro area banks to

182

At https://www.bankingsupervision.europa.eu/banking/priorities/html/ssm.supervisory_priori ties2022~0f890c6b70.en.htm. 183 2° Investing Initiative, Taking the Plunge—A Stocktake of National Financial Sector Climate Alignment Assessments (November 2021), at https://2degrees-investing.org/wp-content/ uploads/2021/11/PACTA-COP-Stocktake.pdf, pp. 6–9. 184 The core of such analyses would presumably not be performed by bank supervisors but rather other institutions. See e.g., Jachnik et al. (2019), p. 6, who calls for further efforts to track gross primary investment flows. 185 ECB, ESRB, Positively Green: Measuring Climate Change Risks to Financial Stability (June 2020), at https://www.esrb.europa.eu/pub/pdf/reports/esrb.report200608_on_Positively_green_-_ Measuring_climate_change_risks_to_financial_stability~d903a83690.en.pdf. 186 Articles 11, 12, and 13(5) and (6) PA. 187 Alogoskoufis et al. (2021), p. 4. 188 ECB/ESRB Project Team on Climate Risk Monitoring, Climate-related Risk and Financial Stability (July 2021), at https://www.esrb.europa.eu/pub/pdf/reports/esrb. climateriskfinancialstability202107~79c10eba1a.en.pdf, p. 36.

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transition and physical risk.189 The results are interpreted to underline the urgent need to transition to a greener economy to facilitate meeting the PA targets, limiting a long-run disruption to economies. The climate stress test methodology and results also informed the ECB supervisory climate risk stress test.190 This exercise aimed to identify vulnerabilities, industry best practices and the challenges faced by banks.191 The results show that despite notable progress most banks do not have robust climate risk stress-testing frameworks and lack relevant data.192 The ECB conducted the test with a supervisory thematic review of banks’ climate-related risk management practices193 and risk disclosures.194 In this context, the ECB benchmarked banks’ practices against the supervisory expectations established in it’s Guide on climaterelated and environmental risks.195 Integrating climate-related risks into financial stability monitoring and the prudential supervision of banks exemplifies a measure to

189

Alogoskoufis et al. (2021), p. 9. The results also show that for corporates and banks most at risk the impact is potentially very significant, especially in the absence of further climate policies. Climate change, thus, is seen as a major source of systemic risk, particularly for banks with portfolios concentrated in certain economic sectors and in specific geographical areas. 190 ECB, ECB Banking Supervision Launches 2022 Climate Risk Stress Test, Press Release, 27.01.2022, at https://www.bankingsupervision.europa.eu/press/pr/date/2022/html/ssm.pr22012 7~bd20df4d3a.en.html. 191 As a learning exercise, it was intended to help enhance data availability and quality and allow supervisors to better understand the stress-testing frameworks banks use to gauge climate risk. The output of the stress test exercise was integrated into the supervisory review and evaluation process (SREP) using a qualitative approach with no direct capital impacts envisaged. 192 ECB, Banks Must Sharpen their Focus on Climate Risk, ECB Supervisory Stress Test Shows, Press Release, 08.07.2022, at https://www.bankingsupervision.europa.eu/press/pr/date/2022/html/ ssm.pr220708~565c38d18a.en.html. According to the test results, almost two-thirds of banks’ income from non-financial corporate customers stems from GHG-intensive industries. In many cases, banks’ “financed emissions” come from a small number of large counterparties. Credit and market losses in the short-term disorderly transition and physical risk scenarios amount to around EUR 70 billion on aggregate for the 41 banks in question. However, according to the ECB, this significantly understates the actual climate-related risk, as it reflects only a fraction of the actual hazard. The test results show that banks’ losses would be lower in an orderly transition scenario than after delayed action. 193 ECB, Walking the Talk (November 2022), at https://www.bankingsupervision.europa.eu/ecb/ pub/pdf/ssm.thematicreviewcerreport112022~2eb322a79c.en.pdf. The ECB also published a set of positive examples how banks already incorporate climate risk considerations. See ECB, Good Practices for climate-related and environmental risk management (November 2022), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.thematicreviewcercompendiumgoodpractices112022 ~b474fb8ed0.en.pdf. 194 ECB, Supervisory Assessment of Institutions’ Climate-related and Environmental Risks Disclosures—Report on Banks’ Progress towards Transparent Disclosure of their Climate-related and Environmental Risk Profiles (March 2022), at https://www.bankingsupervision.europa.eu/ecb/ pub/pdf/ssm.ECB_Report_on_climate_and_environmental_disclosures_202203~4ae33f2a70.de. pdf. 195 ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf.

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implement the ECB pledge at the 2021 COP 26 in Glasgow to contribute, within its field of responsibility, to decisive action by policymakers to implement the PA.196 Similarly, the EBA committed itself to contributing to reaching the PA objectives by revising its regulatory and policy work, thereby supporting the European banking sector in tackling climate change.197 In this context, the EBA conducted an EU-wide pilot exercise198 to analyse the challenges for banks when classifying exposures according to sustainability aspects. The findings show the need for more corporate disclosure on transition strategies and GHG emissions to allow banks and supervisors to assess climate risk more accurately. Implementing this finding requires legislative action to adjust the reporting requirements of companies. Furthermore, banks should improve their risk management and enhance the transparency of their strategies and exposures.199 Based on the results of the exercise, the EBA amended its disclosure standards, inter alia, by integrating key performance indicators. Overall, they200 reflect existing international and EU standards on this matter, such as the FSBs TCFD recommendations,201 the Taxonomy Regulation, the Non-Financial Reporting Directive, and the EBA loan origination and monitoring guidelines.202

196 ECB, The ECB Pledge on Climate Change Action (2021), at https://www.ecb.europa.eu/pub/ pdf/other/ecb.pledge_climate_change_action211103~6af74636d8.pt.pdf. 197 EBA, EBA Statement in the Context of COP26, at https://www.eba.europa.eu/sites/default/ documents/files/document_library/Publications/Other%20publications/2021/1023331/EBA%20 statement%20COP26.pdf. 198 EBA, EBA Report Mapping Climate Risk: Main Findings from the EU-wide Pilot Exercise, Report, 21.05.2021, EBA/Rep/2021/11, at https://www.eba.europa.eu/sites/default/documents/ files/document_library/Publications/Reports/2021/1001589/Mapping%20Climate%20Risk%20-% 20Main%20findings%20from%20the%20EU-wide%20pilot%20exercise%20on%20climate%20 risk.pdf. 199 EBA, EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), EBA/REP/2021/18, at https://www.eba.europa.eu/sites/default/docu ments/files/document_library/Publications/Reports/2021/1015656/EBA%20Report%20on%20 ESG%20risks%20management%20and%20supervision.pdf. 200 EBA, Final Report, Final Draft Implementing Standards on Prudential Disclosures on ESG Risks in accordance with Article 449a CRR (24.01.2022), EBA/ITS/2022/01, at https://www.eba.europa. eu/sites/default/documents/files/document_library/Publications/Draft%20Technical%20Stan dards/2022/1026171/EBA%20draft%20ITS%20on%20Pillar%203%20disclosures%20on%20 ESG%20risks.pdf. The draft ITS are based on Article 434a CRR, which mandates the EBA to specify uniform disclosure formats. The uniform formats are intended to convey sufficiently comprehensive and comparable information for users of that information to assess the risk profiles of institutions and their sustainable finance strategy. 201 Task Force on Climate-related Financial Disclosures, Final Report Recommendations of the Task Force on Climate-related Financial Disclosures, 15.07.2017, at https://assets.bbhub.io/ company/sites/60/2020/10/FINAL-2017-TCFD-Report-11052018.pdf. The Task Force on Climate-related Financial Disclosures (TCFD) was created by the G20 Financial Stability Board. It has developed a framework to help public companies and other organizations more effectively disclose climate-related risks and opportunities through their existing reporting processes. 202 EBA, Final Report, Guidelines on Loan Origination and Monitoring, 29.05.2020, EBA/GL/ 2020/06, at https://www.eba.europa.eu/sites/default/documents/files/document_library/Publica tions/Guidelines/2020/Guidelines%20on%20loan%20origination%20and%20monitoring/884283/

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Stress tests and scenario analyses performed by both supervisory agencies and banks enhance transparency and serve as learning exercises to improve capabilities, methods, and processes, thus gaining a clearer picture of banks’ portfolios from a climate risk angle. This insight constitutes an essential step in line with the PA obligations to provide transparency and capacity building for climate action regarding the banking sector.203 However, gaps in the availability of reliable and comparable company data, especially forward-looking data on debtor companies’ targets and emissions pathways, impede the effective integration of climate change mitigation and adaptation considerations in the prudential supervision operations of the competent institutions.204 Yet, given that bank supervision operates fairly distant from real economy decision-making, it seems challenging to measure or even develop indicators for measuring the specific effects of bank supervisory activities on achieving the PA objectives beyond contributing to a stable financial system as a means of providing transition finance in the context of Article 2(1)(c) PA.205

3.4 3.4.1

Central Banks: The Example of ECB and ESCB The Role and Tasks of the ECB and the ESCB and Climate Change

Central banks may have various objectives, tasks, and instruments at their disposal and different legal frameworks governing their operations.206 In the EU, the TEU and the TFEU confer specific competencies on the ECB and the European System of

EBA%20GL%202020%2006%20Final%20Report%20on%20GL%20on%20loan%20origination %20and%20monitoring.pdf. 203 Articles 11, 13 and 14 PA. 204 See also the NGFS Progress Report on Bridging Data Gaps (May 2021), at https://www.ngfs.net/ sites/default/files/medias/documents/progress_report_on_bridging_data_gaps.pdf. A comprehensive view on banks’ exposures, especially in connection with loans extended to small and medium sized companies (SMEs) and sovereigns, will only be available once remaining data gaps have been addressed. The EBA Report on Management and Supervision of ESG Risks for Credit Institutions and Investment Firms (2021), at https://www.eba.europa.eu/sites/default/documents/files/docu ment_library/Publications/Reports/2021/1015656/EBA%20Report%20on%20ESG%20risks%20 management%20and%20supervision.pdf illustrates available indicators, metrics, and evaluation methods that are needed for effective ESG risk management and identifies remaining gaps and challenges on this front. 205 According to the UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), at https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA %202020%20-%20Summary%20-%20WEB.pdf, p. 14, this is a common challenge for various financial actors. 206 See generally Ortiz (2009).

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Central Banks (ESCB).207 The primary objective of the ECB and the ESCB is to maintain price stability.208 The ECB may define the meaning and specific features of price stability and adopt measures that may further price stability directly or indirectly by fostering the necessary preconditions for price stability.209 The most prominent monetary policy instruments currently used by the Eurosystem include, inter alia, open market operations, such as asset purchase programs, standing facilities, including lending facilities to banks against collateral, minimum reserve requirements for credit institutions, and forward guidance.210 As a secondary objective—without prejudice to price stability—the ECB shall support the general economic policies in the EU with a view to contributing to achieving the EU objectives laid down in Article 3 TEU.211 The ECB shall act following the principle of an open market economy with free competition, favouring an efficient allocation of resources.212 In addition, the ECB and some national central banks have specific tasks in the prudential supervision of banks discussed above213 and in ensuring the financial system’s stability.214 When the ECB supports, within its secondary mandate, general EU objectives, it does not exercise autonomous policymaking powers, but only indirectly supports EU policies pursued by the respective competent EU institutions.215 These general policies, therefore, only inform the ECB’s design of its monetary policy instruments to pursue the secondary objective.216 The ECB shall not support economic policies incompatible with the principles guiding the EU’s economic policy,217 such as stable

207 Following Article 282(1) TFEU, the ECB and the national central banks shall constitute the European System of Central Banks (ESCB). The ECB and the national central banks of those MS whose currency is the euro constitute the Eurosystem. 208 Article 127(1) TFEU; see Arda (2010 [2004-]), pp. 127-5-6. 209 Ioannidis et al. (2021), pp. 9–11. 210 These instruments are based on various decisions, regulations and guidelines of the ECB. For an overview of the ECB’s instruments see https://www.ecb.europa.eu/mopo/implement/html/index.en. html. 211 Article 127(1) TFEU, see Arda (2010 [2004-]), pp. 127-7; Article 2 Protocol (Nr. 4) on the Statute of the European System of Central Banks and of the European Central Bank. According to Article 3 TEU, the Union shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment. 212 Article 2 Protocol (Nr. 4), Article 127 TFEU. 213 See above in Sect. 3.3.1. 214 Article 127 TFEU. Financial stability could also be a means of achieving the monetary policy objective of price stability. 215 Ioannidis et al. (2021), pp. 16–17. 216 Ioannidis et al. (2021), p. 22, also pointing out that even then the ECB’s instruments must be employed to carry out its task of defining and implementing monetary policy, as the ECB may support only within the limits of its basic tasks under Article 127(2) TFEU and Article 3 of the Statute of the ESCB and of the ECB, p. 24. 217 Article 119(3) TFEU.

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prices and sound public finances.218 In practice, as until recently there have been no precedents yet of the ECB explicitly basing monetary policy measures on this secondary objective, the meaning and scope of the “general economic policies” that the ECB shall support have not yet been clarified. However, Article 127 TFEU read in conjunction with Articles 120 and 121(2) TFEU and Article 3(3) TEU are understood to include environmental and social objectives.219 In case different general economic policies conflict, the ECB is seen as enjoying discretion. Thereby, the priorities attached by the respective institutions primarily responsible for the respective policies would guide the ECB’s considerations.220 Accordingly, the high importance that legislators have attached to climate policies may be relevant for the ECB when incorporating climate change considerations into the monetary policy framework under the secondary mandate.221 The ECB and ESCB are independent in the exercise of their powers.222 In its resolution on the ECB’s Annual Report 2021, the EP highlighted that this statutory independence is a prerequisite for the ECB to fulfil its mandate and that a corresponding level of accountability should always complement it.223 In the context of climate change, the EP recalled that the ECB, as an EU institution, was bound by the EU’s commitments under the PA.224 The EP emphasised that tackling the climate emergency required the ECB to take an integrated approach to be reflected in all its policies, decisions, and operations, in line with its mandate of supporting the general economic policies of the EU, specifically the achievement of a climateneutral economy by 2050.225 It considered that the ECB needed to use all its available tools to fight and mitigate climate-related risks. The EP also highlighted the double materiality principle, which lies at the heart of the EU sustainable finance framework.226 218

Ioannidis et al. (2021), p. 15. Ioannidis et al. (2021), p. 14. 220 Ioannidis et al. (2021), pp. 17–19. These institutions are mainly the Union legislators who express priorities through legal acts within their respective competencies and assume international obligations like the PA. Ioannidis also refers to the consistency clause (Article 7 TFEU) as an additional potential criterion for prioritization. 221 Schnabel I, From Market Neutrality to Market Efficiency, Speech, 14.6.2021, at https://www. ecb.europa.eu/press/key/date/2021/html/ecb.sp210614~162bd7c253.en.html. She is, however, also acknowledging the question of how the ECB should operationalise its policy support to accelerate the green transition. 222 Article 282(3) TFEU; Article 7 Protocol (Nr. 4). 223 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html. 224 According to Article 216(2) TFEU, international agreements concluded by the Union are binding upon the institutions of the Union. 225 Cf. the EU’s NDCs and further references at Sect. 2.3. 226 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html. 219

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The principles of limited EU competencies, subsidiarity, and proportionality are essential when assessing whether and how the ECB should contribute to addressing climate change issues.227 They require the ECB to base any action on the powers conferred upon it in the Treaties. In the area of monetary policy, the powers are defined by the “objectives” and “tasks” set out in Article 127 TFEU, and by the instruments set out in the Statute of the ESCB and the ECB.228 The powers of the ECB permit taking climate change factors into account if necessary to maintain price stability.229 In such a case, the ECB would not directly pursue environmental objectives but rather its primary objective.230 Accordingly, such measures are not regarded as equivalent to (direct) economic or environmental policy measures231 but are within the ECB’s mandate. While not implying an obligation to reach concrete results in support of the EU’s climate policy or altering the hierarchy of objectives, the ECB-related TFEU provisions have been interpreted in the light of Article 11 TFEU232 to the effect that the ECB can and should take account of environmental objectives in its policies and activities. Moreover, if the ECB gives thought to climate change considerations, it must base decisions on a careful analysis of the situation and prepare adequate reasoning.233

3.4.2

Activities of the ECB and Climate Change

Climate change poses new challenges to central banks.234 It potentially affects financial market participants, the economy, and the financial system as a whole.235 While central banks may need to consider climate change impacts in their activities,236 it is primarily for governments to decide policy responses to drive the transition to a low-carbon economy.237 In practical terms, discussions related to integrating climate considerations into central bank policy and operations include

227

Article 5 TEU, for details see Ioannidis et al. (2021), pp. 25–28. Ioannidis et al. (2021), p. 6. 229 See below for a discussion on why this may be required from an economic perspective. 230 ECB (2021), p. 140, with reference in this context to Case C-493/17, Weiss and Others, ECLI: EU:C:2018:1000, para. 53; Case C-62/14, Gauweiler and Others, ECLI:EU:C:2015:400, para. 46. 231 According to ECB (2021), p. 140, this is because indirect effects in other policy fields are permitted according to the case law of the CJEU, specifically, e.g., Case C-62/14, Gauweiler and Others, ECLI:EU:C:2015:400. Still, such measures need to observe the general principles of EU law. 232 ECB (2021), p. 141, referring to Article 11 TFEU and case law. 233 ECB (2021), p. 142. 234 Bolton et al. (2020), p. 65. 235 ECB (2021), pp. 6–10. 236 See also the above discussion of the mandate of the ECB. 237 Carney M, Governor of the Bank of England and Chairman of the Financial Stability Board, Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, Speech at Lloyd’s of London, 29.09.2015, at https://www.bis.org/review/r151009a.pdf, p. 8; ECB (2021), pp. 8–9. 228

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incorporating climate change aspects into monetary policy frameworks, macroeconomic models, financial risk assessment, financing the transition to climate neutrality, and aligning the criteria for collateral, refinancing, and asset purchase programs.238 The ECB’s current monetary policy implementation framework relies, inter alia, on market prices and credit ratings for assessing the risk of assets as collateral or in the context of purchase programs. If market prices and ratings did not adequately incorporate climate-related risks, this could distort the implementation of monetary policy and increase risks for the ECB.239 Specifically, when acquiring bonds issued by corporations, e.g., through the ECB’s CSPP, the Eurosystem has direct exposure to corporations, including those in carbon-intensive sectors.240 Scholars have criticised the CSPP’s inherent “carbon bias”.241 Also, the EP “notes with concern that some ECB refinancing and asset purchase programs have been indirectly supporting carbon-intensive activities.”242 In this context, the so-called market neutrality approach is relevant.243 According to critics, the ECB should reduce the climate footprint of its CSPP and make companies’ access to finance more aligned with the goals of the PA.244 However, there are also significant practical challenges245 and doubts about the desired effects and risks to the primary objective of price stability.246 The EP invited the ECB, respecting its independence, to address market failures and ensure the efficient allocation of resources over a long-term

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For selected aspects see, e.g., ECB (2021), pp. 148–154. This would be relevant in the context of asset purchases and the requirement that the conduct of credit operations by the ECB and ESCB with banks should be based on adequate collateral (Article 18.1 of the ESCB/ECB Statute, ECB (2021), p. 141). 240 Papoutsi et al. (2022), pp. 7–12, show that due to big differences in bond issuance across sectors the ECB’s corporate bond portfolio tilts towards carbon-intensive sectors. 241 Dafermos et al. (2020), pp. 9–13; for an overview of the debate on the carbon bias of the Eurosystem’s monetary policy see Breitenfellner and Pointner (2021), pp. 76–77. 242 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html. 243 This principle leads a central bank, in the context of an asset purchase program, to purchase securities in proportion to their relative market capitalization to minimize the impact of asset purchases on the price discovery mechanism and avoiding changing relative borrowing costs across sectors. See, e.g., Schnabel I, From Market Neutrality to Market Efficiency, Speech, 14.6.2021, at https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210614~162bd7c253.en.html citing Benoît Cœuré. 244 Dafermos et al. (2020), pp. 4–5. 245 Bank of England, Discussion Paper, Options for Greening the Bank of England’s Corporate Bond Purchase Scheme (May 2021), at https://www.bankofengland.co.uk/-/media/boe/files/ paper/2021/options-for-greening-the-bank-of-englands-corporate-bond-purchase-scheme-discus sion-paper.pdf?la=en&hash=9BEA669AD3EC4B12D000B30078E4BE8ABD2CC5C1, p. 17. 246 Liebich L, et al., Unconventionally Green: Monetary Policy between Engagement and Conflicting Goals, Arbeitspapier, No. 05/2021 (2021), at https://www.econstor.eu/bitstream/1041 9/247311/1/1777516455.pdf, pp. 18–22. 239

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horizon while remaining as apolitical as possible and respecting the principle of market neutrality.247 The debate continues regarding the extent to which climate factors impinge on central banks’ conventional objectives and central banks’ role in addressing the climate challenge. The problem also touches the discussion of the risks of overstretching the central banks’ mandates and vesting too much power in allegedly unaccountable institutions, and the division of labour between central banks and other institutions.248 Also, the ECB should honour the principle of institutional balance by having regard for the powers of the other institutions.249 Meanwhile, the Governing Council of the ECB has decided on an action plan and a roadmap250 to further incorporate climate change considerations into its policy framework. With this decision, it aims to underline its commitment to reflect environmental sustainability considerations in its monetary policy more systematically and to increase its contribution to addressing climate change, in line with its obligations under the EU Treaties.251 Among other measures, the ECB intends to introduce a disclosure requirement for private sector assets as a new eligibility criterion or as a basis for a differentiated treatment for collateral and asset purchases. When reviewing the valuation and risk control frameworks for assets mobilised as collateral by counterparties for Eurosystem credit operations, the ECB intends to consider relevant climate change risks. Regarding the contentious issue of the allocation of corporate bond purchases, the ECB plans to adjust its framework to incorporate climate change criteria. In line with this action plan, the ECB decided to

247 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html. 248 See, e.g., Volz U, On the Role of Central Banks in Enhancing Green Finance, UN Enquiry Working Paper 17/01 (February 2017), at https://eprints.soas.ac.uk/23817/1/On_the_Role_of_ Central_Banks_in_Enhancing_Green_Finance(1).pdf, pp. 18–19. 249 ECB (2021), p. 142 arguing that according to Article 192 TFEU the Union legislator is competent to decide what Union policy on the environment should be taken to contribute to the objectives of, inter alia, protecting the environment and promoting measures at international level to deal with worldwide environmental problems, in particular combating climate change. 250 ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy, Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ ecb.pr210708_1~f104919225.en.html. 251 For details on this action plan and the timeline for its implementation see ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy, Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210708_1~f104 919225.en.html and the Annex: Detailed Roadmap of Climate Change-related Actions, at https:// www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210708_1_annex~f84ab35968.en.pdf. Overall, the ECB’s activities will focus, inter alia, on developing new analytical models and analyses to monitor the implications of climate change and related policies, as well as new indicators for green financial instruments, banks’ carbon footprint, and their exposures to climate-related risks. The ECB announced to start disclosing climate-related information of the CSPP by 2023. As various aspects of this package rely on data provided by the corporate sector, the implementation of the action plan is intended to be in step with progress on the related EU policies.

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take further steps to account for climate change in its corporate bond purchases, collateral framework, disclosure requirements and risk management.252 These measures aim to reduce financial risk related to climate change on the Eurosystem’s balance sheet, encourage transparency, and—with reference to the ECB’s secondary objective—support the green transition of the economy in line with the EU’s climate neutrality objectives. The ECB intends to review these steps regularly to ensure they are aligned with the objectives of the PA and the EU’s climate neutrality objectives, to respond to future improvements in climate data and climate risk modelling or changes in regulation, and to address additional environmental challenges, within its price stability mandate.253 While welcoming the ECB’s new action plan and detailed roadmap, the EP noted its one-sided focus on climate-related risks while neglecting climate impacts as required by the double materiality principle, which lies at the heart of the EU sustainable finance framework. It warned against delays in aligning the ECB’s CSPP with the PA and reducing the carbon intensity of its portfolio.254 Some scholars questioned the timing of the ECB’s action plan. They argue that the ECB failed to timely align its operations with the objectives set by the EU to comply with the PA and that not reducing its carbon footprint may make the ECB vulnerable if challenged at the ECJ.255 Causes for the climate litigation risk of central banks could originate in the perception that central banks do too little when incorporating climate considerations into their policy frameworks256 or in challenges for exceeding their mandate.257 Scholars and policymakers conduct this legal debate against the background of discussions about potential economic policy reactions to climate change. While some concede that monetary policy may have a role in this regard, they contrast this view with more effective policy responses, e.g., introducing a carbon tax to

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ECB, ECB Takes Further Steps to Incorporate Climate Change into its Monetary Policy Operations, Press Release, 04.07.2022, at https://www.ecb.europa.eu/press/pr/date/2022/html/ecb. pr220704~4f48a72462.en.html. 253 Ibid. For an overview of ongoing ECB actions in the area of climate change see also ECB, ECB Climate Agenda 2022, Press Release, 04.07.2022, Annex, at https://www.ecb.europa.eu/press/pr/ date/2022/html/ecb.pr220704_annex~cb39c2dcbb.en.pdf. For details on how the ECB intends to decarbonise its corporate bond holdings based on issuer-specific climate scores, see ECB, ECB provides details on how it aims to decarbonise its corporate bond holdings, Press Release, 19.9.2022, at https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.pr220919~fae53c59bd.en. html. 254 European Parliament, Resolution of 16 February 2022 on the European Central Bank—Annual Report 2021 (2021/2063(INI)), at https://www.europarl.europa.eu/doceo/document/TA-9-20220029_EN.html; on the NGFS, see below. 255 Van Tilburg R, Simić A, Legally Green—Climate Change and the ECB Mandate, Sustainable Finance Lab Policy Paper (July 2021), at https://sustainablefinancelab.nl/wp-content/uploads/ sites/334/2021/07/Legally-Green.pdf, p. 30. 256 See also below the ClientEarth vs. National Bank of Belgium case. 257 Solana (2021), pp. 54–56.

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internalise the external costs of GHG emissions or implementing strict energy standards for goods and processes.258 Comparing these policies in terms of efficacy, they hold that fighting climate change would be achieved more effectively by curbing the demand for emission-intensive goods rather than by monetary policy instruments. Their considerations square well with the ECB’s action plan.259 Even before the ECB had announced its action plan, the non-profit organisation ClientEarth has filed legal action260 against the Belgian National Bank (BNB) before a Belgian court. ClientEarth invoked a Belgian law allowing certain legal persons to ask for a cease and desist order against acts constituting an obvious violation or a serious threat of violation of legal provisions relating to the protection of the environment.261 Specifically, ClientEarth asked to order the BNB to stop buying bonds under the CSPP, the ultimate aim being to challenge the legality of the ECB decision establishing the program before the CEJU. According to the plaintiff, the CSPP did not take into account the requirements of environmental protection, and the ECB did not adequately mitigate climate-related financial risks to which it was exposed as a result of asset purchases under the CSPP.262 The Belgian Court found the claims unfounded.263 While ClientEarth first announced that it appealed the decision it later declared that it withdrew the case due to the policy changes the ECB undertook in the meantime.264

258 Breitenfellner and Pointner (2021), p. 65, with a detailed discussion of the market neutrality principle, monetary policy instruments, and the “carbon bias” of the Eurosystem’s monetary policy. 259 Breitenfellner and Pointner (2021), p. 59. 260 ClientEarth, ClientEarth Sues over Climate Impact of ECB Policy, Press Release, 13.04.2021, at https://www.clientearth.org/latest/press-office/press/clientearth-sues-over-climate-impact-of-ecbpolicy/. 261 For a detailed analysis of this case and its procedural and substantive aspects see Solana (2021), pp. 51–54, and Linklaters Sustainable Futures, Does the ECB’s Quantitative Easing Programme Fuel Climate Change? NGO ClientEarth Goes Back to Court after the Dismissal of its Claims, 17.02.2022, at https://sustainablefutures.linklaters.com/post/102hj1q/does-the-ecbs-quantitativeeasing-programme-fuel-climate-change-ngo-clientearth. 262 Among other arguments, ClientEarth put forward that the ECB must act consistently with the EU’s climate objectives and policies pursuant to Articles 7 and 127(1) TFEU, that it should take into account environmental protection requirements in the design and implementation of its monetary policy pursuant to Article 11 TFEU and Articles 37 and 41(2)(c) of the EU Charter of Fundamental Rights, and that the ECB must mitigate climate-related financial risks (Solana (2021), p. 51, referring to ClientEarth letter to the ECB from 12.04.2021). The plaintiff also invoked Article 3(3) TEU, Article 11 and 296(2) TFEU. Client Earth, Why ClientEarth is Suing the Central Bank of Belgium for Climate Failings, Press Release, 13.04.2021, at https://www.clientearth.org/latest/ latest-updates/news/why-clientearth-is-suing-the-central-bank-of-belgium-for-climate-failings/. 263 Tribunal de première instance francophone de Bruxelles, Section Civile, 21/38/C (1.12.2021). 264 For details see ClientEarth, Why We’re Going back to Court against the Belgian National Bank, Press Release, 31.01.2022, at https://www.clientearth.org/latest/latest-updates/news/why-we-regoing-back-to-court-against-the-belgian-national-bank/?utm_source=linkedin&utm_medium= social&utm_campaign= and ClientEarth, We’re withdrawing our case against the Belgian National Bank, ClientEarth Communications, 29.11.2022, https://www.clientearth.org/latest/latest-updates/ news/we-re-withdrawing-our-lawsuit-against-the-belgian-national-bank/.

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Apart from matters related to the ECB’s obligations under the EU Treaties and the delineation of its mandate, the case ClientEarth v BNB is instructive for the debate on challenges in the area of sustainable finance in general, ways to achieve the objectives of Article 2(1)(c) PA, and impediments central banks encounter when integrating climate considerations into their frameworks and policies.265 Achieving the PA goals depends, inter alia, on real economy decisions to reduce emissions in line with PA temperature goals and on developing climate resilience. However, assessing the precise real economy impacts of financial flows remains challenging because investors’ portfolio allocations typically are decided in a different sphere than the real economy decisions, thus, they only may have limited direct effects on, e.g., corporations’ capital expenditure plans. Furthermore, finance specifically tailored towards climate objectives accounts for only a small portion of overall financial flows, hence there is a need to ensure the consistency of all financial flows with the long-term goals of the PA. While climate taxonomies can assist in identifying activities consistent with pathways for achieving the PA goals, they also may risk hindering necessary investment in high-GHG emission sectors to enable the transition to such pathways. The EU Platform on Sustainable Finance recommended addressing this “binary classification problem” by developing a transition finance taxonomy recognising that “many sectors of the economy [. . .] must transition to more sustainable models even if they cannot reach the green performance level defined by the taxonomy criteria.”266 This lack of accuracy regarding the impact of green finance policies on the real economy leads to challenges for central banks when integrating climate considerations into their frameworks and policies.267 Various strands of research268 intend to address these informational gaps, and central banks are active in different fora to bridge gaps in reliable and accessible climaterelated data.269 Going forward, specific external data providers will deliver

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The following reflections are based on observations of the UNFCCC Standing Committee on Finance, made in the context of an assessment and overview of climate finance flows, UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), at https://unfccc.int/ sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-%20Summary%20%20WEB.pdf, pp. 14–15. 266 Platform on Sustainable Finance, The Extended Environmental Taxonomy: Final Report on Taxonomy Extension Options Supporting a Sustainable Transition (March 2022), at https://ec. europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/22032 9-sustainable-finance-platform-finance-report-environmental-transition-taxonomy_en.pdf. The report constitutes the Platform’s input to the European Commission’s report under Article 26 Taxonomy Regulation. 267 This vagueness may also be a source of litigation risk, see Solana (2021), p. 56. 268 For examples see ongoing INSPIRE research projects, at Commissioned Projects—INSPIRE Green Finance. 269 See, e.g., NGFS Progress Report on Bridging Data Gaps (May 2021), at https://www.ngfs.net/ sites/default/files/medias/documents/progress_report_on_bridging_data_gaps.pdf; regarding rating, see also the NGFS, Credit Ratings and Climate Change—Challenges for Central Bank

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indicators measuring the climate impact of securities issuers to the Eurosystem.270 Additionally, central banks may also apply their internal climate risk-related analysis for operational and risk management purposes, e.g., concerning the collateral framework of central bank monetary policy operations and for outright purchases of financial assets by the central bank.271 In areas outside monetary policy, the Eurosystem central banks agreed on climate change-related sustainable and responsible investment principles for managing certain portfolios.272 Besides a positive signalling effect, the principles intend to help all Eurosystem members to contribute to the transition to a low-carbon economy and to achieve the EU climate goals.273 Eurosystem central banks also engage in international fora, including the NGFS, to share best practices, contribute to the development of climate risk management in the financial sector, and mobilise finance to support the transition toward a sustainable economy.274

4 Exploring the Way Forward: Potential Policies and Measures in the Banking Sector Contributing to Achieving the Goals of the PA In general, climate-related regulatory and supervisory measures aim at identifying, measuring and managing banks’ potential financial risks resulting from climate change.275 This practice is in line with the statutory mandates of banking regulators and supervisors to ensure the stability of banks and the financial system. It acknowledges that a resilient financial system is necessary to facilitate the transition to low GHG emissions and climate-resilient development. However, there are several

Operations, Report (May 2022), at https://www.ngfs.net/sites/default/files/medias/documents/ credit_ratings_and_climate_change_-_challenges_for_central_bank_operations.pdf. 270 Bundesbank, Climate-related Data Successfully Procured. Key Milestone Reached for Incorporating Climate Factors, Press Release, 09.03.2022, at https://www.bundesbank.de/en/press/pressreleases/climate-related-data-successfully-procured-869246. 271 NGFS, Credit Ratings and Climate Change—Challenges for Central Bank Operations, Report (May 2022), at https://www.ngfs.net/sites/default/files/medias/documents/credit_ratings_and_cli mate_change_-_challenges_for_central_bank_operations.pdf. 272 The Eurosystem has developed practical implementation aspects of climate change-related sustainable and responsible investment principles in non-monetary policy portfolios, see ECB, Eurosystem Agrees on Common Stance for Climate Change-related Sustainable Investments in Non-monetary Policy Portfolios, Press Release, 04.02.2021, at https://www.ecb.europa.eu/press/pr/ date/2021/html/ecb.pr210204_1~a720bc4f03.en.html. 273 ECB (2021), pp. 155–156. 274 See Sect. 2.4. 275 Cf., e.g., ECB, Guide on Climate-related and Environmental Risks (2020), at https://www. bankingsupervision.europa.eu/ecb/pub/pdf/ssm.202011finalguideonclimaterelatedandenvironmentalrisks~58213f6564.en.pdf.

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conceivable approaches to further adapting banking regulation and supervision to facilitate making finance flows consistent with the PA objectives and strengthen the mobilisation of private finance to help implement the PA. An impediment the banking sector faces when considering climate change is the lack of consistent and reliable real economy data. Notably, the banking sector relies largely on data ultimately provided by the corporate sector. The legislators are developing an informational basis for banks and investors to consider climate aspects in their capital allocation. The envisaged rules will harmonise definitions for sustainable activities276 and require disclosure of relevant information, thus potentially mobilising funds to achieve the PA objectives. Moreover, improving corporations’ sustainability reporting as intended by the Corporate Sustainability Reporting Directive (CSRD)277 will enhance the banking sectors’ capabilities to price and manage climate risks and allow assessing corporations’ transition readiness. Information on corporations’ transition plans278 to carbon neutrality would constitute an additional valuable source of information for forward-looking analyses of climate risk not covered by traditional risk models. Another approach is the improvement of the regulatory and supervisory framework. Proposals for enhanced regulatory and supervisory activities to further the objectives of the PA should be mindful of the roles of the individual actors. Selective risk-based amendments to the prudential framework, specifically a forward-looking perspective of climate risks and their specific nature279 and developing consistent

276 Regulation (EU) 2020/852 on the Establishment of a Framework to Facilitate Sustainable Investment and amending Regulation (EU) 2019/2088 (Taxonomy Regulation), OJ 2020 L 198/13. 277 Corporate Sustainability Reporting Directive (CSRD) (Directive of the European Parliament and of the Council amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/ 43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting, PE-CONS 35/22, at https://data.consilium.europa.eu/doc/document/PE-35-2022-INIT/en/pdf), empowering the Commission to adopt sustainability reporting standards taking account of the technical advice of the European Financial Reporting Advisory Group (EFRAG). 278 Cf. in this context also Article 15 of the Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, 23.02.2022, COM/2022/71 final, at https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri= CELEX:52022PC0071&from=EN, which requires MS to ensure that certain companies adopt a plan to ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the PA. The appropriate enforcement authority remains to be discussed. 279 Cf., e.g., Articles 73 and 76 of the proposed Directive of the European Parliament and the Council amending Directive 2013/36/EU as regards Supervisory Powers, Sanctions, Third-country Branches, and Environmental, Social and Governance Risks, and amending Directive 2014/59/EU. 27.10.2021, COM/2021/663 final, at https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri= CELEX:52021PC0663&from=EN (“CRD6”).

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standards for stress-testing methodologies,280 would be beneficial to address these risks more accurately.281 However, the prudential framework should remain riskbased to support its main function,282 namely to ensure the financial stability of the banking system. If private sector banks, e.g., were required to adapt their business models to the EU’s environmental objectives283 for reasons other than containing undue financial risks, this could be seen as expanding the traditional focus of prudential bank regulation. In addition, it is doubtful whether bank supervisors would be the appropriate institutions to enforce such climate-related obligations. This issue also relates to the general problem of whether a bank’s portfolio misalignment with climate objectives per se entails financial risks for the bank. If this were the case, the question arose whether a bank should be permitted to cover such financial risks by adequate risk provisions, thus ensuring its financial resilience, or should instead be required to align its business model. The above considerations underline that the perspectives of financial risk and the impact of financing decisions on actual carbon emissions do not necessarily coincide. Data and methodological improvements in conjunction with banks’ transition plans would put banking regulators and supervisors in a position to connect better the emission intensity of a bank’s business with its capital requirements. Specifically, supervisors could identify banks with high GHG-emission intensity portfolios and benchmark their transition plans against supervisory climate policy scenarios incorporating NDCs and MS’ long-term strategies to achieve the PA goals. Moreover, they also should consider banks’ climate risk management capabilities and address the eventual financial risks arising through measures tailored to the respective bank.284 Supervisors could also conduct supplementary analyses of the climate goal alignment of bank portfolios and the financial sector at large.285 Altogether,

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Article 100 of the proposed CRD6. See specifically, Basel Committee on Banking Supervision, Principles for the Effective Management and Supervision of Climate-related Financial Risk (June 2022), at https://www.bis.org/ bcbs/publ/d532.pdf. The principles build on the current Basel Framework and deduct from current supervisory initiatives and the work in international bodies. They develop a principles-based approach to enhance risk management and supervisory practices for climate-related financial risks. 282 EBA, The Role of Environmental Risks in the Prudential Framework, Discussion Paper, 02.05.2022, EBA/DP/2022/02, at https://www.eba.europa.eu/sites/default/documents/files/docu ment_library/Publications/Discussions/2022/Discussion%20paper%20on%20the%20role%20of% 20environmental%20risk%20in%20the%20prudential%20framework/1031947/Discussion%20 paper%20on%20role%20of%20ESG%20risks%20in%20prudential%20framework.pdf, pp. 16–17; Coelho and Restoy (2022), p. 6; see related discussion and NGFS reports on “supporting factors” and difficulties to differentiate risks from “green” and other loans. 283 Article 87a of the proposed CRD6. 284 Such measures could, e.g., address business model or portfolio concentration risks, see Basel Committee on Banking Supervision, Overview of Pillar 2 Supervisory Review Practices and Approaches (June 2019), at https://www.bis.org/bcbs/publ/d465.pdf, pp. 12–15. 285 2° Investing Initiative, Taking the Plunge—A Stocktake of National Financial Sector Climate Alignment Assessments (November 2021), at https://2degrees-investing.org/wp-content/ uploads/2021/11/PACTA-COP-Stocktake.pdf. 281

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applying such regulatory and supervisory measures could promote financial decisions taking climate change into account and foster coherent measures to contribute to PA objectives. It would also be beneficial to increase further the consistency of various corporate and financial sector reporting and disclosure frameworks to leverage synergies and thus mainstream their utilisation. Regulators, bank supervisors and central banks should continue their work in various international fora to promote compatible frameworks, comparable methods, and metrics, to learn from each other in this evolving field of work and close data gaps. The NGFS work program reflects the relevant topics.286 Capacity-building within central banks, supervisory authorities, and in the financial sector in general remains a central building block. The Taxonomy Regulation is a valuable tool for defining sustainable economic activities, and policymakers should pursue the compatibility of international frameworks. Since economic activities requiring a transition towards carbon neutrality frequently reside outside such taxonomies,287 introducing additional categories of sustainable economic activities, especially in conjunction with appropriate corporate transition plans, could be beneficial.288 Such amendments also may have knock-on effects on regulators and financial actors intending to design their policies accordingly. Furthermore, financial actors use environmental ratings generated by private service agencies for various asset allocation and risk management purposes. Due to their far-reaching implications, greater attention should be dedicated to how the data underlying such ratings are generated.289

286 NGFS, NGFS Publishes its 2022–2024 Work Program, Press Release, 30.05.2022, at https:// www.ngfs.net/sites/default/files/medias/documents/pr_new_work_program_-_final.pdf. 287 UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), at https:// unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-%20Sum mary%20-%20WEB.pdf, p. 15. 288 Cf. in this context Platform on Sustainable Finance, The Extended Environmental Taxonomy: Final Report on Taxonomy Extension Options Supporting a Sustainable Transition (March 2022), at https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/docu ments/220329-sustainable-finance-platform-finance-report-environmental-transition-taxonomy_ en.pdf. 289 On the status quo see Berg et al. (2022), p. 20 and NGFS, Credit Ratings and Climate Change— Challenges for Central Bank Operations, Report (May 2022), at https://www.ngfs.net/sites/default/ files/medias/documents/credit_ratings_and_climate_change_-_challenges_for_central_bank_opera tions.pdf, p. 5. The European Commission consulted to identify possible shortcomings in relation to the consideration of sustainability risks in credit ratings and the disclosures made by credit rating agencies, see European Commission, Targeted Consultation on the Functioning of the ESG Rating Market in the European Union and on the Consideration of ESG Factors in Credit Ratings, Consultation Document (2022), at https://ec.europa.eu/info/sites/default/files/business_economy_ euro/banking_and_finance/documents/2022-esg-ratings-consultation-document_en.pdf.

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Officially supported export credits have an important role in promoting a shift in investments towards climate-neutral and climate-resilient projects. Export credit policies should be adapted accordingly.290 Credit guarantees, and other official support measures could act as levers for the private banking sector, address market failures and institutional gaps and support the transition to lower GHG emissions. Additional measures, including tax-related incentives, subsidies for green advisory and verification services, and establishing a standard for (so-called) “green bonds”291 could also help closing the sustainable investment gap.292 Legislators could promote research in corporations’ transition plans to enhance the informational basis for investors, thus supporting environmentally beneficial shareholder resolutions.293 In the context of accelerating the energy transition in emerging economies, the role of international public finance and closer cooperation between developers, investors, public financial institutions, and governments is essential, also to attract more private capital.294 The Sharm el-Sheikh implementation plan calls on the shareholders of multilateral development banks and international financial institutions to reform their practices and mobilize climate finance.295 Voluntary private sector initiatives may provide important guidance in the efforts to reduce climaterelated financial risks and start aligning financial sector portfolios with PA objectives. Self-commitments should be science-based, transparent and anchored in realeconomy outcomes, thus also reducing the risk of greenwashing.296 These proposals show that legislators should address many key levers simultaneously to further incentives private finance alignment with the PA goals. 290 Council of the EU, The Council Adopted Conclusions on Export Credits, Press Release, 15.03.2022, at The Council adopted conclusions on export credits—Consilium (europa.eu). 291 Cf. in this regard the Proposal for a Regulation of the European Parliament and of the Council on European Green Bonds, 06.07.2021, COM/2021/391 final, at https://eur-lex.europa.eu/legalcontent/EN/TXT/HTML/?uri=CELEX:52021PC0391&from=EN. 292 See, e.g., Deloitte, Recommendations Report—Designing Recommendations for a Sustainable Capital Markets Strategy and Action Plan for Hungary, 31.01.2022, at https://www.mnb.hu/ letoltes/recommendations-report-deloitte-sustainable-capital-market.pdf, pp. 15–16. 293 This seems particularly important as researchers point out that “investors reallocating capital to sustainable activities does not appear to influence corporate decision-making but shareholder resolutions do”, see Rydge (2020), p. 16. 294 International Energy Agency, Net Zero by 2050: A Roadmap for the Global Energy Sector (Revised version, October 2021), at https://iea.blob.core.windows.net/assets/deebef5d-0c34-45399d0c-10b13d840027/NetZeroby2050-ARoadmapfortheGlobalEnergySector_CORR.pdf, p. 21. 295 Sharm el-Sheikh Implementation Plan. Revised draft decision. FCCC/CP/2022/L.19, paras. 40–41, at https://unfccc.int/sites/default/files/resource/cp2022_L19_adv.pdf. 296 Cf. in this regard the UN Environment Programme Finance Initiative (UNEP FI) Recommendations for Credible Net-Zero Commitments from Financial Institutions (2021), at https://www. unepfi.org/publications/recommendations-for-credible-net-zero-commitments-from-financial-insti tutions/. Furthermore, the 1st Progress Report of the UN-convened Net-Zero Asset Owner Alliance of asset owners that commit to achieving net-zero portfolios by 2050 and establish intermediate targets every 5 years in line with the PA’s goal of limiting warming to 1.5 °C (UN-convened Net-zero Asset Owner Alliance, Credible Ambition, Immediate Action (October 2021), at https:// www.unepfi.org/wordpress/wp-content/uploads/2021/10/AOA-Progress-Report-2021.pdf).

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For the ECB in its monetary policy capacity, it will be key to follow up on its roadmap297 to consider climate objectives in its policies and activities adequately. Basing decisions on a careful analysis of the situation and providing adequate reasoning would also reinforce their legal foundation, which is essential as public scrutiny of the ECB’s activities may lead to climate litigation directed at its policies and frameworks.298 The ECB should, within its mandate, calibrate its contribution to addressing climate change in line with its obligations under the EU Treaties, consistent with the price stability objective and taking into account the implications of climate change for an efficient allocation of resources.299 Overcoming impediments to operationalising these intentions will require further improvements to the data basis and methodologies, potentially facilitated by the work conducted in international fora including the NGFS. Central banks and banking supervisors should act in coherence with government climate policies, especially on carbon pricing300 or in the context of retrofitting the building stock, where aligning building regulations, public finance, and the prudential supervision of mortgage portfolios could facilitate effective intermediation of net-zero investment.301 Some policymakers point out that central banks and banking regulators see their role as complementary, amplifying and catalysing wider climate change policy action of the legislators, however, not substituting it.302 This view reflects the PA

297 ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ ecb.pr210708_1~f104919225.en.html. 298 Solana (2021), pp. 54–56. 299 ECB, ECB Presents Action Plan to Include Climate Change Considerations in its Monetary Policy Strategy, Press Release, 08.07.2021, at https://www.ecb.europa.eu/press/pr/date/2021/html/ ecb.pr210708_1~f104919225.en.html. 300 Demekas D, Grippa P, Financial Regulation, Climate Change, and the Transition to a Low-Carbon Economy: A Survey of the Issues, IMF Working Paper, 17.12.2021, at https://www. elibrary.imf.org/view/journals/001/2021/296/article-A001-en.xml, p. 28. 301 Robins et al. (2021) argue that central banks and supervisors should have a role in providing advice to governments on what the financial system needs to do to facilitate the transition and achieve an effective intermediation of net-zero investment. Furthermore, with their oversight of the financial sector and the macroeconomy, they see central banks and supervisors as well placed to identify macrofinancial risks stemming from the net-zero transition and to provide advice to governments on addressing these risks (pp. 6 and 9). 302 Demekas D, Grippa P, Financial Regulation, Climate Change, and the Transition to a Low-Carbon Economy: A Survey of the Issues, IMF Working Paper (17.12.2021), at https:// www.elibrary.imf.org/view/journals/001/2021/296/article-A001-en.xml, discuss in detail whether the legal frameworks currently governing central banks and financial regulators are still fit for purpose in the face of the climate challenge, providing an overview of the arguments and pointing out potential pitfalls and repercussions on the political economy, design, operation, mandate, and functions of central banks and financial regulators.

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implementing obligations that require all parts of society to contribute to achieving the PA goals, including the goal in Article 2(1)(c) PA.303 While the private banking sector, supervisory agencies and central banks have important roles to play, governments as democratically accountable bodies should provide predictable guidance and regulation for resource allocation and redistribution given the potential severe economic and distributive consequences.304

5 Conclusion Climate change is a universal challenge requiring all parts of society to contribute to reducing its adverse effects effectively. The good-faith implementation of the PA obligations requires measures that give effect to the treaty purpose, which implies the scrutiny of all sectors of the economy and society. While Article 2(1)(c) PA only generally refers to the financial sector, subsequent COPs point out the role public and private financial flows can have in climate change. A stocktake shows that many NDCs incorporate a role for the private financial sector and its regulatory framework, complementing public finances. The objectives of EU prudential banking regulation are maintaining the resilience of banks and the stability of the financial system. Accordingly, the mandates of supervisory authorities mainly focus on these objectives. References to potential risks arising from climate change were introduced only recently into the regulatory and supervisory framework. Transparency about sustainability aspects of undertakings and financial products is key to addressing risk and enabling investors to invest in environmentally sustainable projects. Consequently, disclosure regulations for the corporate and financial sectors include references to climate-related financial risks undertakings face and to potential sustainability impacts from corporations. However, data availability and reliability, and comparability of methodologies and metrics are still in a nascent stage. To address these shortcomings, regulators are currently finalising amendments to the disclosure framework and sustainability reporting standards that will lead to incremental advances in achieving a solid data foundation. Bank supervisory authorities have already conducted exploratory analyses to quantify the potential impact of climate risks on the banking sector and individual banks. Furthermore, they reviewed banks’ risk management capabilities, governance frameworks, business models and disclosure practices to incorporate climate risks. 303 UNFCCC Standing Committee on Finance, Summary by the Standing Committee on Finance of the Fourth (2020) Biennial Assessment and Overview of Climate Finance Flows (2020), p. 15, at https://unfccc.int/sites/default/files/resource/54307_1%20-%20UNFCCC%20BA%202020%20-% 20Summary%20-%20WEB.pdf. 304 Demekas D, Grippa P, Financial Regulation, Climate Change, and the Transition to a Low-Carbon Economy: A Survey of the Issues, IMF Working Paper (17.12.2021), at https:// www.elibrary.imf.org/view/journals/001/2021/296/article-A001-en.xml, p. 28.

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In sum, these policies and supervisory practices are mainly tailored towards identifying and managing climate-related risks and spotting clusters of banks’ business exposures towards high-GHG emitting sectors. Banking regulation and supervisory actions have only indirect effects on actual GHG emissions in the real economy sector by implicitly steering banks and investors towards business exposures more aligned with the goals of the PA. Still, this is an important contribution to the PA objectives as a resilient, efficient banking system is needed to facilitate and intermediate the transition to a low-GHG economy and climate adaptation. Private banks increasingly advance in considering climate aspects in their operations, particularly improving financial risk management capabilities, but progress is still uneven. Private finance consisting of corporate investments and private bank financing may be a key potential source of climate-related investment. Appropriately designed public guarantees for such private investments and blended finance structures can reduce risks for the private sector and thus help bringing about the right balance of financial risks and returns to satisfy fiduciary duty and due diligence requirements. Climate change also poses new challenges for central banks, as it may affect their objective of maintaining price stability. Policymakers, scholars and civil society representatives conduct a lively debate on the ECB’s obligations under the EU Treaties to introduce climate considerations into its operations and frameworks. A central issue is, whether and how the ECB should align its monetary policy portfolios and activities with the PA goals. The ECB has recognised the need to act and presented with its latest strategy review an action plan that also aims at increasing the ECB’s contribution to addressing climate change, within its mandate and in line with its obligations under the EU Treaties. The legal framework for the private banking sector and related financial actors could be enhanced to facilitate making finance flows consistent with a pathway towards low GHG emissions and a climate-resilient development, as envisaged by the PA. The EU legislators are currently negotiating several initiatives, and this article outlined additional proposals. To foster an effective implementation of climate considerations in the private banking sector, prudential supervisory authorities and central banks should communicate within the banking sector and submit expectations coherent with government climate policies and measures defined in the NDCs. They should continue contributing to research and efforts to close data gaps, developing methodologies and designing comparable metrics as a basis for discharging their respective tasks. This can best be accomplished by engaging in cross-sectoral and international fora. Regulatory amendments should be mindful of the roles of the respective actors and allocate new tasks to the appropriate institutions. As evidenced by the wide array of measures outlined in NDCs, financial actors and the prudential framework cannot administer the transition to a low-carbon economy alone. Advancing efforts concerning Article 2(1)(c) PA requires coherent action across various areas. Ambitious policies, e.g., on carbon-pricing or reducing subsidies to high-GHG emitting companies without a credible PA-aligned strategy, should—given their potentially severe economic and distributive consequences—be designed and communicated by

Making Finance Flows Consistent with the Aims of the Paris Agreement:. . .

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publicly accountable governments. The policies should be reliable in order to shape financial actors’ expectations of the intended sectoral pathways toward low GHG emissions. Such a frame of reference can guide financial actors to integrate climate considerations into their operations. On this basis financial actors, within their respective areas of expertise and institutional scope as defined by their mandates and obligations under the EU Treaties, secondary EU law, or private law, can contribute to making finance flows consistent with the goals of the PA.

References Alogoskoufis S et al (2021) ECB economy-wide Climate Stress Test. Methodology and results. ECB occasional paper series no 281 (September 2021). https://www.ecb.europa.eu/pub/pdf/ scpops/ecb.op281~05a7735b1c.en.pdf Arda A (2010) Article 127 TFEU. In: Smit H, Herzog P, Campbell C, Zagel G (eds) (2004-), Smit & Herzog on the law of the European Union, 4 volumes, loose-leaf. LexisNexis, New York Arrhenius S (1896) On the influence of carbonic acid in the air upon the temperature of the ground. London Edinburgh Dublin Philos Mag J Sci 41:237–276 Berg F, Kölbel J, Rigobon R (2022) Aggregate confusion - the divergence of ESG ratings (15.4.2022). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533 Bodansky D, Brunnée J, Rajamani L (2017) International climate change law. Oxford University Press, Oxford Bolton P et al (2020) The Green Swan. Central banking and financial stability in the age of climate change. Bank for International Settlements, Basel. https://www.bis.org/publ/othp31.pdf Boyle A, Redgwell C (2021) International law and the environment, 4th edn. Oxford University Press, Oxford Breitenfellner A, Pointner W (2021) The impact of climate change on monetary policy, monetary policy & the economy Q3/21 Coelho R, Restoy F (2022) The regulatory response to climate risks: some challenges. FSI Brief (February 2022), Bank of International Settlements. https://www.bis.org/fsi/fsibriefs16.pdf D’Orazio P, Popoyan L (2022) Realising central banks’ climate ambitions through financial stability mandates. Intereconomics 57(2):103–111. https://link.springer.com/content/ pdf/10.1007/s10272-022-1039-4.pdf Dafermos Y et al (2020) Decarbonising is easy: beyond market neutrality in the ECB’s corporate QE. The New Economics Foundation. https://neweconomics.org/uploads/files/Decarbonisingis-easy.pdf ECB (2021) Climate change and monetary policy in the Euro area. ECB occasional paper series no 271 (September 2021). Climate change and monetary policy in the euro area (europa.eu) Gourdel R et al (2022) The double materiality of climate physical and transition risks in the Euro area (14.04.2022). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3939895 Green F (2014) “This Time Is Different”: the prospects for an effective climate agreement in Paris 2015, Policy Paper (October 2014). Grantham Research Institute on Climate Change and the Environment, Centra for Climate Change Economics and Policy. https://www.cccep.ac.uk/wpcontent/uploads/2015/10/This-Time-is-Different.pdf Ioannidis M et al (2021) The mandate of the ECB: legal considerations in the ECB’s Monetary Policy Strategy Review. ECB occasional paper series no 276 (September 2021). https://www. ecb.europa.eu/pub/pdf/scpops/ecb.op276~3c53a6755d.en.pdf?1c01b997e11da2c1945d9551 bc9a5477 Jachnik R et al (2019) Tracking finance flows towards assessing their consistency with climate objectives – proposed scope, knowns and unknowns. OECD environment working paper

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no. 146, OECD Paris. https://www.oecd-ilibrary.org/docserver/82cc3a4c-en.pdf?expires=1 655741376&id=id&accname=guest&checksum=FDB3EBB90F3B7E639F48E52D2240 CC87 Kahl W, Weller P (2021) Climate change litigation: a handbook. Beck/Hart/Nomos, München/ Oxford/Baden-Baden Le Quang G, Scialom L (2021) Better safe than sorry: macroprudential policy, Covid 19 and climate change. International Economics. https://www.sciencedirect.com/science/article/pii/S2110701 721000482?via%3Dihub Orakhelashvili A (2019) Akehurst’s modern introduction to international law, 8th edn. Routledge, London Ortiz G (2009) Issues in the governance of central banks. A report of the central bank governance group. Bank of International Settlements, Basel Papoutsi M et al (2022) How unconventional is green monetary policy? 30.03.2022, 51 pp. https:// web.stanford.edu/~piazzesi/How_unconventional_is_green_monetary_policy.pdf Rajamani L (2016) Ambition and differentiation in the 2015 Paris Agreement: interpretative possibilities and underlying politics. ICLQ 65:493–514 Reghezza A et al (2021) Do banks fuel climate change? ECB working paper series no 2550 (May 2021). https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2550~24c25d5791.en.pdf? e596fd59561e77340a4b6f4319dce966 Robins N et al (2021) Net-zero central banking: a new phase in greening the financial system. LSE Grantham Research Institute on climate change and the environment policy report (March 2021). https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2021/03/Net-zero-centralbanking.pdf Rydge J (2020) Aligning finance with the Paris Agreement: an overview of concepts, approaches, progress and necessary action, policy insight (December 2020). Grantham Research Institute on Climate Change and the Environment. https://www.lse.ac.uk/granthaminstitute/wp-content/ uploads/2020/12/Aligning-finance-with-the-Paris-Agreement-3.pdf Scialom L (2021) The societal responsibility of central banks. Revue d’économie financière Revue trimestrièlle de l’Association Europe Finances Régulations 144:191–201 Solana J (2021) Climate change litigation risk: central banks and financial institutions. ECB legal working paper series no. 21 (December 2021), pp 51–65 Van Calster G, Reins L (eds) (2021) The Paris Agreement on climate change. A commentary. Elgar, Cheltenham Voigt C (2016) The Paris Agreement: what is the standard of conduct for parties? QIL, Zoom-in 26: 17–28

Gudrun Zagel is Assistant Professor of International Law at the Paris Lodron University Salzburg School of Law. She holds law degrees from the Paris Lodron University Salzburg (Mag. iur., Dr. iur.) and the University of Texas at Austin (LL.M.), where she was a Fulbright Scholar. She was Professor of International Law and Human Rights at the University of the Federal Army Munich and a consultant at the Legal Office of the Austrian Ministry of Foreign Affairs. Her research and teaching focus on international economic law and its linkages to non-economic concerns. Dieter Huber is a Senior Policy Expert for banking regulation and strategy in the Bank Supervisory Policy Dept of Oesterreichische Nationalbank (OeNB). He is a graduate of the Universities of Salzburg (Austria) and Tulane (New Orleans), for which he received a Fulbright grant. During his 25 year career in banking and finance, Dieter has worked in the fields of acquisition and project finance and as legal advisor at the Vienna Stock Exchange. His current areas of responsibility include sustainable finance, where he also represents the OeNB in various international supervisory fora.

The Double Materiality Principle (Article 19a NFRD) as Proposed by the Corporate Sustainability Reporting Directive: An Effective Concept to Tackle Green Washing? Philip Förster

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 What Is Materiality? Different Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Materiality in Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Materiality in the “Sustainability” Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Evaluation of the (Double) Materiality Concept in the “Sustainability” Context . . . . . . . . . 3.1 Benefits of (Double) Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Issues of Double Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract In recent years, investors and lenders have increasingly paid attention to sustainability information, most particularly to sustainability efforts that affect financial performance. Many corporations fulfil these wishes only to a limited extent. Although they publish information, they only select the information that is useful to them (“greenwashing”) or publish so much information that investors cannot get a clear overview of the sustainability performance (“information overload”). With the rise of reporting on sustainability standards, new standards for measurement of environmental, social and governance (ESG) information and reporting thereof have become necessary. Here the concept of materiality comes into play. Through streamlining reports, focusing on the most relevant factors and reducing information overload, it tries to increase the requested transparency and accountability. The determination of which sustainability issues are material to companies, industries, investors and other stakeholders remains a lively area of discussion. Article 19a Directive 2014/95/EU (Non-Financial Reporting Directive, NFRD) as P. Förster (✉) Trinity College Dublin, The University of Dublin, Dublin, Ireland e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 345–364, https://doi.org/10.1007/8165_2022_90, Published online: 22 November 2022

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proposed by the Proposal for a Corporate Sustainability Reporting Directive (CSRD, COM/2021/189 final) aims to implement a so-called double materiality principle. Altogether the new wording of Article 19a NFRD as proposed by the CSRD makes sense—it strongly tackles the main issues of non-financial reporting: information overload and greenwashing. The broader approach in regards to stakeholder engagement is beneficial for a comprehensive picture of material matters. However, there is still a need for clarification in order to get the maximum effect out of the materiality principle.

1 Introduction In recent years, companies are pursuing improved sustainability performances.1 Collaterally they are more and more informing their stakeholders about their footprint, performance and measures regarding sustainability.2 There are plenty of different stakeholder expectations, for instance to comply with regulatory requirements, be transparent and compliant as well as to maintain a good reputation.3 Investors and lenders have increasingly paid attention to sustainability information, most particularly sustainability efforts that affect financial performance.4 With the rise of reporting on sustainability standards, new standards for measurement and reporting have also emerged. In order to acknowledge and facilitate reporting on a company’s sustainability footprint, a corporation must conduct a comprehensive stakeholder engagement process.5 The insights gained through this, coupled with a standardized process, are the answer to the requests of stakeholders and investors for relevant and comparable environmental, social and governance (ESG) information.6 This is where the concept of materiality comes into play. Through streamlining reports, focusing on the most relevant factors and reducing information overload, it tries to increase the requested transparency and accountability.7 Reporting based on materiality is, however, no static process as the ESG factors are ever-changing and therefore subject to continuous priorisation (e.g. which efforts to undertake, which indicators to choose as performance measures and which information to disclose).8 In that sense, the concept of materiality serves as a key

1

Jørgensen et al. (2022), p. 2. Jørgensen et al. (2022), p. 2. 3 Pérez-López et al. (2015) p. 723. 4 Nidumolu et al. (2009), p. 58; Jørgensen et al. (2022), p. 2. 5 Puroila and Mäkelä (2019), p. 1043. 6 Eccles et al. (2012), p. 65. 7 Puroila and Mäkelä (2019), p. 1043. 8 Jørgensen et al. (2022), p. 2. 2

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principle as it enables corporations to value the relative importance of different sustainability issues and to balance potentially very different ESG related activities.9 The concept is used to delineate a corridor in terms of the minimum and maximum information to be disclosed by specifying what information potential users would like to receive as a minimum and what information is permitted as a maximum. The EU legislator also recognised the importance of such a concept about 8 years ago and and gave the materiality concept a legal basis in Article 19a Directive 2014/ 95/EU (Non-Financial Reporting Directive, NFRD). A further development of this concept through the introduction of a so-called double materiality concept is currently being sought through the Proposal for a Corporate Sustainability Reporting Directive (CSRD, COM/2021/189 final). The Proposal is currently being discussed within the Council of the European Union. Nonetheless the determination of which sustainability issues are material to companies, industries, investors and other stakeholders remains a lively area of discussion. The purpose if this article is to shed light on the different concepts of materiality. Based on this, (double) materiality is then discussed in the context of sustainability. The remainder of the article will briefly discuss the implementation of the materiality concept by companies.

2 What Is Materiality? Different Concepts Materiality, like beauty, is in the eye of the beholder.10

The concept of materiality is in general nothing new, for instance it is “one of the cornerstones of accountancy” because “for every decision made in accounting there is a prior, if often subconscious, decision that the item in question is material”.11 It pursues two goals: firstly, it is a guiding principle for financial report users and secondly it serves as a limitation of the amount and detail to be disclosed.12 In addition to financial reporting, non-financial reporting also incorporates the concept of materiality as the broadness and heterogeneity of information available and potential relevance for certain stakeholders create a need for a distinguishing criterion.13 A study of the EU Commission prior to their work on the Directive 2014/95/ EU came to the conclusion that potential users of sustainability reports criticise the lack of materiality of the disclosed information and the frequent incompleteness of this information, whilst contents seem to be selective and mainly draw a positive view of the corporation’s performance.14 9

Jørgensen et al. (2022), p. 2. Hicks (1964), p. 159. 11 Frishkoff (1970), p. 116. 12 Baumüller and Schaffhauser-Linzatti (2018), p. 101. 13 Baumüller and Schaffhauser-Linzatti (2018), p. 102. 14 van Wensen et al. (2010), p. 104. 10

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Materiality in Accounting

In accounting the concept of materiality dates back to the turn of the twentieth century.15 The American Institute of Certified Public Accountants (AICPA) was the first to use the term, which according to accounting historians has a legal origin and had to be understood in the sense of an obligation to disclose material facts, in accounting and auditing texts and in the issued US guidelines.16 The Securities and Exchange Commission (SEC), common law, and legislation have all developed several definitions of materiality in the years thereafter, but none have been in complete agreement.17 Common features of these definitions are merely that the decision on materiality is a matter of professional judgement and that information is considered material if its omission or misrepresentation could influence the economic decisions of the users for whose benefit the concept functions.18 Within the EU, today’s most important accounting framework is constituted by the Directive 2013/34/EU.19 Its Article 4 (3) require companies to “give a true and fair view of the undertaking’s assets, liabilities, financial position and profit or loss” in their annual financial statements. The accounting provisions of the Directive refer to the term “materiality” for the defining the necessary information while Article 2 (16) Accounting Directive defines materiality as follows: “‘material’ means the status of information where its omission or misstatement could reasonably be expected to influence decision that users make on the basis of the financial statements of the undertaking.” This definition leaves it unclear who is deemed to be a “user”. The International Financial Reporting Standards’ (IFRS) Conceptual Framework For Financial Reporting on the other hand clarifies users as primarily “existing and potential investors, lenders and other creditors”.20 Beyond that, the IFRS’ Practice Statement implements a four-step-process to define materiality: (i) identification of information that is potentially material, (ii) assessment whether the information gathered in step 1 is actually material, (iii) organization of the information within the (draft) financial statements to communicate the information clearly and concisely to primary users and (iv) review of the draft financial statements to determine

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Baumüller and Schaffhauser-Linzatti (2018), p. 103. Edgley (2014), p. 257. 17 Brennan and Gray (2005), p. 3. 18 Brennan and Gray (2005), p. 4; Edgley (2014), p. 257. 19 Council Directive 2013/34/EU of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/ 43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC [2013] OJ L182/19 (Accounting Directive). 20 IFRS Conceptual Framework for Financial Reporting, IASB, London https://www.ifrs.org/ content/dam/ifrs/publications/pdf-standards/english/2021/issued/part-a/conceptual-framework-forfinancial-reporting.pdf (last accessed 23 June 2022) para 1.3. 16

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whether all material information is included and materiality is appropriately considered on the basis of the complete set of financial statements.21

2.2 2.2.1

Materiality in the “Sustainability” Context Background: A Need for Materiality

A fundamental problem that has emerged in recent years is that the question of materiality of information in the context of non-financial reporting is far more ambiguous and thus more difficult to substantiate than is the case for financial information. The reason for this is that there are often underlying complexities in respect to ESG topics as well as a much larger number of stakeholders whose interests need to be included in the reporting and consideration - and who can sometimes take diametrically opposed positions and views.22 This leads to more difficulty in defining what is material in regards to sustainability disclosures. The broader the scope of application and the more the impact of companies on the environment and on the society is included in the defining process, the more difficult it is to sharpen the term materiality.23 In that sense it has to be distinguished between investor-focused financially material ESG information (single materiality) and broader ESG information focused on various stakeholders (double materiality).24 A single materiality approach focuses solely on ESG topics which are financially material to investors: it tries to give investors the information relevant for evaluating the financial performance of a company and leaves out externatlities that firms impose on society.25 On the other hand, double materialiy includes information pertinent to a variety of stakeholders by taking into account whether and how its operations have an impact on the sustainability of the systems in which they operate as well as impacts that have financially material consequences for the firm and investors.26 While the purpose of distinguishing between financial issues regarding their materiality is related to the financial performance of the company, materiality in non-financial reporting is about the company’s ESG performance.27 What uncertainty exists regarding the definition of materiality, however, radiates to the entire reporting. Because of that is important

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IFRS practice statement 2: making materiality judgements. IASB, London https://www.ifrs.org/ content/dam/ifrs/publications/amendments/english/2017/ifrs-practice-statement-2-making-material ity-judgements-basis-for-conclusions.pdf (last accessed 23 June 2022) para BC27-BC30. 22 Baumüller and Omazic (2021), p. 41. 23 Christensen et al. (2021), p. 1221. 24 Christensen et al. (2021), p. 1221. 25 Christensen et al. (2021), p. 1221. 26 Christensen et al. (2021), p. 1221. 27 Jørgensen et al. (2022), p. 3, 4.

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to sharpen the term “materiality” before addressing the main benefits and concerns regarding non-financial reporting (information overload and greenwashing28).

2.2.2

The Way to the Principle of “Double Materiality”: And How to Understand It

The first legal step towards the implementation of ESG disclosure requirements was the Non-Financial Reporting Directive (NFRD).29 As of now “materiality” is currently expressed in non-financial (sustainability-related) reporting by the introductory passage in Article 19a (1) NFRD on substantive reporting requirements: “Large undertakings [. . .] shall include in the management report a non-financial statement containing information to the extent necessary for an understanding of the undertaking’s development, performance, position and impact of its activity, relating to, as a minimum, environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters [. . .].” In 2019, the definition was further specified by an EU consultation document whereupon “a company is required to disclose information on environmental, social and employee matters, respect for human rights, and bribery and corruption, to the extent that such information is necessary for an understanding of the company’s development, performance, position and impact of its activities.”30 This EU consultation document also further explained the “double materiality” concept: – The reference to the company’s “development, performance [and] position” indicates financial materiality. Climate-related information should be reported if it is necessary for an understanding of the development, performance and position of the company. This perspective is typically of most interest to investors. – The reference to “impact of [the company’s] activities” indicates environmental and social materiality. Climate-related information should be reported if it is necessary for an understanding of the external impacts of the company. This perspective is typically of most interest to citizens, consumers, employees, communities and civil society organisations. However, an increasing number of investors also need to know about the climate impacts of investee companies in

28

Velte (2017), p. 327. Council Directive 2014/95/EU of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups [2014] OJ L330/1 (NFRD). 30 Consultation document on the update of the non-binding guidelines on non-financial reporting https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/docu ments/2019-non-financial-reporting-guidelines-consultation-document_en.pdf (last accessed 23 June 2022) p. 7. 29

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order to better understand and measure the climate impacts of their investment portfolios.31 Despite these attempts at clarification, the abstractness of the term “impact” remains vague and abstract in sustainability accounting and does not point out what information is material.32 According to the Global Reporting Initiative Standards Glossary 2022 impact means the effect the organization has or could have on the economy, environment, and people, including on their human rights, which in turn can indicate its contribution (negative or positive) to sustainable development. Therefore the term might refer to impacts on the financial situation of the reporting company as well as on impacts on various internal or external stakeholder groups.33 Moreover, this definition does not highlight the differences between stakeholders, wrongly standardizes their interests in regards to ESG topics by symbolically turning their interests such as the environment, society, corruption and human rights, into objects and directs its attention to the corporation’s financial performance.34 Article 19a (1) NFRD tries to align a company’s financial position with the interests of its stakeholders, regardless of the existing trade-off and contrast between their interests.35 However, when including non-financial information into the management commentary, the materiality concept clashes with the materiality of financial reporting.36 As such, the materiality concept in Article 19a (1) NFRD shows the contrast between investor-oriented materiality and broader stakeholder-oriented materiality while simultaneously trying to unify what is material to both investors and stakeholders and the corporation.37 The difficulties mentioned above have not gone unnoticed by the EU legislator. In its Proposal for a Directive as regards corporate sustainability reporting the Commission states in Recital 25 that undertakings are required “to report both on how various sustainability matters affect the undertaking [outside-in], and on the impacts of the activities of the undertaking on people and the environment [inside-out]. That is referred to as the double-materiality perspective, in which the risks to the undertaking and the impacts of the undertaking each represent one materiality perspective. A check on corporate reporting shows that those two perspectives are often not well understood or applied. It is therefore necessary to clarify that undertakings should consider each materiality perspective in its own right, and should disclose

31

Consultation document on the update of the non-binding guidelines on non-financial reporting https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/docu ments/2019-non-financial-reporting-guidelines-consultation-document_en.pdf (last accessed 23 June 2022) p. 7. 32 La Torre et al. (2020), p. 714; Baumüller and Schaffhauser-Linzatti (2018), p. 104. 33 Baumüller and Schaffhauser-Linzatti (2018), p. 104. 34 La Torre et al. (2020), p. 714, 715. 35 Baumüller and Schaffhauser-Linzatti (2018), p. 107. 36 La Torre et al. (2020), p. 715. 37 La Torre et al. (2020), p. 715.

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information that is material from both perspectives as well as information that is material from only one perspective.”38 Along with this, the proposal contains a new formulation of Article 19a NFRD proposed by the Corporate Sustainability Reporting Directive (CSRD):“undertakings [. . .] shall include in the management report information necessary to understand the undertaking’s impacts on sustainability matters, and information necessary to understand how sustainability matters affect the undertaking’s development, performance and position.”39 This similarly applies to parent undertakings (Article 29a).

3 Evaluation of the (Double) Materiality Concept in the “Sustainability” Context This new version of the materiality concept as proposed through Article 19a by the CSRD will play an important role in non-financial reporting in the coming years. Hence, it will be crucial that the norm is carefully worded and easy to implement.

3.1

Benefits of (Double) Materiality

In the following the benefits of the double materiality concept as proposed by the European Commission will be examined by looking at it first from a general view before analysing the double materiality concept.

3.1.1

Materiality in General

When considering the materiality principle itself, the following positive aspects stand out. Firstly, the implementation of the materiality concept improves stakeholder engagement.40 The group of stakeholders are much more diverse than the group of stakeholders of financial reporting as they contain not only investors. According to Unermann and Bennett corporations might engage in debates, allowing all

Commission, ‘Proposal for a Directive of the European Parliament and of the Council of 21 April 2021 amending Directive 2013/34/EU, Directive 2004/109/EC, Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards corporate sustainability reporting’ COM (2021) 189 final. 39 Commission, ‘Proposal for a Directive of the European Parliament and of the Council of 21 April 2021 amending Directive 2013/34/EU, Directive 2004/109/EC, Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards corporate sustainability reporting’ COM (2021) 189 final. 40 Puroila and Mäkelä (2019), p. 1048, 1049. 38

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stakeholders an equal opportunity to participate in a debate which aims to reach an intersubjective moral consensus regarding the acceptability of different corporate actions.41 Through that vehicle corporations gain a comprehensive understanding of what is material in complex business environments.42 Hence, the double materiality analysis increases stakeholder engagement and thereby contributes to diverse accountability relationships between corporations, their stakeholders and wider society by facilitating discussions and assessments on sustainable development.43 The stakeholder engagement leads organisations to continually defining, managing and communicating their sustainable identity, activity and impact. Hereby the concept of sustainable development is progressively shaped and reshaped.44 Secondly, a corporation’s investment in conducting a non-financial materiality analysis can be expensive in the short term but will pay off for the company in the long term45 as the conduct of a materiality analysis can support investment decisionmaking by identifying key stakeholders and sustainability issues, as well as relevant risks and opportunities.46 An empirical study executed by Khan et al. shows that investments in material sustainability issues can lead to an improvement regarding the company's financial performance, while investments in non-material issues do not affect the financial performance.47 This goes hand in hand with the fact that the application of materiality cannot only be used by corporations in terms of reporting but also by “leveraging its informational value to define strategy, identify and manage risks as well as seize opportunities”: Applying the concept of materiality helps corporations to make better decisions about investment in sustainability (knowing what is material and where you can have the biggest impact or mitigate the biggest risk).48 Furthermore it enhances business strategy by using materiality assessment input to reflect new business risks and opportunities.49 Another benefit is that a materiality assessment strengthens the foundation of sustainability work by embedding these issues across departments and the supply chain; through that corporations stay ahead of continuously evolving stakeholder and regulatory compliance on these issues.50

41

Unerman and Bennett (2014), p. 688; Brown and Tregidga (2017), p. 11. Adams et al. (2021), p. 6. 43 Puroila and Mäkelä (2019), p. 1049, 1050; Brown and Dillard (2015), p. 37; Adams et al. (2021), p. 6. 44 Puroila and Mäkelä (2019), p. 1049; Adams et al. (2021), p. 6. 45 Oh et al. (2011), p. 285; Adams et al. (2021), p. 6. 46 Adams et al. (2021), p. 6. 47 See Khan et al. (2016). 48 Datamaran, ‘Materiality Definition: The Ultimate Guide’ https://www.datamaran.com/material ity-definition/ (last accessed 23 June 2022). 49 Datamaran, ‘Materiality Definition: The Ultimate Guide’ https://www.datamaran.com/material ity-definition/ (last accessed 23 June 2022). 50 Datamaran, ‘Materiality Definition: The Ultimate Guide’ https://www.datamaran.com/material ity-definition/ (last accessed 23 June 2022). 42

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Furthermore, the materiality assessment of sustainability reporting affects analysts’ forecasting accuracy, financial performance and the informativeness of share prices.51 Martinez examined the influence of material social and environmental concerns on analysts’ forecasting accuracy and discovered that analysts regard the disclosure of sustainability information on material concerns as a sign of strong environmental and social performance, enhanced transparency, and reduced uncertainty, all of which contribute to more accurate forecasting.52 This demonstrates the need to recognise and expose material sustainability challenges from many stakeholders’ perspectives. A uniform concept of materiality could also lead to improved ESG reporting overall. Despite the fact that there is little experience regarding materiality thresholds for ESG disclosures, implementing a standardised materiality threshold and applying it to multiple corporations could significantly improve the scope and comparability of ESG reporting.53 New ESG reporting standards will take time to develop, and standard setters, corporations and auditors need time to learn.54 An immediate effect will be seen but streamlining all the reporting activities of different corporations will take time.

3.1.2

Double Materiality

The focus of an increasing number of investors is no longer only related to expected future returns. Besides that, investors nowadays also take non-monetary and social aspects into account55 and therefore have a much broader approach to what is relevant and what is not. For instance, an investor who disapproves of child labour wants to get information on a corporation’ dealing on this issue as well as on the use of child labour in the whole supply chain.56 As a result, information related to shareholders’ sustainability preferences is required to “maximize shareholder welfare rather than shareholder value”.57 To put it another way, investors’ wishes nowadays can no longer be satisfied with mere financial materiality. To accommodate such investors' non-monetary preferences while making the implementation possible through limiting the breadth of sustainability reporting, one strategy could be to demand a sufficient level of agreement among capital providers on the importance of an ESG topic first, before standard setters (i.e. Carbon Disclosure Project, Climate Disclosure Standards Board, Global Reporting Initiative,

51

Khan et al. (2016), p. 1716; Adams et al. (2021), p. 6. See Martinez (2016). 53 Christensen et al. (2021), p. 1184. 54 Christensen et al. (2021), p. 1223. 55 Hong and Kostovetsky (2012), p. 1, 2. 56 Christensen et al. (2021), p. 1222. 57 See Hart and Zingales (2017). 52

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International Integrated Reporting Council, International Sustainability Standards Board and Sustainability Accounting Standards Board) consider it.58 In that sense, there are various benefits of double materiality. Especially when looking at the concept from the perspective of users (private/institutional investors), the proposal of Article 19a NFRD by the CSRD makes good sense.

Tackling Information Overload and Greenwashing Two of the most relevant concerns in terms of nonfinancial reporting are information overload and greenwashing.59 These two problems overlap and reinforce each other as the possibility of disclosing unnecessary and unimportant information opens the door for greenwashing. As in the context of financial reporting, the problem of information overload is seen as an impediment to extracting decision-relevant information from the reports produced.60 Because of the information overload problem, the manifold of sustainable information adds to the difficulty in its unique context, thus the value of such reports may be called into doubt.61 Furthermore, given the requirement to reconcile financial and nonfinancial data, a rise in total data accessible might have the opposite impact, thwarting the intended good consequences of reporting, both financial and nonfinancial, from the perspective of its consumers as a whole.62 The obvious view of companies’ sustainability reporting practices as public relations tools and the widespread practice of greenwashing could lead to the consequence that nonfinancial reporting requirements exacerbates the information overload problem.63 As a result, the concomitant call for a greater focus on materiality in this context is seen as a crucial, if not the most effective, countermeasure to this danger.64 At first glance, the broadness of stakeholders perspectives could lead to an information overload when reporting on ESG topics. Stakeholders are a non-homogeneous group with diverse interests, which in turn are weighted differently. To cut a long story short: the larger and more non-homogeneous the group, the more different “sustainability matters” in the sense of the proposal of Article 19a NFRD will be viewed. If a company had to report on all the issues which were considered material by its stakeholders, this would lead to an information overload as the corporations would have to report on a vast number of sustainability matters. When taking a closer look, this threat is not as reasoned as it appears. The new proposal of Article 19a NFRD states in its second part that information necessary to

58

Christensen et al. (2021), p. 1222. Baumüller and Schaffhauser-Linzatti (2018), p. 102. 60 Eppler and Mengis (2004), p. 331, 333. 61 Baumüller and Schaffhauser-Linzatti (2018), p. 102. 62 Baumüller and Schaffhauser-Linzatti (2018), p. 102; see also Neumann et al. (2012). 63 Baumüller and Schaffhauser-Linzatti (2018), p. 102. 64 Baumüller and Omazic (2021), p. 42. 59

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understand how sustainability matters affect the undertaking’s development performance and position shall be included in the management report. So this second part of the provision prevents information overload as the sustainability matters have to reach a certain level of importance to affect the corporation’s development performance and position. It is more complicated, however, when the first part of the proposed Article 19a NFRD is considered in view of a possible information overload. The first part states that information necessary to understand the undertaking’s impacts on sustainability matters has to be included in the management report. Regarding this part, it must be determined whether the wording has a limiting effect that counteracts the information overload. Firstly, the word “impact” has such a limiting effect. Smaller, insignificant sustainability matters that are rarely mentioned by stakeholders make up only a small part of the impact. I suggest that these should be summarised in the management report without going into detail and depth. The smaller a matter’s own impact, the smaller its disclosure must be. Therefore it will often be sufficient to simply name the matter and classify it in a sustainability sub-category. Further disclosure is not necessary. Consequently, the wording “impact” already limits the information overload. The term “impact” also has positive implications for avoiding greenwashing. Greenwashing is “the dissemination of false or incomplete information by an organization to present an environmentally responsible public image”.65 Incomplete information on sustainability matters do not have an impact on the sustanibility performance of a company as a whole. Only together with other information does such information reach the “impact threshold”. Such information must therefore be omitted from the reporting or may only be disclosed when contextualised or combined with other (missing) information. Of course, greenwashing can only be contained within the framework of reporting; public relations measures of a company are not affected by this. In this respect, greenwashing can only be contained vis-à-vis the readers of the report which are mostly investors. To reach larger groups of stakeholders, other measures would become necessary. One solution could be to link the permission of public relations measures with the allowed reporting disclosures. However, this would require a separate legal framework (if at all possible). Furthermore, the information to be disclosed is limited by the wording “necessary to understand”. The only pieces of information that are necessary to understand an undertaking’s impact are those which have a certain relevance for the overall impact. As described above, the impact has to be viewed as a whole. So again, small and insignificant matters are not necessary in order to understand the undertaking’s impact. If they are briefly addressed to give a full view, this will be sufficient. It will be important that corporations summarize and subcategorise insignificant matters to comply with the proposal of Article 19a NFRD. If that is the case, the concept of double materiality will prevent such an information overload. Also, greenwashing (at least in the management report) will be hampered as the dissemination of false or

65

Furlow (2010), p. 22.

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incomplete information to present an environmentally responsible public image is no longer possible. Such information is not necessary to understand the corporation’s impact because it is either too small or not relevant (enough). False information obviously cannot be disclosed.

Adapting to Changing Circumstances The materiality concept is subject to rapid changing circumstances. Accordingly, materiality itself cannot be a static principle and should therefore also be influenced by changes in (the understanding of) risk: “Materiality is a dynamic concept, and the materiality of ESG issues evolves over time. This evolution is driven by changes in legislation and policy, by changes in risk and the understanding of risk, by changes in the social, environmental and economic impacts of the ESG issue in question, and by changes in societal (and beneficiary) expectations and norms.”66 Such change can also be driven by stakeholders. Because of the fact that stakeholder’s interests are usually broader than the interests pursued by old-fashioned investors, a corporation’s environmental and social impact may lead the stakeholders to take action against the company and play its part in the continually shaping the materiality concept.67 “If such (anticipated) stakeholder reactions have financial consequences for the firm, then the topic will be material to investors, and [. . .] [ESG] disclosures that alter the financial consequences of these actions will become material to investors as well (even if the [. . .] [ESG] issue per se seems immaterial).”68 When looking for instance at the environmental impact of plastic products (e.g. drinking straws), the production of such only make up a small amount of production costs and of the sustainability footprint. It could therefore not be material from both a financial and a sustainable view. However, the topic could become material when an increasing amount of consumers view this issue as a problem and decide to take action against the corporation by boycotting the company’s products. Through such action the topic suddenly becomes financially and environmentally material.69 In this respect the double materiality concept is better suited than the single materiality approach as it better represents the dynamic of materiality and the impact of the heterogenous group of stakeholders. A periodic review of the materiality subjects and process is nevertheless still essential.70

PRI, ‘Fiduciary Duty in the 21st Century’ (Principles for Responsible Investment, 8 September 2015) https://www.unpri.org/fiduciary-duty/the-changing-landscape-of-fiduciary-duty/248.article (last accessed 23 June 2022). 67 Christensen et al. (2021), p. 1222. 68 Christensen et al. (2021), p. 1222. 69 See for this example also Christensen et al. (2021), p. 1222, footnote 61. 70 Gibassier (2019), p. 18. 66

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Practical Benefits of Double Materiality When looking at the double materiality principle in comparison to the single materiality approach on a practical level, some more advantages of the double materiality come up. Firstly, ESG information is more difficult to measure in numbers and at least today there is a very weak ratio between ESG activities and a corporation’s value or financial performance.71 Moreover, ESG is often “long-term and intangible”.72 Hence, standard setters (ex ante) and managers (ex post) have a wide discretion in assessing the materiality of ESG topics.73 The concept of double materiality is better suited to this situation, as it can be handled more flexibly and does not only take financial interests into account. Secondly, while materiality in financial reporting depends in a large part on company-specific factors (even though similarities with regard to the capital structure or the sector might also exist), materiality in an ESG context is related to business processes which determine the common ESG issues for all companies in the same industry.74 The materiality of ESG is highly industry-dependent (e.g. greenhouse gas emissions for energy corporations, hazardous waste for chemical corporations) but still more general ESG issues do exist (e.g. occupational safety, board structure, labour relations).75 Therefore, measuring these industryspecific factors through applying the single materiality concept fails. Thirdly, materiality in financial reporting is subject to (negative) changes in microeconomic (e.g. corporate scandals) and macroeconomic matters (e.g. financial crises).76 The occurrence of such events can reshape what is considered as material information.77 These changes are potentially greater revealed in ESG reporting as there is a much broader view of ESG issues by society.78 Issues that are considered important by society can change rapidly, they cover a wide range of topics (many of which are based on normative, moral or political views) and are sometimes triggered by exogenous events (e.g. natural disasters, environmental accidents, protest movements).79 This fluidity is also with regard to a practical point of view likely to be more pronounced under double materiality80 as it delivers the tools to take the mutual interference of financial and ESG topics into account.

71

Christensen et al. (2021), p. 1222. Christensen et al. (2021), p. 1222. 73 Amel-Zadeh and Serafeim (2018),p. 101; Christensen et al. (2021), p. 1223. 74 Christensen et al. (2021), p. 1223. 75 Christensen et al. (2021), p. 1223. 76 Hail et al. (2018), p. 667. 77 Hail et al. (2018), p. 667. 78 Christensen et al. (2021), p. 1223. 79 Christensen et al. (2021), p. 1223. 80 Christensen et al. (2021), p. 1223. 72

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With the application of the double materiality concept such developments can be declared as material before financial implications arise.

3.2

Issues of Double Materiality

Despite the advantages mentioned, the double materiality principle is not exclusively positive. There are some shortcomings, especially from a practical point of view, which, however, do not carry too much weight due to the successful formulation of the proposal regarding Article 19a NFRD. The decision whether to opt for a single or double materiality approach to ESG reporting hinges, inter alia, on normative views (the trade-offs in this regard are not trivial) about the intended scope and target audience.81 Because a double materiality approach will probably lead to external pressures from various (and possibly unforeseen) stakeholders and standard setters have to politically and morally assess their ESG footprint, a single materiality approach might be easier to handle for securities regulators and standard setters, as they have a long-standing and therefore higher expertise on it.82 Furthermore, as described above stakeholder engagement is used to increase transparency and accountability but also to manage risks by reducing materiality attached to reporting information.83 It follows that the more stakeholders you ask the more different opinions you will receive. This is the downside of the improvement of stakeholder engagement. The stakeholder engagement process could lead to less materiality as targeted because many (unimportant) topics have to be disclosed. However, its effect should not be severe, as the received information (as suggested above) may only be reported briefly and summarised under a sub-category in the management report. However, the risks exists that materiality could also narrow the scope of reporting, leading to disclosure omissions84 when corporations should decide not to disclose a certain matter at all. The application of materiality often contains the problem that it depicts sustainability as a business opportunity or risk which has to be “managed” so that “business as usual” can continue.85 In addition to this, the formation of materiality judgment in inter-professional exchanges between sustainability experts and financial reporters is another difficulty to consider.86 The reason for this is that materiality is assessed in a multifaceted environment where diverse reporting philosophies clash with each

81

Christensen et al. (2021), p. 1222. Christensen et al. (2021), p. 1222. 83 Adams et al. (2021), p. 7. 84 Gibassier (2019), p. 18. 85 Gibassier (2019), p. 18. 86 Dowbiggin (2021), p. 100. 82

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other.87 Sharpening the term of materiality is likely to be hampered by differences in reporting expectations, such as business impacts versus corporate reliance on climate, and various intended recipients, such as financially focused investors versus broader stakeholders.88 Interprofessional collaboration will be required, preferably through discussions between sustainability and financial reporters.89 Furthermore, materiality is a resource-intensive process which does not harmonise with the disclosure of sensitive competitive information, future-oriented information or with the assurability of the materiality determination process.90 With the last aspect comes the poor disclosure of the process of determining material sustainability issues.91 Reporting corporations appear to be failing to disclose how materiality was determined.92 Existing materiality approaches have been cited as a source of concern in the 2020 report on risk management integration and disclosure by the Task Force on Climate-related Financial Disclosures (TCFD) which states that companies frequently failed to explain the process by which they determine the materiality of climate-related risks to their operations.93 Robust identification of material impacts of a corporation on sustainable development must be the starting point to determining sustainable development risks and impacts on the financial statements.94 As a result, a reporting system that supports this is harmful to longterm development—and, ironically, financial success.95 One reason for this could be that corporations lack skills to apply materiality to sustainability issues.96 Another obstacle arises when difficulties become material and there is no advice on how to deal with them, leading to further complexities.97 To highlight this point, according to the 2019 TCFD status report, 60% of 198 financial report preparers perceive climate hazards to be material now or in the next one to two years, but only 19% believe they will be material in the next 3–10 years.98 This shows how materiality assessments differ from corporation to corporation, and how they may

87

Power (1996), p. 289, 290. Dowbiggin (2021), p. 100. 89 Dowbiggin (2021), p. 100. 90 Gibassier (2019), p. 18. 91 Adams et al. (2021), p. 7. 92 Dowbiggin (2021), p. 99, 100. 93 TCFD, ‘Guidance on Risk Management Integration and Disclosure’ (Task Force on Climaterelated Financial Disclosures, October 2020) https://assets.bbhub.io/company/sites/60/2020/0 9/2020-TCFD_Guidance-Risk-Management-Integration-and-Disclosure.pdf (last accessed 23 June 2022); O’Dwyer and Unerman (2020), p. 1126. 94 Adams et al. (2021), p. 8. 95 Adams et al. (2021), p. 8. 96 Adams et al. (2021), p. 7. 97 Dowbiggin (2021), p. 100. 98 TCFD, ‘2019 Status Report’ (Task Force on Climate-related Financial Disclosures, 31 May 2019) https://assets.bbhub.io/company/sites/60/2020/10/2019-TCFD-Status-Report-FINAL-0531191.pdf (last accessed 23 June 2022), p. 55. 88

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disclose climate risk only based on their own judgements rather than those of their external recipients.99 A last issue regarding the double materiality principle is that the assessment of materiality favours short-term financial interests.100 Furthermore, because corporations continue to prioritise financial sustainability over social, environmental and governance issues, there is an apparent risk that the concept of double materiality is used only to ESG issues to preserve the company's financial value.101 The risk that corporations focus on increasing legitimacy for their most important stakeholder groups could lead to not adopting the guidelines if it does not enhance their relationship with those favoured stakeholder groups.102

4 Conclusion Altogether the new wording of Article 19a NFRD as proposed by the CSRD makes sense—it strongly tackles the main issues of non-financial reporting: information overload and greenwashing. The broader approach in regards to stakeholder engagement is beneficial for a comprehensive picture of material matters. The abovedescribed problems associated with this can be eradicated by making small practical adjustments. Introducing sector-agnostic and sector-specific disclosures, and especially metrics could mitigate these problems.103 In this sense, the establishment of a core set of common disclosures and various sector-specific pillars, which at best are based on numerical indicators, would be a possible solution. Furthermore, a release of practical guidelines especially regarding the interpretation of “impact” and “necessary to understand” would be helpful. Additionally, a clarification by the standard setters could solve this problem by introducing clear guidance on which matters to disclose since the selection of the information is very difficult for obliged companies.104 Nevertheless, one cannot deny that there are conceptual ambiguities and loose ends in the proposal that need to be tied up. The “Sustainability Building Blocks”105 published by the International Federation of Accountants (IFAC) show a way in which the double materiality concept could be conceptually stratified. A clearer

99

O’Dwyer and Unerman (2020), p. 1126, 1127; Dowbiggin (2021), p. 100. Adams et al. (2021), p. 7. 101 Biondi et al. (2020), p. 899; La Torre et al. (2020), p. 1061, 1064. 102 Nikolaeva and Bicho (2011), p. 153. 103 Baumüller and Sopp (2022), p. 22. 104 CEPS, ‘Study on the Non-Financial Reporting Directive: Final report’ https://www.ceps.eu/wpcontent/uploads/2021/04/EV0220277ENN.en_.pdf (last accessed 4 September 2022) p. 104, 105. 105 IFAC, ‘Enhancing Corporate Reporting’ https://www.ifac.org/system/files/publications/files/ IFAC-enhancing-corporate-reporting-sustainability-building-blocks.pdf (last accessed 23 June 2022). 100

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definition of stakeholders’ information interests that previously touched on value creation could thus be better addressed as this has been often done so far through elaborate stakeholder surveys.106 With a strongly expanded circle of users, it must certainly also be taken into account that not every company has the resources to conduct stakeholder surveys.107 A different approach to stakeholder surveys could be to conduct a purely internal company assessment.108 However, this seems to be less and less in line with the understanding of the required methodological standards that prevail in the field of non-financial reporting.109 A scientific or objectified derivation and assessment of the significant ecological and social impacts would be another conceivable alternative.110 Scientific assessment could be the future of materiality analysis, in the development of which large European concerns in particular could participate.111 This could address the criticisms of stakeholder consultations; however, it should be noted that the large number of approaches already developed can be identified as a problem area due to the variety of results achieved with them.112 In conclusion, the concerns regarding the credibility of sustainability reports and inaccurate portrayal of sustainability performance113 are tackled by the new CSRD’s proposal of Article 19a NFRD. Disclosing good performance, ignoring poor performance, twisting the science and using sustainability reports to legitimate the corporation’s actions and even misleading its stakeholders114 would be reduced significantly.

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Nidumolu R, Prahalad CK, Rangaswami MR (2009) Why sustainability is now the key driver of innovation. Harv Bus Rev 87(9):56–64 Nikolaeva R, Bicho M (2011) The role of institutional and reputational factors in the voluntary adoption of corporate social responsibility reporting standards. J Acad Mark Sci 39:136–157 O’Dwyer B, Unerman J (2020) Shifting the focus of sustainability accounting from impacts to risks and dependencies: researching the transformative potential of TCFD reporting. Account Audit Account J 33(5):1113–1141 Oh WY, Chang YK, Martynov A (2011) The effect of ownership structure on corporate social responsibility: empirical evidence from Korea. J Bus Ethics 104(2):283–297 Pérez-López D, Moreno-Romero A, Barkemeyer R (2015) Exploring the relationship between sustainability reporting and sustainability management practices. Bus Strategy Environ 24:720– 735 Power M (1996) Making things auditable. Account Org Soc 21(2-3):289–315 Puroila J, Mäkelä H (2019) Matter of opinion, exploring the socio-political nature of materiality disclosures in sustainability reporting. Account Audit Account J 32(4):1043–1072 Unerman J, Bennett M (2014) Increased stakeholder dialogue and the internet: towards greater corporate accountability or reinforcing capitalist hegemony? Account Org Soc 29:685–707 van Wensen K, Broer W, Klein J, Knopf J (2010) The state of play in sustainability reporting in the EU Accessed 23 June 2022 Velte P (2017) Prüfung der nichtfinanziellen Erklärung nach dem CSR-RichtlinieUmsetzungsgesetz. Zeitschrift für Internationale Rechnungslegung 7–8:325–328 Philip Förster is a German lawyer (qualified in 2021) working for a leading international law firm in Munich/Germany in the areas of corporate law and M&A. He studied Law at FriedrichAlexander-University Erlangen-Nürnberg (First State Examination) in Germany, Trinity College Dublin (LL.M.) in Ireland and Universidad Autónoma de Madrid in Spain.

Assessing the Climate of ‘Shareholder Based Climate Change Litigation’ in the Global South Nikita Pattajoshi

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 Setting the Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Defining the Scope of Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Shareholder Based Climate Litigation: Understanding the Rationale, the Legal Arguments Invoked and Relief Sought . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 The Rationale Behind Shareholder Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Understanding Climate Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Relief Sought . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Legal Opportunities Structure (“LOS”) Analysis of Select Countries of Global South . . . 3.1 Standing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Judicial Receptiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Result and Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

366 367 369 369 369 370 372 372 373 377 382 382 384 386

Abstract Critical scholarship analysing climate change litigation has identified a growing species of lawsuits called ‘shareholder climate change litigation’ wherein the underlying motivation is to hold corporations liable for ‘climate change related financial risks’ associated with their business activities and their impact on the interests of their shareholders. However, the landscape of shareholder climate change litigation is very Global North centric, both quantitatively and qualitatively. The number of climate change cases against corporations brought by shareholders in a country of the Global South constitutes an alarming zero. This paper is an attempt to contemplate the ‘Legal Opportunity’ of proliferation of shareholder climate lawsuits in nations of the Global South. The central argument is that shareholder climate change litigation will increase even in the Global South and will positively influence the climate change litigation landscape, even if they are unsuccessful in terms of the judicial outcome. N. Pattajoshi (✉) National Law University Odisha, Cuttack, India © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 365–388, https://doi.org/10.1007/8165_2022_89, Published online: 24 November 2022

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1 Introduction With the advancements in scientific knowledge regarding ‘attribution’ of climate change to various actions and increased public mobilization, climate change has called to action both the Government and private actors alike. Numerous lawsuits around the world are being filed against the Government (called public climate change litigation) and against private actors like non-governmental corporations, financing institutions etc. (called private climate change litigation) holding them accountable for the climate crisis. Thus, climate change litigation (CCL) has emerged as an alternative to climate governance through laws and policies by the Government.1 Shareholder based climate change litigation has proliferated in recent years wherein shareholders have emerged as increasingly important actors in bringing claims against corporations. Usually the specific legal arguments that claimants in other climate litigation against corporations rely on to hold them accountable for climate change are based in tort law claims of negligence, nuisance (both public and private) strict liability or other common law doctrines of unjust enrichment.2 However, with the recent wave of shareholder climate suits, shareholders are viewing information related to climate risk as critical to their investment decisions and hence influence corporate disclosure practices. Such shareholder based climate litigation is different from other climate cases brought against corporations in the sense that while in the former claimants attempt to attribute climate change impacts to specific corporations, in the latter the claim is essentially about the assessment of climate change related financial risk and its impact on business activities and consequently on interest of the shareholders. While, as of June 2022, there have been 2002 cases of climate litigation documented worldwide (with 88 of them from the Global South), only 63 of them belong to the category of climate cases against corporations.3 These include securities and financial regulation cases filed by either regulatory bodies in the States or by private plaintiffs. A handful of them are actually filed by shareholders of the same corporation which is made the respondent in these cases. All these forms of litigation brought against corporations display similar goals like stopping corporations from taking actions that damage the environment and cause climate change, ensuring corporations provide accurate information and 1

Peel and Osofsky (2015), p. 9. Business and Human Rights Resource Centre, Climate Litigation against Companies: An Overview of Legal Arguments (June 2019) (last accessed 15 February 2022), p. 1. 3 Joana Setzer and Catherine Higham, Policy Report: Global Trends in Climate Change Litigation 2022 Snapshot (June 2022) , p.13 (last accessed 25 August 2022); Sabin Centre for Climate Change Law, Climate Change Litigation Database (2022) (last accessed 15 February 2022). 2

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detailed disclosure about climate change and its impact on business, so that operational changes can be brought out or in form of shareholder activism to let the corporation adopt resolutions about climate change actions. The basis of the claims in these bracket of cases range from failure of business to adequately assess business risk attributable to climate change, amounting to fraud4; demand of transparency and more proactive disclosure; violation of fiduciary duty towards shareholders.5 Sometimes, they also take the form of litigation by investors in a pension fund alleging failure to disclose climate related risks faced by the fund thereby affecting their decision to invest in the funds.6

1.1

Setting the Context

The contribution of the Global South to the climate change litigation landscape is very humble, both in terms of quantity and quality. Quantitatively, out of around 2002 climate cases filed worldwide till June 2022, only 88 cases hail from the Global South, with a break up of 28 from Asia Pacific, 13 from Africa and 47 from Latin America.7 When it comes to public climate change litigation in the Global South countries, the strategies used and the trends can be seen to be similar to that of their Global North counterparts to a large extent.8 However, at the same time, some of these cases in the Global South display some uniqueness in terms of the strategies used by litigations or reasoning of the Courts which exude a regional jurisprudence.9 The climate litigation landscape in the Global South is characterized by actions brought by climate activists and other members of the civil society against the Government highlighting its failure to act in lines with its commitment under international law. A characteristic feature of climate litigation in the Global South is the reliance on a

4

4 People of the State of New York v Exxon Mobil Corporation, No. 452044/2018 (Decision December 10, 2019) [Supreme Court of State of New York]. 5 Client Earth v Enea, (District Court of Poznań, July 31, 2019). 6 McVeigh v Australian Retail Employees Superannuation Trust [2019] FCA 14 [Federal Court of Australia]. 7 Joana Setzer and Catherine Higham, Policy Report: Global Trends in Climate Change Litigation 2022 Snapshot (June 2022) , p. 2 (last accessed 25 August 2022). 8 Asian Development Bank, Climate Change Coming Soon to a Court Near You: Climate Litigation in Asia and the Pacific and Beyond (December, 2020) (last accessed 18 April 2022), p. 222; Setzer and Benjamin (2020), p. 79. 9 Asian Development Bank, Climate Change Coming Soon to a Court Near You: Climate Litigation in Asia and the Pacific and Beyond (December, 2020) (last accessed 18 April 2022), p. 222.

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constitutionally protected right to healthy environment 10 or a constitutional right ‘of’ nature11 for furthering claims and favourable judicial decisions. The judicial decision is thus in form of a mandate issued to the Government or injunctions ordering implementation of specific measures to prevent any further harm to the claimants or violation of their constitutionally protected rights. The problem with this judicial approach towards the climate cases is that the decision or ruling is against the Government of those States which are not typically substantial contributors to climate crisis, owing to their levels of industrialisations. Also, these countries have a stronger focus on development and often prioritize it over environmental protection. The climate change litigation landscape in the Global South countries resonate the priorities of these countries, be it violation of constitutional rights due to Government inaction or human rights violation by the Government or corporations action.12 Therefore, while the outcome of these litigations in the Global South nations might seem very rosy, but they fail to have a real impact on the climate regulation in the countries.. Implying, no substantial change is seen in the climate change policy or actions of the Government despite the Court’s ruling and the judgements broadly remain enforced only against specific actors or parties This adds on to the notion that the Global south countries have historically low level of enforcement of environmental laws, including climate change laws and policies. Hence, it is important that the type of climate litigation that proliferates in the developing nations of the Global South is private climate litigations against corporations, wherein the corporations can be made answerable for their carbon footprints, and other activities having a bearing on climate change. This can be made possible within the existing legal rules and doctrines and one does not need to depend on the other States to effectuate it. Despite this, the number of climate change litigation cases against corporations brought by shareholders in a country of Global South is an alarming zero. This paper is thus an attempt to study the Legal Opportunities Structure (“LOS”)13 of select nations of the Global South to understand the scope for shareholder based climate litigations in these countries.

10 Ashgar Leghari v Federation of Pakistan W.P. No. 25501/2015 (Lahore High Court, September 15, 2018). 11 T-341 of 2016 (5 April 2018) [Supreme Court of Columbia Judgment]. 12 See Philippine Reconstruction Movement and Greenpeace v Carbon Majors Case No. CHR-NI2016-0001 [Philippines Commission on Human Rights]. 13 Legal Opportunities Structure, a term first coined by Chris Hilson is a tool to assess how features of a judicial system like the law, standing rules, costs etc. influence social movements attempting to mobilise the law. [Hilson (2002)]. Some of the literature using LOS are: Vanhala (2012), p. 523; Wilson and Carlos (2006), p. 325.

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369

Defining the Scope of Study

While there is dearth of Global south centric literature in the field of climate change litigation, the one in field of shareholder based climate litigation remains scanty. This paper covers climate change litigation initiated by only shareholders, both institutional and private, of a corporation against the corporation. It thus excludes litigation against corporations brought by regulators, the State or non-shareholder citizens. Further, shareholders holding corporations accountable for climate change may do so by both judicial and non—judicial means. While the judicial means include bringing charges or questions of liability before the Courts of law, non-judicial means include various forms of activism like raising shareholder resolutions in Board or annual meetings, lobbying financial institutions to withdraw support from fossil fuel groups with a large carbon footprint etc.14 It is only the former that has been taken into the scope of this study. Section 2 of this paper will discuss some key strategies and legal arguments that mark the journey of shareholder climate litigation, while also discussing what prompts shareholders to take actions, at a doctrinal level. Section 3 will delve into a Legal Opportunities Structure study (based on factors identified in Sect. 2 of four select countries of the Global South. This will be followed by result and discussions of the study in Sect. 4 and will form the central part of this paper. Section 5 of the paper will elicit the conclusion about proliferation of climate litigation in the Global South.

2 Shareholder Based Climate Litigation: Understanding the Rationale, the Legal Arguments Invoked and Relief Sought 2.1

The Rationale Behind Shareholder Action

Mark Carney, former Governor of the Bank of England and Chairman, Financial Stability Board delivered a seminal speech articulating how climate crisis can pose various types of risk to financial stability.15 The typologies of risk as portrayed by

14 Business and Human Rights Resource Centre, Turning up the Heat: Corporate Legal Accountability for Climate Change (2018) (last accessed 15 April 2022), p. 14. 15 Mark Carney, ‘Speech: Breaking the Tragedy of the Horizon – Climate Change and Financial Stability (City Dinner by Lloyd’s, London, 29 September 2015) (last accessed 13 May 2022).

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Carney informed and influenced many regulatory and industry initiatives undertaken to deal with climate risks.16 In his speech, Carney coined a phrase ‘tragedy of the horizon’ which he used to refer to the impact of climate change beyond the ‘traditional horizon of the actors’ and to extend to the future generations’ economic stability. He argued that the tragedy of the horizon can be broken by a better assessment of risk associated with a business. Such a risk assessment should reflect in the company’s statements and disclosures. While there is a huge volume of economic and financial literature that discusses the importance of disclosures in dealing with climate change and the risk arising therefrom, this paper shall focus on the role of shareholders, without getting into the economic theories justifying disclosure requirements. Shareholders may be tempted to bring an action against a corporation when it does not act in favour of either the shareholder welfare or in favour of shareholder value. While the former includes all concerns of the shareholders—environmental, social or ethical, the latter includes valuation of shares of the corporation. When ‘climate sensitive’ shareholders bring an action against a corporation for its climate actions, influenced by either of the two possibilities above, the corporation can be held answerable for its actions—in this context, assessment of climate risk. This forms the basis for shareholder climate actions against corporations.

2.2

Understanding Climate Risks

Carney identified three risks that climate change poses to financial stability: physical risk—loss to financial assets due to catastrophic climatic events like floods, storms etc. or slow onset events like desertification, sea level rise etc..; liability risk— ensuing liability on carbon emitters who are held responsible for the events by the people who suffered loss in such events; transition risk—change in value of assets owing to transition towards a low carbon economy in light of new policies, regulations, technologies etc.17 However, in addition to this, business or corporations also undergo a reputational risk for generating higher carbon footprint or not being able to mitigate climate impacts on business.18 Corollary to a firm’s reputational risk is the litigation risk a corporation may face i.e. risk of climate lawsuits being filed

16

Solana (2020), p. 366. Mark Carney, ‘Speech: Breaking the Tragedy of the Horizon – Climate Change and Financial Stability (City Dinner by Lloyd’s, London, 29 September 2015) (last accessed 13 May 2022). 18 See Parella (2018). 17

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against the corporation that could in turn pose financial, operational and transitional risk for the corporation and its Directors.19 Legal Arguments Involved. To be able to identify the relevant factors for undertaking a Legal Opportunities Structure study, the various legal arguments and litigation strategies used in pre-existing shareholder based climate change litigation cases need to be discussed at the outset. For this purpose, we must turn to prominent instances from the Global North as a point of reference. One of the earliest climate litigation under securities law was brought in form of a class action suit against Exxon Mobil Corporation in the District Court for the Southern District of Texas in 2016 by investors claiming that the corporation failed to adequately assess and disclose business risks owing to climate change.20 It was alleged that the corporation projected an artificially inflated value of its oil reserves and made false and misleading statements about impact of climate change on its business. This led to fall in stock prices by 13% in the year 2016 and hence the relief sought by the investors was damages.21 The legal basis for the claim was fraud and misrepresentation. Further, according to the claimants, a case of breach of fiduciary duty was also made out in this case and hence they claimed for a declaration regarding the breach by the defendant corporation. Interestingly, this case was dismissed by the District Court for the Southern District of Texas as they felt that the claim lacked merit, but it kick started a series of such climate claims against various other corporations. A second class action was brought by investors against a Californian public utility company, Edison International in the year 2018before the District Court for Central District of California alleging false and misleading statements related to climate change impacts made by the corporation in its financial reporting.22 It was alleged that the corporation discounted the increased risk of wildfires in California and the impact it has on its business. The suit however extinguished in April this year as the federal judge ruled that none of the company’s statements amounted to the level of fraud as alleged. On very similar lines, a group of investors sued the Pacific Gas and Electric Company for fall in the value of the pension funds, which could be attributed to the default on part of company to disclose risk because of company’s wildfire safety practices.23

Shaym Divan, ‘Legal Opinion: Directors’ obligations to consider climate change-related risk in India’ (September 2021) , p. 29. 20 Fentress v Exxon Mobil Corporation et al., (filed 23 November 2016) [US District Court for the Southern District of Texas]. 21 Fentress v Exxon Mobil Corporation et al., (filed 23 November 2016) [US District Court for the Southern District of Texas]. 22 Glen Barnes, et al. v Edison International, et al. (filed 16 November 2018) [US District Court for Central District of California]. 23 York County on Behalf of the County of York Retirement Fund v Rambo (filed 22 February 2019) [US District Court for Northern District of California]. 19

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This was shortly after the Pacific Gas company underwent something which was referred to in the news as the first ‘climate change bankruptcy’.24 If we look beyond the US, we have the case of ClientEarth, where the not for profit organization and shareholder in a Polish energy company, Enea SA, alleged that the company’s approval for a coal power plant harms the interest of its shareholders in economic terms, as the power plant may pose some climate related financial risks.25 Though the District Court of Poznań ruled in favour of the shareholders and blocked the approval, it did not get into the question of whether the climate related financial risk were assessed. The strategies above are premised on the proposition that default on the part of the company harms the interest of the shareholders.

2.3

Relief Sought

In light of the legal arguments indicated above, the various reliefs that shareholders may seek and have indeed sought in some of the leading cases are: monetary compensation that is often claimed by shareholders when they allege that the value of shares or stakes they held or invested in, fell down due to lack of adequate disclosure by the defendant corporation; restitution under the law of contracts alleging that the investors entered into the contract based on misrepresentation; private enforcement of disclosure obligations under securities laws; damages under common law/tort law for breach of duty by the directors on lines of Derry v. Peek.26

3 Legal Opportunities Structure (“LOS”) Analysis of Select Countries of Global South Use of LOS can be seen in some other environment and climate change literature.27 The purpose behind studying the Legal Opportunities Structure is to identify the opportunities and challenges in proliferating shareholder based climate litigation in countries of Global South. However, owing to different legal cultures and judicial Steven Mufson, ‘Inside a California utility: Mandatory blackouts amid wildfire threats and bankruptcy’ (22 December 2019) The Washington Post (last accessed 23 April 2022); Russell Gold, ‘PG&E: The First Climate-Change Bankruptcy, Probably Not the Last’ (18 January 2019) The Wall Street Journal (last accessed 23 April 2022). 25 ClientEarth v Enea, (District Court of Poznań, July 31, 2019). 26 [1889] UKHL 1. 27 See Hilson (2002), p. 240; Vanhala (2012), p. 526. 24

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process, greater caution must be exercised before making generalizations about impact of various claims and litigation strategies on climate change litigation. For instance, a tort based claim against a defendant corporation will only succeed in a common law jurisdiction, but will have no standing in a civil law jurisdiction. Therefore, an analysis of the LOS will help us identify the encouraging or discouraging features of the judicial system. In order to attain adequate geographical representation of the Global South, four countries from 3 different continents have been selected for the purpose of this study: Brazil from South America, India from Asia, Philippines from south east Asia and South Africa from the African continent. All the four countries chosen have evolved legal systems, with India and South Africa identified as a common law system, Brazil identified as a civil law system and Philippines as a mixed or hybrid legal system.

3.1

Standing

The question of standing assumes importance in the Legal Opportunities Structure as without standing there cannot be a meaningful exercise of the right of access to justice. In the context of shareholder actions, standing comes from the company laws and corporate governance theories that allow the shareholders, individually or collectively to approach the Courts. From the examples of shareholder litigation of the Global North discussed in Sect. 2 above, we find that the standing arises in 2 different contexts: – Enforceability of disclosure requirements regarding climate risk – Breach of fiduciary duty/Directors’ and Officers’ (D&O) Responsibility

3.1.1

Enforceability of Disclosure Requirements

The standing in this context arises when loss incurred by shareholder due to fall in value of shares held by them can be attributed to ‘incomplete/inadequate disclosure’ or ‘false and misleading statements’ about asset valuation, financial statement, business risk etc. The default on the part of the company may be a default as per the securities and financial regulation law on disclosure obligations that applies to the company. Premised on this, we have seen a rise in use if securities laws as a mechanism to combat fraudulent climate change disclosure.28 There are two pronged benefits that can be reaped out of a shareholder class action—compensation for the harm caused to shareholders and deterrence from causing future harm. 28

Joana Setzer and Rebecca Byrnes, Global Trends in Climate Change Litigation: 2020 Snapshot, Policy report (July 2020) (last accessed 3 May 2022).

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The presence of disclosure obligations for companies that are publicly listed is pervasive in almost all jurisdictions. The primary objective behind disclosure requirement for publicly listed companies in any jurisdiction is to maintain integrity of the market and protect interest of investors who make investing decisions based on the information disclosed by the corporation. The primary question that warrants discussion as part of LOS here is whether the jurisdiction under study allows private enforcement of the disclosure obligations i.e. whether shareholders can approach courts individually or through class action and seek civil justice or not. However, addressing the question of is there a private right of action against the breach of disclosure requirements will take one back to a more rudimentary question that is what part of the disclosure requirement is mandatory and what part is voluntary. In the context of shareholder climate litigation, as we have seen in the prominent cases of the Global North (discussed in Sect. 2 above), shareholders allege default on part of companies to disclose business risk that is attributable to climate change. For instance, in the Exxon Mobil case29 of 2018, the class actions was premised on failure to disclose business risk under the Securities and Exchange Commission’s disclosure mandates.30 Similar climate change reporting by listed companies has been introduced in the U.K., on a ‘comply or explain’ basis from the 2021–22 financial year.31 However, for jurisdictions that might not have a robust disclosure requirement framework, structuring claims on basis of non-disclosure of business risk might be difficult. In such a situation, claimants need to substantiate their claims with help of extra-legal sources like guidelines etc. A mention of the recommendations issued for climate related financial disclosures by a voluntary association under the name Task Force on Climate Related Financial Disclosures (TCFD)32 is important at this juncture as they propose a detailed and ‘forward-facing risk assessment’ by companies to understand the real financial implications of climate-related risks and their potential impacts on business models, strategy. The disclosure model proposed therein can be integrated into the domestic disclosure requirements or can be adhered to by companies on a voluntary basis. Turning to the countries under review in this paper, in Brazil, the obligation to disclose on part of listed companies arises from Article 157 of the Brazilian

29

Fentress v Exxon Mobil Corporation et al., (filed 23 November 2016) [US District Court for the Southern District of Texas]. 30 Climate change related disclosures (Section 501.15), Code on Financial Regulations (CFR); See also Securities Exchange Commission, Commission Guidance Regarding Disclosure related to Climate Change (8 February 2010) 75 FR 6289. 31 Financial Conduct Authority, Climate Related Reporting Requirement (23 April 2021) (last accessed 13 May 2022). 32 UK Financial Stability Board, Recommendations of the Task Force on Climate related Financial Disclosures – Final Report (15 June 2017) (last accessed 3 May 2022).

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Corporation Act33 and Article 2 of Brazilian Securities and Exchanges Commission (CVM) Instructions of 2002.34 Further, there are few voluntary adherence to best practices for ESG disclosures in form of Brazilian Corporate Governance Code. However, no specific regulation or guidance aims to integrate analysis and disclosure of climate change-related risks into the required financial disclosure by listed companies. To strengthen the ESG disclosures, the Brazilian Commission on December, 2020 circulated proposal for changes to the existing Rulings to integrate ESG disclosure guidelines on a ‘comply or explain’ basis, and is still under consideration by the Commission.35 If accepted, it will bring Brazil in lines with the global trend. The Indian law and policy on disclosure requirement of listed companies witnessed some positive changes in this regard with the Securities Exchange Board of India (SEBI), India’s securities market regulator revising the ambit of business responsibility reporting under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 in as recent as May, 2021 to include reporting on Environment, Social and Governance (ESG) indicators.36 Accordingly, Business Responsibility Reporting (BRR) was rechristened as Business Responsibility and Sustainability Reporting (BRSR) which is intended to be mandatory from 2022–23 financial year. This move of the regulator is expected to increase transparency and disclosure about sustainability related risks and opportunities. Likewise, in South Africa the disclosure requirements are provided for in the Companies Act of 2008 and the Johannesburg Stock Exchange (JSE)‘s listing requirements. These requirements and corresponding obligations are further bolstered with The King Report on Governance for South Africa, 2016, thereby increasing the avenue for shareholder activism and shareholder right enforcement. Philippines has its disclosure requirements covered under the mandate of the Philippines Securities Exchange Commission. The Commission in 2019 issued the Sustainability Reporting Guidelines for public listed companies, which needs to be adopted on a ‘comply or explain’ basis.37 However, less than 22% of Philippines public listed companies have actually published a sustainability report since the circular. Further, the country has in place a disclosure requirement framework specifically for the banks under which banks should disclose their risk appetite

33

Brazilian Corporation Law, Federal Law No. 6.404/1976. Ruling No. 358/02; Ruling CVM No. 480/2009; Ruling CVM No. 578/2016. 35 CVM, Public Consultation Notice No. 9/20 (December 2020) (last accessed 13 May 2022). 36 SEBI Circular on Business Responsibility and Sustainability Reporting by listed companies (10 May 2021) SEBI/HO/CFD/CMD-2/P/CIR/2021/562 (last accessed 13 May 2022). 37 Philippines Securities and Exchange Commission, Sustainability Reporting Guidelines for Public Listed Companies (SEC Memo Circular No. 4 of 2019) (last accessed 25 August 2022). 34

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with respect to ESG factors like climate risk, health hazards, environmental pollution etc.38Most jurisdictions are moving from a voluntary disclosure requirement to a mandatory disclosure requirement and the importance and impact of this shift on shareholder climate litigation cannot be understated. Though there is shortage of judicial precedent in the jurisdictions under study, making it difficult to assess whether climate risk related claims will be successful on grounds of breach of disclosure requirements, the avenues are open for the litigants to explore and the law to develop.

3.1.2

Breach of Duty/Directors’ and Officers’ (D&O) Responsibility

In a traditional corporate governance model, there is a split between the Board and the shareholders. Based on this, laws place the Directors under an obligation to disclose material facts about the company.39 Hence, any default in disclosing climate risk of the company can also be used as a ground to hold the Director liable under the statutory laws, as long as it is considered to be ‘material’. In absence of a specific provision on Director’s duty, a common law action for breach of fiduciary duty may be brought against the Directors in such a case. For instance, in India, the Supreme Court upheld that Directors owe fiduciary duty to the company, even before the directors’ duty was codified.40 In the context of shareholder climate litigation, the hazard of taking the ‘breach of fiduciary duty’ road is that there is an additional roadblock of proving the ‘knowledge’ element. In case of Brazil, being a civil law country, the law is quite clearly codified in the Brazilian Corporate Law which has provided a very interesting avenue to activist shareholders—threat of liability of the controlling shareholders or the management upon breach of their fiduciary duty thereby causing loss and damage to the company and its shareholders.41 Though the claim for such liability has been generally low in the Brazilian activist scenario due to lack of any incentive to the shareholders who file the suit, the avenue cannot be ruled out. A new wave of climate litigation cases premised on fiduciary duty theories are expected.42 South Africa being a common law jurisdiction has due regard for the common law duty of care which includes Director’s duty to act in good faith, and with loyalty in best interest of the right holders (shareholders, in this case) and discharging duties with due care and prudence. This common law principle has also made inroads into 38

Central Bank of Philippines, Sustainable Finance Framework (Circular No. 1085 of 2020)

(last accessed 25 August 2022). 39 Indian Companies Act 2013, s 166; South African Companies Act 2008, s 77. 40 Dale and Carrington Invt. (P) Ltd. and Ors. v P.K. Prathapan and Ors. (2005) 1 SCC 212 [Supreme Court of India] [“. . .they have a duty to make full and honest disclosure to the shareholders regarding all important matters relating to the company. . .”]. 41 Brazilian Corporate Law 1976, s 159. 42 Lehmen (2021), p. 1478.

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the South African Companies Act, 2008 as fiduciary duty of good faith, loyalty and due diligence.43 Thus, gauging the legal conviction of the South African community, it can be said that director’s failure to consider climate risk and act accordingly amounts to failure in acting in best interest of the shareholders and hence can be actionable.44 The only barrier is the ‘business judgement rule’ followed in South Africa (styled in line with the US), that weakens the power of the Courts to review business decision of Directors acting in good faith. In Philippines, under the Philippines Corporate Law Compendium, 2018 directors’ fiduciary duty encompasses three duties—duty of loyalty, diligence and obedience. However owing to the prevalence of the business judgement rule, it is difficulty to expose a Director to personal or criminal liability for his actions regarding climate change, when he is not acting in ‘bad faith’.45 Thus, litigant needs to cross the evidentiary threshold of ‘bad faith’ to successfully sue the Director for breach of fiduciary duty with respect to climate actions. It is evident from academic and practitioner literature of these countries that laws of all of these jurisdictions provide enough scope for the activist shareholders to take the ‘breach of fiduciary duty’ route for various forms of climate actions. Still, a clearer guideline or interpretative guidance that environmental, social and governance (ESG) concerns like climate change should also be integrated into the fiduciary duty of the management or the Directors, will make it easier for the shareholders to bring an action before Courts of law. Such an interpretative guidance is still awaited in the fours jurisdictions under study here.

3.2

Costs

The issue of financial resources to pursue climate claims before the Courts has been discussed as part of Legal Opportunities Structure in context of public climate litigation.,46 but not in the context of shareholder based litigations. When it comes to shareholder climate litigation, ‘cost’ as a legal opportunity assumes greater importance, as unlike the former where the claimant fights for a right, in the latter the claimants shareholder fights for a pecuniary loss. When a corporation is harmed, shareholders suffer reflective loss in terms of loss due to change in value of shares they hold in the company. Thus, their incentive to sue the Directors will be weak in a 43

South African Companies Act 2008, s 76(4). Christine Reddell, Director’s Liability and Climate Risk: South Africa – Country Paper (Commonwealth Climate and Law Initiative, April 2018) , p. 10 (last accessed 25 August 2022). 45 Climate Governance Initiative and Commonwealth Climate and Law Initiative, Primer on Climate Change: Directors’ Duties and Disclosure Obligations (2nd ed., July 2022, World Economic Forum) , p. 129 (last accessed 26 August 2022). 46 See Vanhala (2018), p. 114. 44

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jurisdiction that is marked by greater procedural hassles and higher litigation costs. Hence the LOS study warrants a discussion on costs, which in this context indicates litigation cost. In the context of public climate litigation in Global South the costs do not act as a deterrence as it has been seen that the litigants enjoy the support of various non-governmental organizations in financial and other logistical terms.47 In absence of any specific study or relevant literature, it is hazardous to assume that costs act as a deterrence for shareholders of the Global South in bringing climate actions against the corporations. However, for the purpose of this paper, author would like to discuss the issue of costs vis-à-vis shareholder actions on basis of two parameters: scope for third party litigation funding and class action suits.

3.2.1

Third Party Litigation Funding

Though the term third party litigation funding (TPF) encompasses a variety of funding activities, in simplest terms, it indicates lawsuits being funded by entities who are neither parties to the dispute nor legal representatives of such parties, with an interest in the potential outcome of the case. However the term might also include funding by a third party agency, usually a non-governmental organization who have a non-pecuniary interest in the outcome.48 Third party litigation funding has become very visible in financing civil litigation in the U.S, some European countries and Australia, and has a role to play in access to justice as claimants who otherwise could not afford to pursue their claims owing to lack of financial means have resorted to third party funding. Third party funding assumes importance in the context of action brought by shareholders, for reasons already discussed. Also, shareholder claims or securities claims are a favourite destination for third party funders. For instance, in Australia, over the past 5 years, third party litigation funding has predominantly facilitated access to the courts in a narrow range of claims, namely securities and investor class actions. Of the 71 funded claims filed in the Federal Court from 2013 to 2018, 52.1% (37) were claims by shareholders, and 23.9% (17) were claims by investors.49 Historically, third party funding was considered illegal in most common law jurisdictions due to application of doctrine of maintenance and champerty.50

47

Peel and Lin (2019), p. 710 [43% of Global South litigation enjoyed local or non-local NGO support]. 48 American Bar Association, American Bar Association Best Practices for Third Party Litigation Funding (August 2020) (last accessed 10 May 2022), p. 3. 49 Australia Law Commission, Integrity, Fairness and Efficiency – An Inquiry into Class Action Proceedings and Third Party Litigation Funders – Final Report, (ALRC 134, 2018) 27. 50 Natasha Shoult & Simon Latham, ‘Jurisdiction – United Kingdom’ (2021) The Third Party Litigation Funding Law Review (last accessed 10 May 2022).

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However with England becoming the first common law country to allow selfregulation of third party litigation funding agreements,51 and with passage of time, third party funding has emerged in various common law jurisdictions, in absence of any specific statutory law prohibiting or regulating such a practice. In India, with the third party funding scenario being in its embryonic stage, there are no laws making third party funding of litigation impermissible.52 In the context of Brazil, though as on 2020, there is not a single instance of third party funding of litigation before judicial forums, TPF is usually used in arbitrations and there is no law regulating use of TPF in litigation and parties are free to choose their own contractual terms.53 When it comes to South Africa, third party funding is allowed since the High Court’s decision stating that third party funding agreements are not illegal54 and the jurisprudence has further been developed by the Court through its rulings. In Philippines, though third party funding is not relevant or in practice in commercial litigation,55 no law in force places a prohibition on third party funding of litigation.56 Theoretically, the prospect of shareholder litigants seeking third party funding in the four jurisdictions is high, provided the shareholders are made aware about exploring such a possibility. In absence of some leading examples of third party funding existing beyond the realm of arbitration, it is difficult to assess the existence of such funding sources in practical sense.

3.2.2

Class Action Suit

Class action suits are suits filed collectively by a group of individuals who have same or similar claims against a particular defendant. In the context of public climate litigation, class actions mark the recent wave of lawsuits on climate actions filed against the Government.57 The pertinent question under study here is whether

51

Jackson (2010); Mulheron (2014), p. 586. Anirudh Krishnan & Lakshana, ‘Country Report – India’ (March 2018) Handbook on Third Party Funding in International Arbitration. 53 Rodrigo Oliviera et al., ‘The Third Party Litigation Funding Law Review: Brazil’ (10 January 2021) The Law Reviews (last accessed 23 April 2022). 54 Price Waterhouse Coopers Inc. v National Potato Co-operative Ltd [2004] ZASCA 64 [Supreme Court of Appeal of South Africa]. 55 Alejandro Navarro et.al, ‘Jurisdiction: Philippines’ (2020) Lexis Nexis Dispute Resolution Law Guide (last accessed 25 April 2022), p. 7. 56 Marvin Masangkay, ‘Third Party Funding in International Arbitration’ (March, 2018) The Philippine ADR Review (last accessed 25 April 2022). 57 Urgenda Foundation v State of Netherlands (9 October 2018) [Hague Court of Appeals]; See also Kalajdzic (2021). 52

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availability of class actions will bolster shareholder climate actions against the corporations. There is enough evidence that the most common use of class action is in shareholder claims or securities claims as, more often than not, their claims are too modest to justify the cost of complex litigation. Individual shareholder losses may be too meagre to pursue litigation and hence a funded shareholder class action eases their path to the Courts by bringing the claimant shareholders at par with the defendant corporation. For instance, in the United States, class actions are pervasive and spread over a wide range of claims, but the majority relate to securities and antitrust claims which are almost 30% of the total number of claims, followed by labour and employment issues (15%) and consumer claims (12%), all other claims holding a minute share.58 Likewise, with the introduction of Part IVA on class action suits in the Federal Court of Australia Act, 1976, the most common type of actions instituted are class action on behalf of shareholders against their corporation.59 Class action by shareholders against the corporation for false or misleading disclosures have been in vogue for quite some time now. To take a very recent example, investors of Zoom in the U.S. filed a class action against the company based on allegations that the company’s disclosures about its encryption abilities had the effect of misleading the investors.60 Similarly, in the U.K., class actions were filed by shareholders alleging breach of director’s duty61 and by investors claiming compensation from the corporation for false and misleading financial statements.62 This judicial trend indicates that class action is the most conducive mode for invoking shareholder climate litigation claims before the Courts. This presumption necessitates a look into the class action jurisprudence in the four countries under study. Brazil is a moderately conducive jurisdiction for class actions and it is believed that Brazil sets an example for all cognate civil law jurisdictions in terms of regulation of class action by means of statutes.63 The Brazilian law categorizes collectively actionable rights into categories—diffusive, collective and homogenous individual rights.64 This classification of actionable rights into 3 types is unique to the Brazilian system and is unfounded in the US jurisprudence on class actions, to which the Brazilian jurisprudence owes its origin. The difficulty that such a categorization creates for the claimants is that the law might consider their claim to be divisible and hence justiciable through individual claims, thereby refuting the scope for any class action. Now, in light of this, shareholders intending to bring claims

58

Klement and Klonoff (2018), p. 151, 190–191. Australia Law Commission, Integrity, Fairness and Efficiency – An Inquiry into Class Action Proceedings and Third Party Litigation Funders – Final Report, (ALRC 134, 2018) 257. 60 Drieu v Zoom Video Communications Inc. et al., (N.D. Cal. April 7, 2020). 61 Sharp v Blank [2019] EWHC 3078 (Ch). 62 SL Claimants v Tesco Plc [2019] EWHC 2858 (Ch). 63 Brazilian Class Action Law (Law No. 7347 of 1985). 64 Portugal and Campos (2020), p. 3. 59

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against losses suffered by them through a class action may run through the difficulty as discussed. This means climate change class actions brought by shareholders may never see the light of the day in the Brazilian courts if the ground for the claims are the financial losses being suffered by them. Rather, for the claim to succeed as a class action, the claimants may have to establish a trans-individual right. India has a modest class action culture though Section 245 and 246 of the Companies Act, 2013 provide for class action to be filed by shareholders. Instead, there are instances where individual claims before Courts have been reverted with class—wide remedies.65 This indicates that there is judicial receptiveness towards class actions. In the South African jurisdiction, there has been no real use of class actions route for private remedies or actions, the use of class action being mostly limited to cases of violation of Bill of Rights. It was only in 1994 when class action was introduced into the jurisdiction and only in 2013 the Court clarified that class action may be brought for cases other than vindication of constitutional rights.66 Even specific provisions for class action in substantive laws, like the Consumer Protection Act remain largely unutilized.67 As far as shareholder actions are concerned, Section 157 (1) of the Companies Act, 2008 permits class actions to be brought before the Companies Tribunal, Companies and Intellectual Property Commission or Takeover Panel. Yet, it is only recently that an application was filed to certify filing a class action for collective claims of shareholders against the Steinhoff group and its Directors to seek relief for the loss suffered by them as share prices fell by 96% owing to some accounting irregularities in the company. According to the shareholders the Directors owed a duty of care towards them, which they breached.68 The South African High Court however refused to certify the class action by shareholders against the company’s directors on ground that the legal issue at hand that gives rise to the claim is not triable.69 In the Philippian context, the Philippines Rules of Procedure provides for class suit mechanism in cases where the subject matter underlying the claim is pervasive to many individuals and it is impracticable to get redressal through individual claims. However, here again there is no prominent successful use of class action by shareholders. The reasonable likelihood of shareholder litigation against Directors may be limited because of various procedural, evidentiary and cost related barriers. While 65

Dr Virendra Pal Kapoor v Union of India and Ors. (29 May 2014) (High Court of Allahabad, India). 66 Children’s Resource Centre Trust and Others v. Pioneer Food (Pty) Ltd and Others 2013 (2) SA 213 [Supreme Court of Appeals South Africa). 67 Broodryk (2020), p. 74. 68 De Bruyn v Steinhoff International Holdings N.V. and Others [2020] ZAGPJHC 145 (26 June 2020) [High Court of South Africa]. 69 De Bruyn v Steinhoff International Holdings N.V. and Others [2020] ZAGPJHC 145 (26 June 2020) [High Court of South Africa].

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procedural and evidentiary requirements cannot be altered, the cost related barrier can be removed or minimized through third party funding or through class actions. Given the shaky contours of class actions in South Africa, the position seems hostile. Also none of the jurisdictions yet have a successful class action for climate filed by shareholder litigants. Any conclusion drawn may be based on a theoretical premise only.

3.3

Judicial Receptiveness

Another essential characteristic of a LOS study is the element of judicial receptiveness. It is a daunting task in itself to have an objective assessment of ‘judicial receptiveness’ as a feature of the LOS analysis and come up with a binary yes or no answer to whether the judiciary is receptive to climate claims. However, it can be assessed by a study of judicial creativity displayed by courts from time to time in climate claims. Hence, for this purpose, parallelism needs to be drawn with public climate litigation cases. If the court has been receptive to climate claims brought by plaintiff citizens, it will be most likely receptive to claims of plaintiff shareholders against defendant corporations. It is presumed that courts that have not shied away from holding their own Governments accountable, would not step back from holding their corporations accountable. In public climate litigation cases, courts in the Global South countries have displayed lofty standard of sensitivity and creativity in their rulings.70 It is expected that similar standard of sensitivity will be displayed by courts in cases of shareholder climate litigation. However, since we do not have a single case of shareholder climate litigation filed in any of the Global South countries yet, it is only apposite to not discuss the idea of judicial receptiveness any further.

4 Result and Discussion A macro-comparison of the four jurisdictions studied herein (Brazil, India, Philippines, South Africa) indicates that the prospect of shareholder climate change litigation is mostly uniform across the four countries. However, a micro level comparison based on the Legal Opportunities Structure displays slight variations. Also, in absence of any tangible or objective tool to measure the Legal Opportunity, existing literature using LOS study usually flag the LOS of a country in subjective terms—as open or closed, or liberal or conservative. For the purpose of this study to determine the LOS for shareholder litigation, the outcome may be flagged as hostile or encouraging.

70

For instance, the use of the public trust doctrine in Urgenda v State of Netherlands.

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For instance, in terms of standing of the shareholders as litigants, all the four countries have displayed an ‘encouraging’ LOS factors. Implying shareholders bringing climate actions against corporation based on breach of fiduciary duty are less likely to face the procedural bottleneck of standing. Though there might be some evidentiary hassle in proving the ‘breach’ or ‘bad faith’, due to lack of a settled jurisprudence of fiduciary duty vis-à-vis climate risk and actions. However, the position remains a little tricky when it comes to standing of the shareholders as individual litigants on grounds of violation of disclosure norms. In absence of wellestablished right to private enforcement of disclosure obligations across the four countries, LOS remains a little unassuming or ‘moderately encouraging’ for shareholders intending to recover damages on basis of non-disclosure of climate risk by corporations. Irrespective of whether the existing disclosure requirements or regulations of a country explicitly provide for climate disclosures or not, it is upon the judiciary to identify what climate change related disclosure amounts to ‘material disclosure’ under the existing laws and hence usher in a new jurisprudence of ‘climate related disclosure’ within the ambit of the existing regulations. The judiciary’s role in this context has been noticeable in the U.S.71 Since all the countries under study here have a ‘materiality’ threshold in their disclosure requirements, we can only turn to the Courts to develop a jurisprudence like that of the Courts in the U.S. Though in India, the chances of successfully suing a company for wrongful disclosures are negligible.72 This is because the enforcement process lies in the hands of the securities regulator, Securities Exchange Board of India (SEBI), which lodges investigation to ascertain a violation, then followed by a lengthy three-step appeal process, which adds to the delay and inefficiency. The extended litigation and associated costs acts as a major disincentive for the shareholders to bring to light the wrongful disclosure. There thus has been a call for amendment to the regulatory framework in India to safeguard shareholders and investors who suffer due to non-disclosure of climate risks.73 On the other hand, Brazil is one of the legal systems which has opted for arbitration as the mode of resolution of securities disputes in listed companies by making inclusion of a mandatory arbitration clause as a mandatory element of the articles of incorporation and a pre-requisite for getting publicly listed.74 This might widen the avenue for shareholder to raise claims regarding non-disclosure of climate information and loss suffered therefrom.

71

Vizcara (2020). Umakanth Varottil, ‘The Nature of the Market for Corporate Control in India’ (2015) NUS Working Paper No. 2015/011 (last accessed 15 May, 2022). 73 Bhaduri (2021), p. 157. 74 OECD Report, Private Enforcement of Shareholder Rights: A Comparison of Selected Jurisdictions and Policy Alternatives for Brazil (18 November, 2020) (last accessed 10 April 2022). 72

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In terms of cost, it is seen that with third party funding finding a fertile ground in all the four countries under consideration, shareholders intending to bring climate actions can seek funding of a third party environmental group or agency. The prospect of third party funding of shareholder litigation is high within the LOS of all the four countries, making the position encouraging. Alternatively, deep pocket funders can fund shareholders actions before the Court. For instance, in Australia owing to lack of restrictions under the litigation funding laws, shareholder actions are increasingly being funded by third party funders. At the same time, we need to be wary of the situation that a lower transaction cost should not open up floodgates for frivolous shareholder actions. With regard to class action suits, the state of affairs seem a little discouraging or ‘hostile’ in South Africa as so far there are no completed trials of class action cases, thereby making it difficult for shareholders to successfully initiate an action for climate disclosures or risks, through a class action. The problem being that class action in South Africa not being governed by a specific legislation (procedural law) and being broadly governed by Court given guidelines only, makes it a little shaky and unpredictable as judge made law is more susceptible to change than statutory law. However, in the case of the other 3 countries under study here, the developments seem assuring. Thus the LOS for class actions in Brazil, India and Philippines continues to remain encouraging. Thus, cumulatively the LOS of all the four countries is encouraging enough to support shareholder climate litigation, other things remaining constant.

5 Conclusion Given the fact that we have not had a single case of shareholder litigation with a favourable outcome in the Global North, it might seem a bit too early to discuss the prospects of the same in Global South countries. Owing to the difference in legal systems, economic factors, corporate governance norms etc. approaches and their respective outcomes may vary significantly between Global North and Global South countries at one level and between one country to the other, at another level. While it is true that the mere presence of ‘encouraging’ Legal Opportunities (LO) is not a guarantee that the shareholders will succeed in their claims, but they provide some certainty. Here, it also becomes important to clarify that success of litigation in context of this paper or in context of shareholder climate litigation need not always mean a favourable judicial outcome, but rather the impact of such litigation on judges and on the respondents. Implying, the litigation strategy should be able to prompt the courts to display judicial creativity within existing framework to hold the corporations accountable for their actions.75 At the same time, the litigation should make the respondent

75

Ganguly (2018), p. 842.

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corporations rethink their corporate strategies to align with more environmentally acceptable practices. This is because such litigations might have an adverse or not so adverse impact on the value of the shares of the defendant corporation as has been seen in asbestos and tobacco litigation cases.76 It is noteworthy that even in the process of a case getting dismissed, a lot is said by a court in terms of need for change in regulations, or other alternative methods that the unsuccessful claimant may adhere to.77 Irrespective of the fact that the shareholder actions culminate in a judicial determination, or a settlement between the parties before such determination, its contribution at a doctrinal level in terms of regulatory impact will be noteworthy. A dynamic shareholder litigation landscape in the Global South countries will not only bolster climate governance in these countries, but also reap results at the international level. With the kind of efforts put by litigants in climate cases in both Global North and Global South coming at par, the divide between these set of countries at an international level for various environmental concerns will be bridged to a greater extent. Further, experience of shareholder based climate cases in Global North countries indicates that even if similar cases/claims in the Global South are unlikely to succeed, regulators may still initiate investigations to use the threat of litigation to convince companies to change or increase their climate risk disclosures. This is particularly important for the countries of the Global South because these regions in the Asia and the Pacific have a history of weak environmental governance resulting in poor resilience to climate change. Thus, Courts, and not the executive or any regulatory wing of the Government, need to take the lead in the discourse against climate change. As per a recent report by the Environmental Law Institute judicial determination of climate issues should influence public discussion on climate change.78 This way courts can contribute to the global discourse on climate change. In a 2020 study by the Asian Development Bank on the scenario of climate change litigation in Asia and Pacific vis-à-vis the global approaches, the researchers have concluded that there is increased judicial acceptance of the realities of climate change and Courts have stepped in to push the executive to work towards implementation of policies. 79 We need to see some similar push for the defendant corporations, which is as of now an elusive phenomena globally. Further, the difference in judicial approach of Global North and Global South countries and its

76

Joana Setzer and Rebecca Byrnes, Global Trends in Climate Change Litigation: 2020 Snapshot, Policy report (July 2020) (las accessed 3 March 2022), p. 25. 77 Ganguly (2018), p. 866. 78 Banda (2020). 79 Asian Development Bank, Climate Change Coming Soon to a Court Near You: Climate Litigation in Asia and the Pacific and Beyond (December, 2020) (last accessed 18 April 2022), p. 222.

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impact on corporations may gradually obliterate as climate change has transboundary effects, and defendant corporations may face litigation threat from any jurisdiction in which the effect of harm to the climate reaches. The practical implication of this work is that with studies of this nature, shareholders in the developing countries will be prompted to make informed choices and efforts to hold corporations liable, even though it is done with a rent seeking behaviour. The perceived environmental performance of the company will affect its financial performance. There is empirical evidence for listed companies in Singapore that there is a positive co-relationship between sustainability reporting of a firm and its market value. Therefore, a rise of climate-literate directors and climate—activist shareholders will be most likely seen in the coming decade as some countries of the Global South (like Singapore) have already ventured in that journey.

References Bhaduri A (2021) Taking the heat: (non) disclosure of climate change risk in India. Bus Law Rev 42(3):152 Broodryk T (2020) An empirical analysis of class actions in South Africa. Law Democracy Dev 24: 54 Ganguly G, Setzer J, Heyvaert V (2018) If at first you don’t succeed: suing corporations for climate change. Oxf J Leg Stud 38(4):841 Hilson C (2002) New social movements: the role of legal opportunity. J Eur Publ Policy 9(2):238 Jackson R (2010) Review of civil litigation costs: final report. Ministry of Justice, United Kingdom Kalajdzic J (2021) Climate change class actions in Canada. Supreme Court Law Rev 100:31 Lehmen A (2021) Advancing strategic climate litigation in Brazil. German Law J 22:1471 Mulheron R (2014) England’s unique approach to the self-regulation of third party funding: a critical analysis of recent developments. Cambridge Law J 73:570 Parella K (2018) Reputational regulation. Duke Law J 67:907 Peel J, Lin J (2019) Transnational climate litigation: the contribution of the global south. Am J Int Law 113(4):679 Peel J, Osofsky H (2015) Climate change litigation: regulatory pathways to cleaner energy. Cambridge University Press Portugal C, Campos H (2020) Class action in Brazil: overview, current trends and case studies. In: Fitzpatrick B, Thomas R (eds) Cambridge handbook of class actions 3 Setzer J, Benjamin L (2020) Climate litigation in the global south: constraints and innovations. Transnatl Environ Law 9(1):77 Vanhala L (2012) Legal opportunity structures and the paradox of legal mobilization by the environmental movement in the UK. Law Soc Rev 46(3):523 Vanhala L (2018) Shaping the structure of legal opportunities: environmental NGOs bringing international environmental procedural rights Back home. Law Policy 40(1):110 Vizcara H (2020) Reasonable investors’ growing awareness of climate risk and its impact on U.S. corporate disclosure law. In: Esty D, Cort T (eds) Values at work: sustainable investing and ESG reporting. Macmillan

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Wilson B, Carlos J (2006) Legal opportunity structures and social movements: the effects of institutional change on Costa Rican politics. Comp Public Stud 39(3):325 Solana J (2020) Climate change litigation as financial risk. Green Finance 2(4):344 Klement A, Klonoff R (2018) Class actions in the United States and Israel: a comparative approach. Theoret Inq Law 19(1):151, 190–191 Banda M (2020) Climate science in the courts: a review of U.S. and international judicial pronouncements. Environmental Law Institute, Washington DC. https://www.eli.org/researchreport/climate-science-courts-review-us-and-international-judicial-pronouncements. Accessed 5 Mar 2022

Nikita Pattajoshi is an Assistant Professor of Law at the National Law University Odisha, India where she offers courses on Environmental Law and Comparative Legal Systems. She holds an LL. M. degree from the National University of Juridical Sciences, Kolkata (India) and is currently pursuing her doctoral studies in the field of climate change litigation.

From Unilateral Border Carbon Adjustments to Cooperation in Climate Clubs: Rethinking Exclusion in Light of Trade and Climate Law Constraints Ilaria Espa and Kateryna Holzer

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The Exclusion Features of the EU CBAM in Their Context . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 WTO and Climate Law Implications of the EU CBAM Exclusion Scope . . . . . . . . . . . . . . . . 4 From Exclusion to Climate Clubs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract This article analyses the trade and climate law constraints applicable to border carbon adjustments (BCAs), and to the carbon border adjustment mechanism (CBAM) recently proposed by the European Union (EU) in particular, by focusing on its ‘exclusion’ features. After introducing the concept of and the rationale behind BCAs (Sect. 1), the article gives an overview of the EU CBAM proposal and explains how, depending on the level of ambition of their country of origin, covered imports can either be partially or fully excluded from the scope of application of the EU CBAM (Sect. 2). Section 3 delves into the specifics of such exclusion features and discusses trade and climate change law implications. Section 4 elaborates on whether and, if so, how the main issues raised by the exclusion features of the EU CBAM as a unilateral measure could be overcome by opting for a carbon club approach and further considers which model of clubbing could be more appropriate also with a view to foster mutual supportiveness between the multilateral trade and climate regimes. Finally, Sect. 5 concludes.

I. Espa (✉) Università della Svizzera italiana, Institute of Law, Lugano, Switzerland e-mail: [email protected] K. Holzer University of Eastern Finland, Law School, Joensuu, Finland e-mail: kateryna.holzer@uef.fi © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 389–410, https://doi.org/10.1007/8165_2022_101, Published online: 18 January 2023

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1 Introduction After decades of theoretical thinking around the use of border carbon adjustments (BCAs), the first examples are in the making. The European Union (EU) is the first to have proposed the introduction of a carbon border adjustment mechanism (CBAM) in connection with its emission trading system (ETS) within the context of its ‘Fit for 55’ package.1 Although not yet in force, the legislative process has already gone a long way and the EU CBAM is expected to become effective on 1 January 2023, upon successful completion of the ‘Trilogue’ negotiations between the European Commission, the European Parliament and the Council.2 An increasing number of jurisdictions, including the United States, the United Kingdom, Canada and Japan, are also considering the introduction of their own border carbon adjustments.3 As measures conceived to preserve the environmental effectiveness of ambitious climate policies via levelling the playing field (that is, by addressing competitiveness concerns over unfair advantages conferred to businesses subject to no or less stringent carbon constraints), BCAs remains contentious.4 On the one hand, they are unilateral trade measures with extraterritorial implications, which have already provoked fierce reactions among third countries:5 upon implementation, the risk of

1

Released on 14 July 2021, the Fit-for-55 package is a comprehensive legislative package that contains the revisions and initiatives linked to the European Green Deal climate actions (European Commission (2019), ‘The European Green Deal’, COM(2019) 640 final) and, in particular, the legally binding target of reducing emissions to at least 55% below 1990 levels by 2030 with a view to achieve carbon neutrality by 2050, as set forth in the EU Climate Law (Regulation (EU) 2021/ 1119 of the European Parliament and of the Council of 30 June 2021 establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 OJ L243/1). In the context of this paper, the generic expressions ‘BCAs’ and ‘CBAMs’ are used interchangeably, whereas the border carbon adjustment proposed by the EU will be addressed as the ‘EU CBAM’. 2 After the publication of the CBAM proposal of the European Commission on 14 July 2021 (European Commission (2021), ‘Proposal for a Regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism’, COM(2021) 564 final [hereinafter ‘CBAM Proposal’]), deliberations within both the European Council and the European Parliament started, leading to an agreement on a ‘general approach’ on 15 March 2022 (Council of the European Union (2022), ‘Draft regulation of the European Parliament and of the Council Establishing a Carbon Border Adjustment Mechanism – General Approach’, ST 7226/22) and a position adopted by the European Parliament on 22 June 2022 (European Parliament (2022), ‘Amendments adopted by the European Parliament on 22 June 2022 on the proposal for a regulation of the European Parliament and of the Council establishing a carbon border adjustment mechanism’ (P9_TA(2022)0248 [hereinafter ‘CBAM Position’])), respectively. Since then, ‘Trilogue’ negotiations are ongoing. 3 Cosbey (2021); IPCC (2022), chapter 11, 97 and chapter 14, 72-3; Mathieu (2021). 4 For a more detailed explanation of the ‘fair competition’ narrative inherent to BCAs, which requires them to work by equalizing carbon prices and thus restore ‘fair’ competition, see Pirlot (2021), pp. 28–31. 5 See, among others, the Joint Statement issued at the conclusion of the 30th BASIC Ministerial Meeting on Climate Change hosted by India (8 April 2021), para 19.

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trade frictions is extremely high and the question of the compatibility of BCAs with the law of the World Trade Organization (WTO) becomes therefore central.6 Albeit not impossible in abstracto, designing a WTO-proof border carbon adjustment is utterly complicated, and a certain degree of uncertainty is ultimately likely to remain given the complex, experimental nature of the measures that are currently being discussed.7 On the other hand, BCAs are presented as climate-related trade measures that seek to address carbon leakage risks in order to support climate mitigation in line with the Paris Agreement.8 Concerns over their WTO legality therefore intersects with issues related to their consistency with climate change law obligations arising out of the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement.9 While most contributions addressing this dimension have focused on the potential problems raised with respect to the principle of the common but differentiated responsibilities and capabilities (CBDRRC) espoused in the climate change regime,10 an increasing number of the most recent analyses have been scrutinizing BCAs (and the proposed EU CBAM in particular) having due regard to both trade and climate constraints in light of the multi-fold interactions between the two regimes. Scholars have noticed how ‘the incorporation of climate-(in)consistent design choices might affect prospects of WTO compatibility’,11 and highlighted in particular how CBDRRC-(in)compatible features may prove critical in determining whether the measures may pass the two-tier test of Article XX GATT (and especially the chapeau requirements), which is most likely be needed to legitimize BCAs in the WTO system as climate-motivated instruments.12 At the same time, existing analyses have convincingly shown how WTO-proofing BCAs, particularly with regards to those features that are most relevant for strengthening a defence under Article XX GATT, may improve their environmental effectiveness and accordingly contribute to reconciling BCAs with their stated carbon leakage avoidance objective, even if the equalisation logic inherent to BCAs inevitably implies the incorporation of industrial-informed features.13

6

The scholarly debate on the prospects for WTO-proofing BCAs more generally and the EU CBAM more specifically is extremely rich and conspicuous. On the former, see, among others, Meyer and Tucker (2022); Quick (2020); Mehling et al. (2019); Trachtman (2017); Pauwelyn (2013); Espa (2012); Holzer (2014); Tamiotti (2011). On the latter, see, among others, Espa (2022); Espa et al. (2022); Galiffa and Garcia Bercero (2022); Marín Durán (2022); Sato (2022); Schippers and De Wit (2022); Dias et al. (2020). 7 Holzer (2021), pp. 636–641; Espa et al. (2022), pp. 30–32. 8 See, for instance, European Commission (2021), CBAM proposal, 15 and recital 9. For a discussion, see Pirlot (2021), pp. 32–33. 9 See, among others, Marín Durán (2022), pp. 9–14 and references cited therein. 10 See, for all, Marín Durán (2022), forthcoming (exact page to be added) and references cited therein. 11 Espa et al. (2022), p. 5. 12 Marín Durán (2022), p. 16; Venzke and Vidigal (2022). 13 Espa (2022), pp. 208–212.

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Against this backdrop, this article espouses a trade and climate law focus but elaborates on a particular set of BCA features that have received less attention of their own in existing contributions on border carbon adjustments: these are what we call here ‘exclusion’ features, that is, those features that determine the criteria for excluding third countries from the scope of application of the measure or, by extension, for excluding third countries from being subject to the measure in its full form depending on the level of ambition of their national climate policies.14 Such ‘exclusion’ features are typical of BCAs as unilateral trade measures aimed at combatting free riding and exerting political pressure on ‘climate laggards’,15 as showed by the earlier proposals for BCAs put forward over the years,16 but have been sophisticated in the recent EU CBAM proposal given the high level of technicality involved in the design of the measure. Arguably, the specific design of such exclusion features will be critical in either strengthening or weakening compatibility prospects of BCAs: from a trade perspective, exclusion brings in the principle of non-discrimination that is central in WTO law and particularly its external facet, that is, the most-favoured nation (MFN) principle; from a climate perspective, exclusion is relevant to the extent that it may or may not be tailored to accommodate for different responsibilities and capabilities of third countries.17 For this reason, this article will focus on the exclusion features of the EU CBAM proposal (as the most complete measure available to date) in light of existing trade and climate constraints; the core arguments presented here are however directly relevant for BCAs discussed in other jurisdictions. In light of the foregoing, this article is organized as follows. Section 2 gives an overview of the EU CBAM proposal with a view to understand the context for its exclusion features and the delicate balance that the proposal attempts at striking between trade and climate objectives in designing the measure. Section 3 delves into the specifics of the EU CBAM’s exclusion features and discusses trade and climate change law implications. Section 4 elaborates on whether and, if so, how the main issues raised by the exclusion features of the EU CBAM as a unilateral measure could be overcome by opting for a carbon club approach and further considers which model of clubbing could be more appropriate also with a view to foster mutual supportiveness between the multilateral trade and climate regimes. Finally, Sect. 5 concludes.

14

Although these features have by some been analyzed in terms of their legal implications, existing contributions have not attempted at looking at them as part of an ‘exclusion’ paradigm that is however typical of BCAs conceived as unilateral measures: see, for instance, Espa et al. (2022), forthcoming (exact page to be added). 15 For a more detailed explanation of the political leverage narrative (or so-called ‘climate leadership story’) of BCAs, see Pirlot (2021), pp. 33–35. 16 For a recollection, see, among others, Mehling et al. (2019), p. 42; van Asselt and Brewer (2010), pp. 448–451. 17 For more details, see below, Sect. 3.

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2 The Exclusion Features of the EU CBAM in Their Context In presenting the EU CBAM, the European Commission has consistently insisted on the measure being conceived as a climate measure with the ‘overarching objective’ to ‘address[. . .] the risk of carbon leakage in order to fight climate change by reducing GHG emissions in the Union and globally’.18 While recognizing that such goal reposes on the definition of a mechanism to put EU products and imported products on equal footing in terms of EU ETS carbon pricing,19 the Commission has allegedly designed the CBAM in a way that is meant to achieve the equalization of carbon costs rather than over-protecting EU industries: in other words, the measure has been conceived with the declared intention to make it ‘comply with World Trade Organization (WTO) rules, including as regards the principle of non-discrimination’,20 and to defend its fair competition logic as instrumental to achieving its carbon leakage avoidance purpose.21 The struggle to align the CBAM (as much as possible) to a climate-informed equalization logic is reflected into the configuration of virtually any of the main design elements of the measure. First, the EU CBAM is expected to work in parallel with the EU ETS and has even been presented as a measure that is supposed to ‘mirror’ the ETS so that covered imported products be ‘subject to a carbon price equivalent to the one they would have paid under the EU ETS, had they been produced in the EU’.22 In concrete, however, the EU CBAM exhibits a number of important differences as compared to the ETS functioning. First, based on the proposal, the EU CBAM would enter into force on 1 January 2023 and apply to imported products in five sectors only (namely, cement, iron and steel, aluminium, fertilizers and electricity), at least at the beginning.23 The choice of sectors was seemingly studied to achieve the ‘highest environmental impact at relatively low administrative effort’ as these are the sectors most exposed to carbon leakage risks due to both their carbon and trade intensities.24 18

European Commission (2021), CBAM Proposal, p. 15; see also Article 1. European Commission (2021), CBAM Proposal, p. 21. 20 European Commission (2019), The European Green Deal, p. 5. 21 European Commission (2021), CBAM Proposal, Explanatory Memorandum, p. 1; European Commission, ‘Staff Working Paper – Impact Assessment Report’ SWD (2021) 643 final [CBAM Impact Assessment], p. 4. In this sense, but noting the apparent contradiction between climateinformed and industrial-informed features, see Espa (2022), p. 208. 22 European Commission (2021), CBAM Proposal, p. 17. 23 European Commission (2021), CBAM Proposal, Annex I. 24 European Commission (2021), CBAM Impact Assessment, p. 84. Referring to the exact same reasons, however, the European Parliament has pushed for a broader coverage including, in particular, organic chemicals, hydrogen, and polymers, with the declared purpose to make the EU CBAM reflect ‘the highest possible ambition from the beginning to ensure that the free allowances are phased-out as soon as possible’. European Parliament Position (2021), Amendment 175 (Annex I of the Proposal for a regulation). 19

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Second, importers of covered products will have to purchase non-tradable ‘CBAM certificates’ instead of EU emission allowances and surrender such certificates to cover the embedded direct25 emissions in their imports.26 Although the price of these CBAM certificates will mirror the weekly average price of emission allowances auctioned under the EU ETS,27 it would be naïve to assume that this is in and of itself sufficient to ensure that imported and domestic products are subject to the same carbon price overall. This is because the actual costs borne by imported products under the CBAM result out of the number of CBAM certificates to be surrendered at the EU allowance (EUA) price and this number may more or less adequately reflect the extent of the difference in carbon pricing imposed on such products based on their carbon content. The number of CBAM certificates is in fact dependent on a number of factors. First, it is directly dependent on the way the carbon content of imported products is determined. The CBAM proposal envisages using actual emissions data at installation level (verified by accredited verifiers) and, only where that is not possible, relying on ‘default values’.28 For electricity, the proposal also resorts to default values, although a declarant can opt for declaring actual emissions under certain conditions.29 The choice to combine a method based on actual embedded emissions and a method based on default values reflects a trade-off between accuracy and administrative feasibility, in addition to signal awareness of the legal constraints arising out of non-discrimination obligations (namely, the national treatment principle that preserves competitive equality between domestic and imported products) under WTO law.30 However, based on the Commission’s own estimated impact of compliance costs,31 many scholars have expressed concerns over the possibility that firms might be induced to opt for default values.32 And since the proposal envisages default values based on European production site average emissions and even average emissions of the 10% worst performing EU installations that have generally

25

According to the EU Commission’s CBAM Proposal, the CBAM would only cover direct emissions (i.e. ‘emissions from the production processes on which producers have direct control’) and not indirect emissions (e.g. emissions from electricity used in production processes). 26 European Commission, CBAM Proposal, Articles 20–22. The financial adjustment phase will follow a 3-year transition (2023–2025) during which authorised declarants will need to get ready through compliance with a number of reporting obligations: European Commission (2021), CBAM Proposal, Articles 32–35. 27 European Commission (2021), CBAM Proposal, Article 21. 28 European Commission (2021), CBAM Proposal, Article 7.2 and Annex III. 29 European Commission (2021), CBAM Proposal, Article 7.3 and Annex III. 30 Espa et al. (2022), p. 23. 31 See European Commission (2021), ‘Staff Working Document Accompanying the Proposal for a Regulation of the European Parliament and of the Council on foreign subsidies distorting the internal market’, SWD(2021) 99 final. 32 Espa et al. (2022), p. 26, also citing Balistreri et al. (2019), p. 1037.

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been considered rather ‘punitive’,33 the risk that imported products might end up being treated less favourably than EU products cannot be excluded.34 Even assuming covered imports’ embedded emissions are fairly determined, or perhaps even more so considering that they might not be, a number of adjustments are still required to align the EU CBAM to a strict equalization logic. Some are specific to the fact that the measure proposed by the EU works in parallel with the EU ETS and therefore address those ETS features that might have a bearing in compromising the CBAM’s carbon leakage narrative: this is the case of the free allocation of allowances, which continues to de facto exempt (at least partially) EU firms in the sectors covered by the CBAM from the costs they would otherwise incur because of the EU ETS. Although free allocation is considered a carbon leakage measure alternative to the CBAM,35 the proposal envisages them operating side by side even after the pilot phase (2023–2025) for a period of time that is still uncertain given that it has proven one of the most contentious CBAM features to define.36 Irrespective of the exact phase-out schedule that would be approved, and the specific legal issues raised by free allocation of emissions allowances as such37 and by using it in combination with the CBAM,38 the Commission importantly proposed that, until free allowances are being granted, the number of CBAM certificates to be surrendered will be reduced to reflect the extent to which EU ETS allowances are

33

Espa et al. (2022), footnote 162 and references cited therein. For goods others than electricity, the CBAM proposal envisages that, in the absence of reliable data for the exporting country, the default value will be based on the average emission intensity of the 10% worst performing EU installations for that type of good. For electricity, where third country-specific default values have not been determined, the calculation will be based on a default value set at the average CO2 intensity of electricity produced by fossil fuels in the EU: European Commission (2021), CBAM Proposal, Annex III. 34 See e.g. Holzer (2014) and Espa et al. (2022), noting that a violation of the national treatment principle is most likely, but discussing scenario for justification of the measure under Article XX GATT: exact pages to be added. 35 As explained by Alice Pirlot, free allocation levels down carbon prices domestically, whereas the EU CBAM (and CBAMs more generally) seek to “level [up] carbon costs for foreign producers and maintain their application on domestic firms, except when they export their products abroad”. See Pirlot (2021), p. 29. In this sense, it has already been noted that ‘they can in principle constitute a better climate alternative in that they would allow countries to keep strong domestic carbon prices while at the same time avoiding an “unfair” loss of competitiveness for domestic enterprises’. See Espa (2022), p. 208. 36 The Commission proposal envisaged that the CBAM be gradually phased in parallel with the phasing out of free allocation (by 10% each year) over a 10-year period: European Commission (2021), CBAM Proposal, Article 31. In a specific amendment adopted by the European Parliament on 22 June 2022, free allocation will be gradually reduced over 2027–2032 according to a CBAM factor of 93% in 2027, 84% in 2028, 69% in 2029, 50% in 2030, 25% in 2031, reaching 0% in 2032. See European Parliament (2022), CBAM Position, Amendment 262 (Article 31, para 1a (new)). 37 Bacchus (2021), p. 4. 38 See Espa et al. (2022), noting that a violation of the national treatment principle is most likely, but discussing scenarios for justifying the measure under Article XX GATT, also citing Bacchus (2021), p. 4.

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allocated free of charge.39 Although the methodology for correcting the number of required CBAM certificates is far from being settled,40 this additional adjustment mechanism is at least in principle consistent with the pursuit of a strict equalization logic since maintaining free allocation alongside the CBAM would arguably translate into EU-based industries being granted ‘double protection’.41 Another type of adjustment mechanism that at least formally responds to a strict equalization logic consists of reducing the number of CBAM certificates for the carbon costs already paid in the country of origin of imported products. The rationale behind this correction mechanism is simple: to the extent that carbon leakage risks only materialize out of carbon price differentials, and that the CBAM aims at correcting these gaps to address those risks, imported products can only bear the price that results out of that difference. In this sense, the idea of crediting third countries’ climate policies responds, among others,42 to the need to avoid double charging for the carbon in the covered imported goods and is hence a feature that is considered in designing border carbon adjustments more generally. In the CBAM, two main features can at least theoretically be considered to reflect this logic. First, and more immediately, the CBAM proposal allows for crediting explicit carbon pricing policies of third countries (that is, carbon taxes or emission trading systems) through the granting of what has been called a ‘CBAM discount’.43 It excludes, however, recognition of implicit carbon pricing policies (e.g. regulatory approaches).44 Second, the proposal exempts certain countries, namely the European Economic Area (EEA) countries (Iceland, Liechtenstein and Norway) and Switzerland,45 which are all countries that have been either integrated in, or linked to (in the case of Switzerland), the EU ETS.46

39

European Commission (2021), CBAM Proposal, Article 6, para 2(c) and Article 31, para 1. The European Commission regulation leaves this to be determined by implementing acts: European Commission (2021), CBAM Proposal, Article 31, para 2. 41 See, among others, Bacchus (2021), p. 4, who also notes that ‘the free emissions allowances currently granted to domestic producers by the EU through the ETS are arguably already illegal’ under the rules of the WTO Agreement on Subsidies and Countervailing Measures (ASCM). 42 For an overview of the different considerations inspiring the inclusion of such a feature, see Espa et al. (2022), pp. 27–30. 43 Marín Durán (2022), p. 5. 44 European Commission (2021), CBAM Proposal, Article 9. 45 European Commission (2021), CBAM Proposal, Article 2.5, and Annex II, Section A. This section also excludes the following territories: Büsingen, Heligoland, Livigno, Ceuta and Melilla. 46 The proposal also provides for another type of exemption, namely in cases where ‘a third country or territory has an electricity market which is integrated with the Union internal market for electricity through market coupling, and it has not been possible to find a technical solution for the application of the CBAM to the importation of electricity into the Union, from that third country or territory’, although under very stringent requirements, which arguably make it very hard to abide by this exemption. European Commission (2021), CBAM Proposal, Art. 2.7. When the proposal was released, no country was indeed listed (see Annex II, Section B) and scholars have expressed doubts as to whether there will be any countries fulfilling the requirements: Espa et al. (2022), pp. 19–20. 40

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Although the exemption features may not at a first glance appear to follow a logic that is similar to the crediting features, it could actually be argued that ‘the ‘formal’ exemption practically amounts to crediting for the equivalence in the carbon price imposed in the EEA countries and Switzerland,47 given that these countries have the same carbon price as the EU’.48 This is even more so if one considers that the CBAM proposal specifies that the exemption is not automatic but subject to verification that ‘the price paid in the country where the goods are originating in is effectively charged on those goods without any rebate beyond those also applied in the EU ETS’.49 Both features ultimately consists of excluding imports, either partially or in full, from bearing the costs arising out of embedded emissions that would have been imposed under the CBAM. As mentioned, this exclusion features find their context in the need to adjust the CBAM design to the climate policy realities of third countries as required by strict equalization logic that informs the carbon leakage narrative and, as such, they are not necessarily specific to the EU CBAM. In the next section, however, we will look into the specifics of the EU CBAM’s exclusion features and discuss to which extent they were successfully calibrated to ensure consistency with a climate-informed equalization logic, that is, in keeping with applicable trade and climate constraints.

3 WTO and Climate Law Implications of the EU CBAM Exclusion Scope As explained in Sect. 2, the rationale behind the exclusion features of the EU CBAM responds, at least formally, to its asserted carbon leakage avoidance objectives: the scope for full or partial exclusion is in fact dependent on the existence of differences in carbon prices between the EU and the countries of origin of covered imported products.50 Following the logic that there is no (or minimal) risk of carbon leakage where carbon prices are the same, the EU Commission proposes to exclude imports from countries having an ETS, which is either integrated in the EU ETS or linked with it.51 At the same time, if the carbon price paid by imports in their countries of origin is lower than the EU carbon price, imports are not fully excluded but rather credited for the carbon price already paid so that the price borne by imported products corresponds to the difference between the EUA price and the price imposed

47

Espa et al. (2022), p. 20. Marcu et al. (2022), p. 28. 49 European Commission (2021), CBAM Proposal, Article 2.5(b). 50 European Commission (2021), CBAM Proposal, Article 9 and Annex II. 51 For a similar vision, see Espa et al. (2022), p. 20; Marcu et al. (2022), p. 28. As already mentioned in Sect. 2, the Proposal also foresees another type of exemption for electricity imports: given the idiosyncrasy of electricity as a product and a market, however, the analysis of legal implications requires a separate study that we leave for future research. 48

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in their country of origin.52 As already mentioned in the previous section, the exclusion of imports from countries with an ETS integrated with the EU ETS could arguably be regarded as a special case of crediting given that in such cases the carbon price earlier imposed on covered imported products is identical to the EU carbon price.53 While it is in principle possible to understand how the exclusion scope of the EU CBAM was conceived with the intention to advocate that it contributes to aligning the measure to a climate-informed equalization logic, the specifics of the mechanism may still raise problems when scrutinized under the lens of WTO law and climate change law. Under WTO law, the main issue raised by the exclusion of imports is discrimination, which is prohibited when origin-based. Under the GATT, in particular, the consistency with the non-discrimination principle needs to be assessed against two types of non-discrimination provisions: the first is concerned with the discriminatory effect of a measure; the second with its discriminatory intent.54 The first type of non-discrimination is expressed by the most favoured nation clause under Article I:1 GATT and by the national treatment principle under Article III GATT, which prohibits discrimination amongst and against foreign (imported) like imports, respectively. The exclusion of imports from the EU CBAM as proposed by the Commission has been generally considered most likely to run counter against these provisions for the following reasons. With regards to the MFN clause, full or partial exemption (by way of crediting) is de facto country-based, even if it reflects the carbon price paid by imports in the country of origin.55 With regards to the national treatment principle, while it is true that the CBAM discount aims at avoiding that foreign producers pay a double price of carbon (that is, the one in their country of origin and the one in the EU), the exclusion of implicit pricing from the scope of the discount could materialize this scenario for producers of covered products situated in those countries that adopt a regulatory approach to climate change mitigation.56 Given the uncertainty surrounding these aspects, it is generally believed that ‘the EU CBAM is most certainly in need of justification under the GATT general exceptions clause’.57 Accordingly, the second type of non-discrimination requirement is non-discrimination within the meaning of the general exceptions clauses of Article XX GATT. Complying with this type of non-discrimination, which is laid down

52

European Commission (2021), CBAM Proposal, Article 9. In this sense, see Espa et al. (2022), p. 20 and references cited therein. 54 Quick and Lau (2003), p. 454. 55 It should be noted that some elements of the interpretation of Article I GATT by the panel in Canada-Autos give grounds to believe that truly origin-neutral conditions, such as carbon footprint of products, might be found to be permissible for derogation under the most-favoured nation clause. See Panel Report, Canada–Certain Measures Affecting the Automotive Industry, WT/DS139/R, adopted 11 February 2000, para 10.25. 56 Similarly, see Espa et al. (2022), pp. 27–30; Marín Durán (2022), p. 13. 57 Marín Durán (2022), p. 16. See also Holzer (2021), pp. 638–639. 53

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under the chapeau of Article XX GATT,58 is essential for the ability of the EU CBAM (and for BCAs more generally) to be successfully justified as a legitimate, climate-motived measure covered under the GATT ‘environmental’ exceptions.59 A key condition for justification as set out in the chapeau of GATT Article XX is that a measure should not be applied in a manner which constitutes a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail. As clarified in a number of WTO disputes, it implies that a measure should take into account conditions in other countries which are relevant for the objective pursued by the measure.60 The objective of the EU CBAM, as stated in the proposal, is to prevent carbon leakage.61 Hence, in order to meet the requirements of the chapeau, the CBAM should foresee an exclusion for imports from countries where a safeguard against carbon leakage is in place. Following this logic, the imposition of a carbon price that is comparable to the EUA price can apparently be considered a reliable safeguard against carbon leakage to the extent that it ensures a level playing field. For this reason, the way the criteria for the full exclusion of imports are calibrated (that is, an exemption for countries where the same carbon price applies because they have an ETS that is either integrated or linked to the EU ETS) could most likely be considered in line with the requirements under the chapeau of Article XX GATT.62 The partial exclusion of imports through the CBAM discount feature, however, is more problematic. Article 9 of the EU CBAM Proposal states that ‘the EU can negotiate agreements with third countries to facilitate the recognition of their carbon pricing systems and the reductions accorded to their exporters’. On the one hand, it is true that considering the conditions in other countries that are relevant for the pursued objective, as required by the chapeau, imposes an obligation to take into account the carbon prices paid in the country of origin of imported products, even if these prices are lower than the EU carbon price. On the other hand, the determination of carbon prices in other countries raises the question about the role of non-pricing mechanisms in their formation so that excluding the relevance of the latter for the

58

This contribution will not explicitly deal with the analysis of whether the exclusion features of the EU CBAM comply with the requirements set out under the relevant sub-paragraphs of Article XX GATT (namely, Article XX (b), (g) and potentially (d)) as these are aspects that have already been extensively analyzed in the existing literature on the EU CBAM, with virtually all the scholars converging in considering that the first part of the two-tier test under Article XX GATT could relatively safely be complied with by the measure as currently proposed: see, among others, Espa et al. (2022), pp. 30–32; Marín Durán (2022), pp. 16–17 and references cited therein. 59 For a more comprehensive analysis of these aspects as applicable to BCAs more generally, see Holzer (2014), pp. 219–238. 60 See e.g. Appellate Body Report, Brazil – Measures Affecting Imports of Retreaded Tyres, WT/DS332/AB/R, adopted 17 December 2007, paras 225–227 and Appellate Body Report, European Communities – Measures Prohibiting the Importation and Marketing of Seal Products, WT/DS401/AB/R, adopted 18 June 2014, para 5.318. 61 European Commission (2022), CBAM Proposal, Article 1; see also the explanatory note to the Proposal, pp. 1–3. 62 Similarly, Espa et al. (2022), p. 29.

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purposes of determining CBAM discounts may lead to allegations of arbitrary or unjustifiable discrimination in violation of Article XX GATT.63 Article 3 of the EU CBAM proposal defines the carbon price as ‘the monetary amount paid in a third country in the form of a tax or emission allowances under a greenhouse gas emissions trading system, calculated on greenhouse gases covered by such a measure and released during the production of goods’, i.e. it foresees only crediting for explicit carbon pricing policies. The rationale behind this choice is caution, since implicit, or effective, prices are not obvious. They are hidden behind many policies and regulatory measures, even those with no direct relation to climate policy. For instance, energy saving and air pollution measures, including relevant product standards, are not directly related to carbon reduction policy but nevertheless they have a significant impact on it.64 Would they be included in the list of relevant measures to be considered when calculating effective carbon prices? As noted by Oliver Sartor et al., ‘if the exporting country decides, the list will be long, and if the importing country decides, the decision might be disputed as an intrusion on national sovereignty.’65 Moreover, as the EU itself relies on various non-pricing mechanisms, particularly in sectors subject to effort sharing at the national level of EU Member States, 66 crediting for an effective carbon price will make the EU calculate the carbon costs of its own non-pricing emission reduction mechanisms.67 The more policies are accounted for, the higher the risk of arbitrariness, especially considering the difficulty of expressing non-pricing mechanisms in prices. Even if a list of measures relevant for calculating the effective carbon price were set up, what methodologies should be used to calculate implicit prices? And how to treat voluntary carbon offsetting? Should carbon credits earned from offset projects be also accepted as a basis for receiving a ‘CBAM discount’? In short, crediting for implicit carbon prices raises many questions that make it difficult to implement in practice.68 However, not considering third countries’ measures when different from an ETS or a carbon tax, may likely create grounds for accusation of arbitrariness, which goes contrary to the requirements of the chapeau of Article XX GATT. In the ShrimpTurtle dispute, an import ban passed the test on arbitrariness under the chapeau only after it had been modified to become flexible enough to require from trading partners ‘the adoption of a program comparable in effectiveness’ rather than ‘the adoption of 63

Similar considerations apply in the case of climate change law. IPCC (2022), pp. 35, 46, 52. 65 Sartor et al. (2022), p. 12. 66 This concerns construction, heating of buildings, housing, agriculture, transport, and waste management sectors. https://ec.europa.eu/clima/eu-action/effort-sharing-member-states-emissiontargets/effort-sharing-2021-2030-targets-and-flexibilities_en. 67 See Espa et al. (2022), p. 28. 68 Such questions are difficult but, at least theoretically, not impossible. In this respect, a potential solution can be provided by the recently established OECD Inclusive Forum on Carbon Mitigation Approaches, the main objective of which is to develop a database on mitigation policies of OECD member and non-member countries and estimate their effectiveness regarding emissions reductions. See OECD (2022). 64

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essentially the same program’ as a domestic one.69 This suggests that all measures (pricing and non-pricing) taken by trading partners that are as effective as the EU ETS would need to be taken into account when determining the exclusion scope. For instance, the US, which does not have a federal ETS in place but rather a number of cap-and-trade systems operating at the sub-federal (state) level, as well as various energy efficiency and air pollution regulations,70 may argue that its national climate policy measures are in no way less effective than the EU ETS or carbon pricing mechanisms in general. Answering the question of whether pricing and non-pricing measures are comparable in effectiveness requires a comparison of the impacts of the measures on emission reduction. Although this is a task to be performed by economists, the possibility that a non-pricing mechanism be found comparable in effectiveness to carbon pricing mechanisms cannot arguably be excluded at the outset.71 Neglecting non-pricing climate policy measures also raises serious concerns under climate change law to the extent that it contradicts the bottom-up approach of the Paris Agreement.72 The Paris Agreement parties are free to choose any measures suitable for them to achieve their nationally determined contributions (NDCs) ‘reflecting common but differentiated responsibilities and respective capabilities, in the light of different national circumstances’.73 In other words, the Paris Agreement does not accord any preference to carbon pricing mechanisms over non-pricing mechanisms; accepting only the former as the basis for the CBAM discount or even for the full exemption impairs the right of the Paris Agreement parties to choose their emissions reduction tools.74 One could, of course, argue that the EU CBAM will indirectly consider non-pricing instruments. This is because ‘by taking actual emissions into account, the EU CBAM does implicitly recognize the impact of third countries’ regulatory frameworks on imports’.75 Faced with compliance obligations under non-pricing policies, foreign producers bear costs of these policies and attempt to reduce their carbon footprint, which is reflected in a lower CBAM charge. Therefore, it has been contended that the EU ‘in no way discriminates against countries that have not introduced a carbon-pricing scheme, but rather aims to ensure that all domestic and foreign producers are subject to an equivalent

Appellate Body Report, Unites States – Import Prohibition of Certain Shrimp and Shrimp Products (Article 21.5), WT/DS58/AB/RW, adopted 21 November 2001, para 144. 70 See, among others, Shouse et al. (2021). 71 Parry et al. (2021). 72 It should be highlighted that this applies to both of the exclusion features of the EU CBAM: as a matter of fact, full exclusion of imports (i.e. exemption of EEA countries) is granted only to those countries where the same policy applies (i.e. ETS integrated or linked to the ETS). 73 Paris Agreement, Article 4.3. 74 Similarly, Marín Durán (2022), p. 13. It is important to note that Article of the Paris Agreement offers parties the possibility to cooperate on the achievement of their NDC targets not only by means of market-based mechanisms but also using non-market approaches (Article 6.8 and Article 6.9). 75 Galiffa and Garcia Bercero (2022), p. 198. 69

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carbon price’.76 However, that may not hold true. The actual emission footprint of imports would not necessarily reflect the total costs incurred by foreign producers under non-pricing policies, which means that part of the costs would remain uncaptured in the calculation of amount of CBAM certificates to be surrendered, thus potentially leading to discrimination. Another tension with climate change law may likely arise out of the omission of imports from developing countries based on their level of economic development or level of emissions (namely, least least-developed countries (LDCs) and small island developing States (SIDS) benefitting from a privileged status under the Paris Agreement)77 out of the CBAM exclusion scope. The EU Commission has justified its choice by the supposed ineffectiveness of this approach, claiming that it would disincentivize these countries to reduce their emissions and run counter to the overarching objective of the CBAM and long-run interests of the third countries.78 This choice, however, would likely run counter to the CBDRRC principle espoused in the UNFCCC and the Paris Agreement.79 This choice reposes on a reasoning that does not adequately take into account the fact that both the UNFCCC and the Paris Agreement explicitly acknowledge the ‘specific needs and situations’ of LDCs and SIDSs and call on developed countries like the EU to support them in the implementation of their obligations. In other words, the risk that an exemption would lead to higher emissions or higher costs of adaption for LDCs and SIDSs ‘can – and arguably should – be addressed by the EU fulfilling its commitments under the UNFCCC and the Paris Agreement on providing climate finance’.80 Accordingly, should the EU finally decide not to exclude imports of LDCs (and SIDSs) from the scope of the EU CBAM, the EU would arguably need to accommodate for their specific needs by committing to contribute towards funding the decarbonisation of their industries with a view to help them to mitigate the negative impact of the CBAM on their economies.81 It can partly be done through returning

76

Ibid., p. 199. In this sense, see in particular Marín Durán (2022), p. 12. 78 European Commission (2021), CBAM Impact Assessment Report, p. 30. At the same time, it has also been argued that excluding LDCs from the application of the EU CBAM will not be critical for reducing emissions and preserving a level playing field, given the generally small volumes of the covered imports from these countries. See European Commission (2021), CBAM Impact Assessment Report, Annex 10, pp. 100–101. This is with the exception of aluminium imports from Mozambique. 79 It should be noted that the European Parliament urges the EU Commission to take into account the impact of the EU CBAM on LDCs and SIDSs, stressing that ‘Least Developed Countries and Small Island Developing States should be given special treatment in order to take account of their specificities and the potential negative impacts of the CBAM on their development’. See European Parliament Resolution towards a WTO-compatible EU carbon border adjustment mechanism of 10 March 2021, para 8. Accordingly, the European Parliament has explicitly called on the EU to support LDCs: European Parliament (2022), CBAM Position, Amendment 130 (Article 24a, para 2 (new)). 80 Espa et al. (2022), p. 22. 81 In this sense, Espa et al. (2022), p. 12; Marín Durán (2022), pp. 23–24. 77

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the CBAM revenues by transferring them to special mitigation and adaptation funds. In doing so, the EU would increase not only compliance with the Paris Agreement but also prospects for successful justification of the CBAM as a climate-motivated measure in a WTO dispute under Article XX GATT.82 In sum, the legal analysis undertaken in this section shows that, when designing the exclusion features of EU CBAM, the Commission had very little room for manoeuver within the existing WTO law and climate law constraints, especially considering that it was also faced with the limited practical feasibility of different variations of such features. As a result, the proposed scope for exclusion contains elements that can be challenged under both WTO law and climate law. In the next section, we discuss whether a cooperative approach to addressing these challenges might also be useful for decreasing tensions over the EU CBAM in general.

4 From Exclusion to Climate Clubs It follows from the above that an important element of the proposed exclusion scope for imports from the EU CBAM is cooperation with third countries on the implementation of crediting for carbon prices, including the possibility of concluding agreements on the comparison of carbon pricing mechanisms. The EU Commission suggests that such ‘[a]greements with third countries could be considered as an alternative to the application of CBAM in case they ensure a higher degree of effectiveness and ambition to achieve decarbonisation of a sector’.83 However, instead of working on approaches and modalities for excluding imports from the CBAM partially or in full, the EU could arguably put its efforts into building up coalitions of like-minded countries willing to take concrete measures to reduce emissions. International cooperation is really needed. It will better reflect the rules of the WTO and the international climate regime.84 But what is even more important, international cooperation could gradually lead to a convergence of climate policies and carbon prices, which over time will obviate the need for CBAMs. Indeed, a universal carbon price has long been recognized as the first-best solution to carbon leakage.85 Several proposals have been put forward with a view to propose how to achieve a global carbon price.86 IMF experts suggest that the most feasible way would be to start with a mandatory minimum and agree on an 82

For a thorough explanation of how this feature of the EU CBAM could help strengthen a defense under the chapeau of Article XX GATT, see Marín Durán (2022), pp. 12–14. More generally for BCAs, see Holzer (2014), pp. 236–238. 83 European Commission (2021), CBAM Proposal, pp. 2–3. 84 As already noted, Article 6 of the Paris Agreement establishes a legal framework for international cooperation on climate change based on both market and non-market mechanisms. 85 See e.g. Biermann et al. (2003); Lodefalk and Storey (2005); Dröge et al. (2009); OkonjoIweala (2021). 86 See e.g. Parry et al. (2021) and Fleming and Giles (2021).

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international carbon price floor.87 This could be made through an agreement among world’s largest emitters, including emerging market economies, such as China and India. Adopting carbon price floors for the largest emitters, which are at the same time the world’s largest economies, would influence other countries to follow suit and enable ratcheting up policy action to achieve near-term climate change mitigation targets fixed in the NDCs by 2030 as a necessary intermediary step in achieving the long-term goal of climate neutrality by 2050/2060. No unilateral CBAMs would be needed in that case. In fact, it is contended that such an option would even be more effective for emissions reductions than CBAMs, given that it would constrain emissions in the whole economy and not only in trade, where emissions embodied in products constitute less than 10% of countries’ total emissions.88 The OECD also favours convergence of carbon prices over unilateral border restrictions. In an interview, senior OECD officials suggested that an approach towards global rules on carbon restrictions aimed at convergence of national carbon prices could follow a global agreement on corporate taxation setting a minimum tax of 15% on profits of multinational enterprises.89 Whatever approach to a global carbon pricing is chosen, one thing is clear: it will take time and international cooperation to achieve it. Today, the most widely discussed form of such cooperation is a climate club. The idea of a climate club got increased attention in 2015 due to a proposal by William Nordhaus.90 Based on classical club theory,91 Professor Nordhaus proposes to create a climate club as a voluntary cooperative arrangement on the climate mitigation public good that would provide benefits for its members in return for sharing emission abatement costs and sanctions for non-members in the form of a uniform tariff, thus eliminating the incentive for free riding. In this case, the climate club idea overlaps with the idea of a CBAM that foresees crediting, except that instead of

87

Negotiations of such an agreement would focus on the minimum carbon price that each country participating in the agreement must put on its CO2 emissions based on equity considerations in line with the CBDRRC principle. Accepting differentiated minimum carbon prices based on equity considerations (the price floors could be 25, 50 and 75 dollars for poorer, middle-income and richer countries, respectively), supported by financial and technology transfer commitments of richer countries, and allowing for crediting implicit carbon pricing mechanisms, would make such an agreement possible among a smaller group of countries. See Parry et al. (2021). 88 In theory, an exemption of the agreement signatories from a CBAM might be a good motivation for other countries to join the agreement. In practice, however, the incentives for participation may be limited, as carbon embodied in traded goods is only a small share of total emissions in a domestic economy. Moreover, discussions about a CBAM are likely to complicate negotiations over establishing minimum carbon price floors. See Parry et al. (2021). 89 Fleming and Giles (2021). 90 Nordhaus (2015). Similar ideas were discussed in the context of cooperative approaches on BCAs and other climate policy measures before. See e.g. Jegou et al. (2009), Keohane and Victor (2011); Victor (2011); Holzer (2014). See also Brewer (2015), who in promoting a black carbon mitigation club assumed that participation might be incentivized by restricting the right to operate in the Arctic waters to ships meeting club standards for equipment and operation. 91 See e.g. Buchanan (1965).

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flat-rate tariffs, a carbon footprint-based CBAM would be used. In fact, the introduction of the EU CBAM with an option for crediting could create a snowball effect: this can happen if several countries introduce their own carbon pricing mechanisms in order to keep revenues (or at least part of them) for themselves instead of paying the CBAM fees through their exporters to the EU, which would then induce other countries to follow suit and therefore lead to the creation of an EU CBAM-based climate club with participants undertaking harmonized emission reductions.92 Yet, the concept of a climate club is much broader than this and can include a whole range of cooperative arrangements. For instance, Falkner et al. (2022) break down climate clubs into three types: normative, bargaining and transformational, based on the degree of legalization.93 Members of a normative climate club are likeminded countries that agree on the need to take climate action forming a coalition of the willing without concrete commitments or common rules. A bargaining climate club has the potential to unite a small group of countries that undertake concrete commitments resulting from bargaining in negotiations in a smaller group. A transformational club represents the most legalized form of a climate club similar to the Nordhaus-type. A transformational climate club creates benefits available only to members (e.g. preferential trading, access to technology and finance etc.) and disadvantages for non-compliant members (e.g. withdrawal of club benefits, expulsion etc.) and non-members that are unwilling to join (e.g. CBAMs, carbon tariffs etc.). Thus, climate clubs can be different in purpose and legal form, ranging from those resembling geopolitical alliances in the context of climate politics to plurilateral agreements promoting industrial decarbonisation and trade in low-carbon products.94 Potentially, there can be multiple climate clubs focusing on the solutions of concrete climate policy problems. As already noted, there is a clear connection between a climate club à la Nordhaus (or of transformational type) and BCAs like the EU CBAM. While a climate club is unlikely to become a substitute for unilateral BCAs,95 there is certainly a place for cooperation on unilateral CBAMs under a climate club. A climate club can even be entirely dedicated to the CBAM-related issues. Some experts even believe that the EU CBAM is today the main or even the ‘only realworld route to a possible climate club’.96 At the same time, a recent climate club proposal made by G7 is more discreet about CBAMs than the above-mentioned scholarly proposals.97 While it speaks 92

Overland and Sadaqat Huda (2022), p. 17. Falkner et al. (2022). 94 Similarly, see Mehling et al. (2022) and Mbengue and Cima (2022). 95 A climate club can hardly obviate the need for a CBAM. For this to happen, there should be no carbon leakage risk anymore. This will only be possible if participating countries achieve the same carbon price and constitute a critical mass of markets for CBAM products, which is unlikely to happen quickly. 96 Overland and Sadaqat Huda (2022), p. 17. 97 This proposal for a cooperative and open climate club was prepared by the German Ministry of Finance (https://www.bundesfinanzministerium.de/Content/DE/Downloads/Klimaschutz/ 93

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about cooperation on carbon leakage safeguards, including BCAs, it is not clear whether it means coordination of unilateral CBAMs or the use of a common CBAM against imports from non-members. The latter option would obviously require a common carbon price within the club (or an agreement on price equivalence among its members), which would arguably not be possible to achieve in the near future. Yet, it might be possible to agree on the use of a common CBAM, or rather an external tariff, if the latter is not based on a common carbon price but rather on agreed production methods (technologies) for certain products. This echoes a recently initiated arrangement between the US and the EU for duty-free trade in low-carbon steel and aluminium (‘Global Arrangement on Sustainable Steel and Aluminium’).98 Participants to such an arrangement could agree on good practices for decarbonisation of certain industrial sectors and on the ex-ante approval of external carbon tariffs based on certain principles. As in the case of a climate club à la Nordhaus, carbon tariffs imposed by countries participating in such an arrangement would create a strong incentive for other countries to join. However, this type of arrangement has little chances to pass the test on compliance with WTO rules and international climate change obligations.99 It will likely be perceived as being too aggressive and exclusive and will be rejected by the majority of countries provoking their retaliations. Therefore, in the short to medium term, a more realistic development seems to be the co-existence of a cooperative climate club dedicated to various issues of climate policy (including CBAMs) and the use of CBAMs by its members on a unilateral basis. CBAMs will function as the main carbon leakage safeguards, whereas a key task of a climate club will be to agree on common sector-based carbon standards in production.100 Other tasks of a cooperative climate club could consist of adopting rules for the use of green subsidies, facilitating technology transfer and increasing compliance with the Paris Agreement obligations, including reporting, transparency and climate finance.101 Today, the idea of a cooperative climate club can also be promoted in the premises of the WTO. The EU as the first-runner on CBAM could take the lead and use the established WTO Trade and Environmental Sustainability Structured Discussions (TESSD) as a platform for discussing concerns over its proposed CBAM.102 It should be noted that a group of 74 WTO members participating in

eckpunkte-internationaler-klimaclub.pdf?__blob=publicationFile&v=6) and presented under Germany’s G7 Presidency at the G7 meeting in June 2022: see https://www.g7germany.de/g7-en/ current-information/g7-climate-club-2058310. 98 Joint EU-US Statement on a Global Arrangement on Sustainable Steel and Aluminium (Nov. 1, 2021), https://europeansting.com/2021/11/01/joint-eu-us-statement-on-a-global-arrangementon-sustainable-steel-and-aluminium/#comments. 99 Lester (2022). 100 Sartor et al. (2022), pp. 10–11. 101 Springmann (2013). 102 It should be noted that parties have already started sharing their views on CBAMs within the TESSD dialogue. See e.g. TESSD, Communication by Japan, Proposal on Contributions to

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the TESSD dialogue initially agreed to discuss issues related to trade-related climate policy measures.103 Importantly, among such members are the world’s largest GHG emitters, including China, the US, the EU, the Russian Federation, Japan and South Korea. Over time, these discussions could grow into a plurilateral WTO agreement on the application of climate policy-related trade measures. In addition, TESSD countries could agree on the establishment of a comparability forum, where members would compare their decarbonizing policies. To make this forum a success, the WTO would need to cooperate with other international organizations (OECD, ISO, IPCC etc.) pulling their expertise to perform the difficult task of harmonizing carbon footprint methodologies and sector-specific carbon standards. If established under the WTO, which has already been recognized by a majority of its members as having ‘jurisdiction’ over trade-related aspects of climate policy, such a forum would possibly be more effective than the existing UNFCCC Forum on the impact of the implementation of response measures, which has not yet become a platform for discussing BCAs. However, the main purpose of such a WTO forum would be diffusing trade tensions and preventing trade disputes. The experience of raising and discussing specific trade concerns at the WTO TBT Committee shows that this mission is possible.104 This opportunity should not be missed.

5 Concluding Remarks This article has analysed the trade and climate law constraints applicable to border carbon adjustments, and to the EU CBAM more specifically, with particular respect to built-in exclusion features, that is, those features that aim at excluding imports of covered products, either partially or in full, from the scope of application of the measure. From the perspective of WTO law, the analysis has shown that, despite the Commission’s declared intention to align the CBAM to a climate-informed equalization logic, it remains (at the very least) uncertain whether its current design would be sufficient to make it compatible with the basic WTO rules on non-discrimination (MFN and national treatment), whereas the most likely scenario entails that the EU will seek justification under the GATT general exceptions clause. In this respect, this article has found that the exclusion features of the EU CBAM may not be calibrated enough to ensure compliance with the requirements of the chapeau of Article XX GATT, namely because of two main factors: (1) with regards to full exclusion, the lack of an exemption clause for LDCs (and SIDSs), or, alternatively,

Achieving Global Carbon Neutrality at the WTO, 23 March 2021, INF/TE/SSD/W/10, pointing out the need to discuss ‘how carbon border adjustment measures should be formulated based on the GATT principles’. 103 WTO Ministerial statement on trade and environmental sustainability, WT/MIN(21)/6/Rev.2, WTO, 14 December 2021, para 2. 104 Holzer (2019).

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provisions on the reallocation of CBAM revenues to support decarbonization efforts in such countries; (2) with regards to partial exclusion, the granting of a CBAM discount only to imports coming from countries engaged in explicit carbon pricing mechanisms. Importantly, this article has shown that, while the EU CBAM (and BCAs more generally) are unlikely to simultaneously meet both types of WTO non-discrimination requirements (that is, the basic rule of non-discrimination as per Articles I and III GATT and the non-discrimination requirement within the meaning of Article XX GATT exceptions), those exclusion features that better align the measure with the conditions of the chapeau also reinforce its compatibility with the CBDRRC principle enshrined in the UNFCCC and the Paris Agreement. Also in this vein, this article has explored the potential of carbon club approaches to increase compatibility prospects and found that, even if a transformational climate club à la Nordhaus is likely to run counter to the spirit of Article XX GATT, there is high value in building up cooperative approaches incrementally in order to address critical issues such as comparability across climate policies, harmonization of carbon footprint calculation methodologies and sector-specific production methods.

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Ilaria Espa is Senior Assistant Professor of International Economic Law at USI and a Senior Research Fellow at the World Trade Institute (WTI) in Bern. She is furthermore Lead Counsel of the ‘Natural Resources’ Programme of the Centre for International Sustainable Development Law (CISDL) and Adjunct Professor at the Law Faculty of the Catholic University of the Sacred Heart and at the Department of Environmental Science and Policy of the University of Milan. Ilaria holds a PhD in International Law and Economics from the Department of Legal Studies of Bocconi University and she was awarded a Marie Curie fellowship from the European Commission for her post-doctoral studies. A member of the IUCN World Commission on Environmental Law and of the Executive Council of the Society of International Economic Law (SIEL), she has published extensively on issues at the intersection of trade and sustainability, mainly in the areas of climate change, energy and commodities. Kateryna Holzer is Senior Researcher with the Centre for Climate Change, Energy, and Environmental Law (CCEEL) at the University of Eastern Finland Law School, where she leads a project on regulatory cooperation on carbon standards and a course on international economic law and green transitions. Holding a PhD in Law from the University of Bern and a PhD in Economics from Ukraine, she has many years of experience in climate change and energy research, teaching and consultancy, with a focus on trade rules and measures supporting sustainable development.

Environmental and Sustainability Aspects in EU Competition Law: Towards a “More Economic & Ecological Approach” Under Article 101 TFEU? Bernadette Zelger

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Environmental Considerations and Sustainability Aspects: The Treaties, Competition Law Objectives and the Green Deal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 The Treaties and Competition Law Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The European Union Going “Green”: The EU Green Deal . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Environmental Considerations and Sustainability Aspects Under Article 101 TFEU . . . . . 3.1 Article 101 TFEU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 The Different Routes to Consider Environmental and Sustainability Aspects Under Article 101 TFEU in the Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 The Four Categories to Consider Environmental and Sustainability Aspects Under Article 101 TFEU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract Since the European Commission announced its Green Deal in 2019, the debate as regards how European Union (EU) competition law could contribute to making Europe climate-neutral and “green(er)” has steadily increased. However, the discussion about whether aspects other than economic ones shall be considered within the assessment of a measure from a competition law perspective has indeed been going on much longer. Following the European Court of Justice’s (ECJ) landmark judgement in Wouters, for example, there is a strand in the case law where non-economic considerations were taken account of already at the level of Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) itself. The debate on how to interpret Article 101(3) TFEU and the question whether The views expressed in this article do not reflect those of any institution with which I am affiliated, and I have no personal interest or involvement in any of the cases that are reviewed in this article. B. Zelger (✉) University of Innsbruck, Department for European and Public International Law, Innsbruck, Austria e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 411–442, https://doi.org/10.1007/8165_2022_97, Published online: 23 December 2022

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improvements in economic efficiency shall be considered only or whether Article 101(3) TFEU is to be interpreted broadly and in line with the wider EU aims and objectives, such as, for example, social, environmental or sustainability aspects, serves as another example to this effect. Against this backdrop, this article shall provide an analysis of the Treaty competition provision of Article 101, and shed light on the question if, to what extent and on which legal basis environmental considerations and sustainability aspects, can be taken account of within the current competition law framework of the European Union. Hence, light shall be shed on the question whether our competition law toolkit is “fit and proper” to meet the challenges as imposed by climate change.

1 Introduction The competition provisions, i.e. Article 101 and 102 TFEU, lie at the heart of the European integration project and the aim to create an internal market. Hence, they act as corresponding rules to those related to the fundamental freedoms of the European Union, namely the free movement of goods, persons, services and capital. Both sets of provisions are seen as cornerstones for the promotion and creation of the European Single Market by eliminating nation-state barriers as well as obstacles created by private undertakings. Moreover, since the European Commission (Commission or EC) announced its Green Deal1 in 2019, the debate as regards how EU competition law could contribute to making Europe climate-neutral and “green(er)” has steadily increased.2 However, the discussion about whether aspects other than economic ones shall be considered within the assessment of a measure from a competition law perspective has indeed been going on much longer.3 Take for example the debate as regards Article 101 (3) TFEU and the question whether improvements in economic efficiency shall be considered under the latter provision only or whether Article 101(3) TFEU is to be interpreted broadly and in line with the wider EU aims and objectives, such as, for example, social, environmental or sustainability aspects.4 Moreover, considering the European Court of Justice’s (ECJ or Court) decision in Wouters5 and subsequent

Communication from the Commission, The European Green Deal, COM(2019) 640 final. Gassler (2021), p. 431. 3 Take for example the debate as regards Article 101(3) TFEU and the question whether improvements in economic efficiency shall be considered under the latter provision mentioned only or whether Article 101(3) is to be interpreted broadly in line with the wider EU aims and objectives. See Gerbrandy (2019), p. 129; Jones et al. (2019), pp. 265 et seq.; Whish and Bailey (2021), pp. 161 et seq.; Petit (2009); Schweitzer (2007); Komninos (2005); Semmelmann (2008a, b). 4 Jones et al. (2019), pp. 265 et seq.; Whish and Bailey (2021), pp. 161 et seq. 5 Case C-309/99 Wouters and Others, ECLI:EU:C:2002:98. 1 2

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cases, such as Meca-Medina,6 OTOC,7 Italian Geologists8 or API,9 this line in the case law provides another example where non-economic considerations were taken account of already at the level of Article 101(1) TFEU itself.10 Against this backdrop, the following shall provide an analysis of Article 101 TFEU and shed light on the question if, to what extent and on which legal basis environmental considerations, such as, for example sustainability aspects, can be considered within the current legal framework of the EU competition provision of Article 101 TFEU. Hence, light shall be shed on the question whether our competition law toolkit is “fit and proper” to meet the challenges as imposed by climate change. It will be argued that while the law provides for a framework flexible enough to adapt accordingly, it is our approach to it and thus the commitment to apply Article 101 TFEU not only in a more economic, but also more ecological manner that needs to be implemented. Therefore, Sect. 2 will give an overview of the EU Treaties objectives as well as of the goals, competition law is aiming to achieve. It will be argued and shown that EU competition law, from a normative perspective, has never and still is not blind to non-economic considerations. Against this backdrop Sect. 3 will provide a short overview of the EU competition law framework and shed light on the possible levels on which one could take into account environmental aspects in the competition law assessment under Article 101 TFEU. Section 4 shall provide a short conclusion and summary of the central findings.

2 Environmental Considerations and Sustainability Aspects: The Treaties, Competition Law Objectives and the Green Deal 2.1

The Treaties and Competition Law Objectives

The European Union integration project, built on its internal market and “a system ensuring that competition is not distorted”11 has ever since pursued economic objectives. Undoubtedly though the European Union is more than an economic community. As becomes evident considering Article 3 of the Treaty on the

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Case C-519/04 P Meca-Medina, ECLI:EU:C:2006:492. Case C-1/12 Ordem dos Técnicos Oficias de Contas, ECLI:EU:C:2013:127. 8 Case C-136/12 Consiglio nazionale dei geologi and Autorità garante della concorrenza del mercato, ECLI:EU:C:2013:489. 9 Joined Cases C-184/13 to C-187/13, C-194/13, C-195/13 and C-208/13 API and Others, ECLI: EU:C:2014:2147. 10 Kingston (2009), p. 168. 11 Consolidated version of the Treaty on European Union Protocol (No 27) on the internal market and competition, OJ 2008 C115/309. 7

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European Union (TEU), it aims to strive further objectives, notwithstanding the fact, however, that an “ever closer Union”12 has ever since been fostered by market integration via a system based on competition,13 and thus with a clear focus on economic means.14 Hence, looking at the objectives of European competition law, some have called them “an unresolved puzzle”.15 However, in order to interpret rules coherently, a clear understanding of a rule’s purpose and its objectives is essential.16 Therefore, as rightly noted by Witt while [a]t first sight, attempting to capture the objective of EU antitrust law may appear like little more than a philosophical exercise without practical relevance. That, however, is not the case.17

Most recently, with an extensive analysis (of almost 4000 sources18) of the literature and the decisional practice of the EU institutions, Stylianou and Iacovides19 have identified seven “overarching”20 or “key”21 goals and purposes of EU competition law: efficiency, welfare, commercial or economic freedom and freedom to compete, fairness, European integration and the protection of the competitive process. Moreover, as particularly the early decisional practice of the EU institutions proves,22 also other aspects, such as for example social,23 environmental24 and employment25 considerations might play a role in the application of competition

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Referred to in both of the EU Treaties’ preambles. Ruffert (2022), para. 25; Pennings (2019), p. 2; Luczak (2009), p. 162; Joerges and Rödl (2004), p. 3. 14 Monti (2002), p. 1062. 15 Van den Bergh (2016), p. 15. 16 Witt (2016), p. 77. 17 Witt (2016), p. 77. 18 Stylianou and Iacovides (2022), p. 4. 19 Stylianou and Iacovides (2022). 20 Stylianou and Iacovides (2022), p. 10. 21 Stylianou and Iacovides (2022), p. 11. 22 For example: as regards environmental considerations see Commission Decision in COMP/ 36.718 CECED, OJ 1999 L187/47, para. 35; Case COMP.F.1/37.893 CECED II, OJ 2001 C250/ 4; Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. As regards employment being a relevant factor see Case 26/76 Metro v. Commission, ECLI:EU:C:1977:167, para. 43; Case 42/84 Remia BV and others v. Commission, ECLI:EU:C:1985:327, para. 42. Taking account of social benefits see Commission Decision in COMP/30.810 Synthetic fibres, OJ 1984 L207/17. 23 Commission Decision in COMP/30.810 Synthetic fibres, OJ 1984 L207/17. 24 Commission Decision in COMP/36.718 CECED, OJ 1999 L187/47, para. 35; Case COMP.F.1/ 37.893 CECED II, OJ 2001 C250/4; Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. 25 Case 26/76 Metro v. Commission, ECLI:EU:C:1977:167, para. 43. 13

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law. Moreover, competition law also underpins more fundamental values such as individual freedom, equality of opportunity and democracy.26 In light of the above, following Stylianou and Iacovides [i]n all, it is evident that there is both great variety and wide disagreement of views on the proper or actual goal of competition law [in the literature].27

However, their empirical results prove that competition law is not monothematic or concerned with one main goal only.28 Rather, it becomes apparent from the analysis of the institutional practice that, while fluctuating as regards their significance, all seven of the “key” goals have persistently been present from the 1960s until today.29 Moreover, looking at the EU Treaties and their constitutional provisions,30 Article 3 TEU mentions “sustainable development of Europe”31 alongside with “a high level of protection and improvement of the quality of the environment”32 as well as “sustainable development of the earth”.33 In addition, Article 11 TFEU explicitly emphasizes that [e]nvironmental protection requirements must be integrated into the definition and implementation of the Union’s policies and activities, in particular with a view to promoting sustainable development. (emphasis added)

Furthermore, also the Charter of Fundamental Rights of the European Union (CFR) stresses in its Article 37 that [a] high level of environmental protection and the improvement of the quality of the environment must be integrated into the policies of the Union and ensured in accordance with the principle of sustainable development. (emphasis added)

Therefore, the wording of the provisions clearly stipulates that environmental and sustainability aspects are not only to be considered but rather “integrated” into the EU’s policies and activities.34 Above all Article 7 TFEU stipulates that in order to ensure consistency between its policies and activities, the European Union shall take into account all of its goals. Hence, the Treaty provisions must be interpreted in light of the objectives of the EU Treaties.35 In other words, as legitimately asked by Holmes,

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The list is influenced by the following authors: Ezrachi A, EU Competition Law Goals and the Digital Economy. Oxford Legal Studies Research Paper No. 17/2018, https://doi.org/10.2139/ssrn. 3191766; Van den Bergh (2016), pp. 16 and 19, Witt (2016), pp. 80 and 83. 27 Stylianou and Iacovides (2022), p. 12. 28 Stylianou and Iacovides (2022), p. 18; arguing similarly Gerbrandy (2017), pp. 548 and 560. 29 Stylianou and Iacovides (2022), p. 17. 30 Holmes (2020), p. 359. 31 Article 3(3) TEU. 32 Article 3(3) TEU. 33 Article 3(5) TEU. 34 Arguing similarly Holmes (2020), pp. 359 et seq. 35 Middelschulte (2020), p. 7.

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[w]here does it say ‘except when implementing the Union’s Policies on competition’?36

Hence, the EU Treaties are not blind to considerations other than economic ones, such as social as well as ecological and sustainability aspects and arguments. A fact that is, arguably, also echoed in the fact that the aim of the EU has never been to establish a purely liberal market economy, but however, as emphasised since the Treaty of Lisbon explicitly in Art 3(3) TEU, a social market economy. It follows that competition provisions do not only serve economic, but also non-economic goals.37 This seems inherent to the nature of competition law serving, from a normative perspective, the broader picture and idea of a liberal democracy. However, as carved out by Iacovidis and Vettros,38 much of the recent debate about competition law goals and non-economic considerations to this effect might stem from the development towards a “more economic approach” to which the Commission has committed itself in the late 1990s.39 By means of the latter, the Commission narrowed down its arguably “initially broad and holistic position”,40 which allowed it, for example, to consider industrial, social and environmental policy concerns in its assessment under Article 101(3) TFEU,41 towards an application of the competition provisions predominantly focusing on consumer welfare and market integration.42 Back in the days, these developments were very much appreciated as the “formalistic” manner in which competition law had been applied until then was revised and replaced by the introduction of a more economic or effects-based approach aiming to apply the law based on sound economic principles and thus to warrant adequacy with respect to competition law assessment.43 Hence, the “narrowing down” of the objectives of competition law and a primary focus on consumer welfare and market integration put emphasis on the latter, thereby making economic thinking serving as the “lowest common denominator”44 aiming for a constant benchmark which may provide a stabilizing effect and a focal point for antitrust enforcement.45

In other words, the more economic approach was all about providing more clarity and predictability in the competition law assessment.46 However, such primary focus

36

Holmes (2020), p. 361. Arguing similarly: Baarsma and Rosenboom (2015), p. 403. 38 Iacovidis and Vettros (2021), p. 97. 39 White Paper on Modernisation of the Rules Implementing Article 85 and 86 of the EC Treaty, OJ 1999 C132/1. 40 Witt (2016), p. 77. 41 Gerbrandy (2017), p. 547. 42 Witt (2016), pp. 77 and 109. 43 Zelger (2022a), p. 22. 44 Zelger (2022a), p. 22. 45 Ezrachi (2017), p. 59. 46 Gerbrandy (2017), p. 544. 37

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on consumer welfare and market integration must not lead to a situation where all other goals and objectives of competition law, namely, all political, social, moral, cultural and other fundamental values of a modern, liberal democracy, that is, all goals not exclusively economic in nature, are entirely left aside when addressing questions relating to the application of the competition law provisions.47 Furthermore, one could also doubt that the Commission’s approach and narrow interpretation focusing on the consumer welfare standard has indeed been embraced by the case law of the EU courts.48 Moreover, as identified and claimed by Iacovidis and Vettros the evolution of the more economic approach goes hand-in-hand with an ideology (neoliberal, laissez-faire, trickle-down economics) and a model of competition, between companies just as among states, that was prevalent at that time.49

Hence, in this author’s, view pure liberalism as an ideology has proven to be shortsighted as an understanding of competition as a means to serve as universal solution for each and every problem a society might face is just too simplistic. As illustrated by Stucke and Ezrachi, competition can at one point become “toxic” and thus turn into something that negatively affects not only product quality but also the functioning of our society as such.50 Moreover, the liberal idea is blind to fundamental problems a society might face, such as, for example ecological as well as social51 ones. Therefore, as our current times are marked by various crisis and enormous challenges, is it not time to refine our approach and bring it in line with what we consider absolutely vital today? Provocatively speaking, is climate change and the threat of global warming not convincing enough to adapt or complement our more economic approach and make competition law assessment subject to a more economic and ecological approach? This is where current crisis and the EU’s ambitious project to further a “green revolution”, i.e. the EU Green Deal, comes into play.

2.2

The European Union Going “Green”: The EU Green Deal

The world in the twenty-first century is facing tremendous challenges. Take for example, the war in Ukraine, the Covid-19 pandemic and its aftermath, challenges related to the so-called “digital revolution” as well as to global warming and thus climate change. With respect to the latter, the European Union has decided to act and

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Zelger (2022a), p. 53; Monti and Mulder (2017), p. 650. Gerbrandy (2017), p. 548; Monti and Mulder (2017), pp. 648 et seq., in particular p. 650. 49 Iacovidis and Vettros (2021), p. 99. 50 Stucke and Ezrachi (2020); For a short overview see the following book review: Bernadette Zelger, WuW 2021, 30. 51 Röpke (1942), p. 6. 48

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adopted a regulation, i.e. the so-called “European Climate Law”,52 thereby writing into law the ambitious goals as set by the European Commission in its “European Green Deal”.53 By means of the latter, the European Union is determined to ambitious undertakings as regards a reduction of net greenhouse gas emissions by at least 55% (compared to the levels in 1990) by 2030.54 The aim of this is to make the EU the first climate neutral continent.55 Moreover, according to the Commission, the Green Deal is not only a means to reduce net greenhouse gas emission. Rather, it shall transform the EU economy and society in a certain way and thus be seen as an opportunity to build a new economic model.56

In light of the above it seems apparent, that the EU Green Deal has an impact on various different policy fields.57 Hence, it seems quite obvious that also EU Competition Law does not remain unaffected. Therefore, the ambitions of the Commission to combat climate change also have an impact on various adaptions and revisions of EU secondary laws. Take for example the new Guidelines on State aid for climate, environmental protection and energy 2022,58 the new Vertical Guidelines 202259 as well as the Draft Horizontal Guidelines 2022.60 Moreover, given the opportunity the EU Green Deal offers in order to shape and create a “new economic model”, one would, arguably intuitively, expect the application of the

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Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021 establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (‘European Climate Law’), OJ 2021 L243/1. 53 Communication from the Commission, The European Green Deal, COM(2019) 640 final. 54 Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021 establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (‘European Climate Law’), OJ 2021 L 243/1, recital 26; European Commission Press Release, IP/21/3541 (14 July 2021). 55 Regulation (EU) 2021/1119 of the European Parliament and of the Council of 30 June 2021 establishing the framework for achieving climate neutrality and amending Regulations (EC) No 401/2009 and (EU) 2018/1999 (‘European Climate Law’), OJ 2021 L 243/1, recital 25. 56 European Commission, European Green Deal—Delivering on our own targets (Factsheet 14 July 2021), https://ec.europa.eu/commission/presscorner/detail/en/fs_21_3688, p. 4. 57 For example, climate, energy, transport and taxation policies, where the Commission has adopted a set of concrete proposals to make the latter “fit and proper” to meet the goals and ambitions set out in the EU Green Deal; see https://ec.europa.eu/info/strategy/priorities-2019-2024/european-greendeal/delivering-european-green-deal_en. 58 Communication from the Commission—Guidelines on State aid for climate, environmental protection and energy 2022, OJ 2022 C80/1. For an overview of what is new, see: Zelger (2022b). 59 European Commission, Guidelines on Vertical Restraints, C(2020) 3006, para. 8, 9, 144 and 316. 60 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en and in particular section 9 on “Sustainability Agreements”.

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primary law EU competition provisions going “radically”61 green. This is, however, not the case,62 as according to Commissioner Vestager [c]ompetition policy is not, and it cannot be, in the lead when it comes to making Europe green.63

Moreover, also further statements of the Commissioner clearly give the impression that in the context of the green revolution needed to combat climate change, competition law shall play a supportive role only, by making sure “that we’re doing what we can to help”64 while “[g]reen policies like regulations, taxes, and investment are the key to the Green Deal.”65 Such an approach seems controversial as it is somehow contradictory to shape a sustainable EU economy and thus build this new economic model undoubtedly based on competition while, at the same time, neglecting that EU competition law could or should take over any central role in this respect. Provocatively speaking: How can we build or shape our economy based on a competitive system with the aim to make it “greener” without competition law being one of the key players?66 Notwithstanding the fact that other policy areas may for sure have a huge impact on implementing and fostering the achievement of the goals as set out in the Green Deal, such as, most obviously,67 regulation, the role of EU competition law to this effect should not be belittled, regardless of the fact that it might be only a small part of a very big picture.68

With that in mind, the following section shall provide an analysis of how environmental and sustainability considerations and aspects can and should be taken account of within the current legal framework of Article 101 TFEU. It will be argued that the latter’s assessment framework provides for an adequate toolkit to do so,

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Gassler (2021), p. 430. Gassler (2021), p. 430. 63 Vestager M, The Green Deal and competition policy. Renew Webinar, 22 September 2020, https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/green-dealand-competition-policy_en. 64 Vestager M, Competition policy in support of the Green Deal. Keynote speech at the 25th IBA Competition Conference, delivered by Inge Bernaerts, Director, DG Competition, 10 September 2021, https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/compe tition-policy-support-green-deal_en. 65 Vestager M, Competition policy in support of the Green Deal. Keynote speech at the 25th IBA Competition Conference, delivered by Inge Bernaerts, Director, DG Competition, 10 September 2021, https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/compe tition-policy-support-green-deal_en. 66 Also see Gerbrandy (2017), p. 544 stressing that pointing out the sustainability deficit is “at least also a problem of competition law to solve”. 67 Holmes (2020), p. 355. 68 Holmes (2020), p. 355. 62

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notwithstanding the fact that there is for sure a need to adapt or reinterpret existing doctrines.69 Hence, as Holmes puts it: It’s not the law that needs to change but our approach to it.70

3 Environmental Considerations and Sustainability Aspects Under Article 101 TFEU 3.1

Article 101 TFEU

Article 101(1) TFEU prohibits agreements, decisions by associations of undertakings and concerted practices, which may affect trade between Member States and have as their object or effect the prevention, restriction or distortion of competition within the internal market. Moreover, Article 101(3) TFEU provides the legal basis for an exemption of a measure qualifying as object or effect infringement of competition pursuant to Article 101(1) TFEU, given two positive and two negative requirements are met.71 Hence, agreements which – contribute to improving the production or distribution of goods or to promoting technical or economic progress, – while allowing consumers a fair share of the resulting benefit, and furthermore – do not impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives, and – do not afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question meet the requirements as set out in Article 101(3) TFEU. For that reason, they are deemed lawful and thus do not infringe Article 101(1) TFEU.

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Gerbrandy (2017), p. 559. Holmes (2020), p. 355. 71 Whish and Bailey (2018), p. 157. 70

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The Different Routes to Consider Environmental and Sustainability Aspects Under Article 101 TFEU in the Literature

As identified in the literature,72 with respect to Article 101 TFEU, there are various ways how environmental and sustainability aspects could have an impact on the assessment of a measure from a competition law perspective. Besides, different authors have different preferences (see Table 1): While Holmes considers five, overlapping ways in which measures potentially caught by Article 101 TFEU might escape from the latter,73 Gassler identifies four possible routes where sustainability aspects could be taken account of in the competition law assessment.74 Moreover, Gerbrandy identifies three rather broad categories where she offers a variety of different arguments to solve, as she calls it, the “sustainability deficit”75 of the current assessment framework for Article 101 TFEU. Monti and Mulder, however, describe four “avenues” within the case law of the EU courts that would be available for public and private sustainability initiatives to escape Article 101 (1) TFEU.76 Last but not least, Nowag,77 in his extensive analysis of environmental integration in competition and free-movement laws, identifies two main forms of environmental integration, that is, supportive and preventive integration, and basically provides for a matrix structure that can be used to solve the “sustainability gap” in the competition law context. From a substantive perspective, the various different categories recognised are to a large extent congruent, but however grouped and framed differently by the authors. However, the differences as regards the respective classifications have their roots in the distinct angles and perspectives as taken by the authors. On the one hand Holmes approaches the issue guided by the general question of how competition law can support vital sustainability78 and thus, within its list of potential escape routes for measures from Article 101(1) TFEU, he also considers secondary law measures and thus the possibility of an increased use and more generous treatment of standardisation agreements as a separate category.79

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Gassler (2021), pp. 432 et seq.; Holmes (2020), p. 368; Nowag (2019), pp. 4 et seq.; Gerbrandy (2017), pp. 553 et seq.; Monti and Mulder (2017), p. 644; Nowag (2016). Moreover, also see: Van den Brink and Ellison (2021), p. 40; however, the latter authors focus their analysis mainly on Article 101(3) TFEU. 73 Holmes (2020), p. 368. 74 Gassler (2021), pp. 432 et seq. 75 Gerbrandy (2017), pp. 545 et seq. 76 Monti and Mulder (2017), p. 644. 77 Nowag (2016). For an overview of the matrix structure and main line of arguments: Nowag (2019), pp. 4 et seq. 78 Holmes (2020), p. 368. 79 Holmes (2020), pp. 382 et seq.

Nowag – Supportive integration (shield = interpretation in order to allow sustainability measures) 1. Questions of scope— competition provisions are not applicable due to: a lack of an undertaking, the state action defence, an assessment of the effect on competition (with further sub-categories, e.g. standardisation agreements, de minimis) 2. Balancing (where a restriction by object or effect between undertakings has been established): Wouters, Article 101(3), 106(2) TFEU. – Preventative integration (sword = interpretation in order to prevent measures harming sustainability)

Monti, Mulder - No restriction of competition under Article 101 - No application of Article 101(1) TFEU (Wouters and the subsequent respective case law) - Exception according to Article 101(3) TFEU - State-supported initiatives (State Action doctrine and procedural defence, i.e. Article 4(3) TFEU in conjunction with Article 101 TFEU)

Gerbrandy - Exception according to Article 101(3) TFEU - Agreements falling outside the scope of Article 101 (1) TFEU (ancillary restraints, Wouters, solidarity, “useful effect doctrine”, i.e. the case law shedding light on the interplay of Article 4(3) TFEU in conjunction with Article 101 TFEU) - Revisiting the fundamentals of competition law

Holmes - Sustainability agreements unlikely to restrict competition at all (Horizontal Guidelines 2001) - The Albany route claiming sustainability agreements fall outside Article 101(1) TFEU altogether - The ancillary restraints/ objective necessity doctrine route - Exception according Article 101(3) TFEU - More use and more generous treatment of standardisation agreements

Gassler - Sustainability agreements outside the scope of Article 101(1) TFEU (lack of an economic activity and thus undertaking, Albany) - Non-application of Article 101(1) TFEU (ancillary restraints) - No restriction of competition (Horizontal Guidelines 2001) - Exception according Article 101(3) TFEU

Table 1 As Van den Brink and Ellison (2021) put great emphasis on Article 101(3) TFEU only, the latter are not included in this table. Moreover, from a substantive perspective, their further categories identified are in any case covered by the possible routes illustrated in this table

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Gassler on the other hand also discusses the need for more safe harbours and even advocates for a sustainability block exemption regulation.80 However, he does not include this discussion within its proposed list of routes to take account of sustainability aspects within the assessment framework of Article 101(1) TFEU. Rather, his list is guided mainly by assessment routes offered by Article 101(1) TFEU as such and thus primary law, despite the fact that he nevertheless also mentions the Commission Horizontal Guidelines 2001 in the context of his category three (no restriction of competition). Moreover, under category one Gassler also outlines those cases where the competition provisions are not to be applied due to the lack of an economic activity as necessary precondition to be qualified as undertaking. The issue in this regard surrounds the question whether an activity is to be qualified as economic thereby making an entity qualify as undertaking according to Article 101 and 102 TFEU and thus triggering the application of the Treaty competition provisions, or whether an activity rather falls within the ambit of so-called public services (i.e. the exercise of public powers, the provision of social or health services or services related to education),81 where an application of the Treaty rules of competition does not seem justified.82,83 Gerbrandy, however, focuses her analysis on primary law and thus sheds light on solutions for the, as she calls it, “sustainability deficit”84 based on a wide interpretation of Article 101(3) TFEU85 as well as solutions located at the level of Article 101 (1) TFEU.86 Arguments in the context of the latter stem from the ancillary restraints doctrine,87 the reasoning of the ECJ’s decision in Wouters88 as well as solidarity considerations,89 which surround the above illustrated notion of an undertaking and the lack of a qualification as the latter, given an entity pursues an activity that does not qualify as economic but rather falls within the scope of public services. Moreover, she also identifies the interplay of Article 101 TFEU and Article 4(3) TFEU (duty of sincere cooperation) and the respective case law90 as a possible route to let sustainability or environment-enhancing agreements escape from the competition 80

Gassler (2021), pp. 440 et seq. Sauter (2015), pp. 56 et seq. 82 For example, Case C-49/07 MOTOE, ECLI:EU:C:2008:376, para. 24. 83 On the notion of an undertaking in general see: Odudu (2005) as well as the elaborations of AG Jacobs in its Opinion in Case C-67/96 Albany, ECLI:EU:C:1999:430: Opinion of AG Jacobs in Cases C-67/96 Albany, ECLI:EU:C:1999:28, para. 205 et seq. On public services in EU law as well as on public and private spheres in EU law and their meaning in the context of the notion of an undertaking in EU Competition law see: Sauter (2015); Sauter and Schepel (2009); Monti (2002). 84 Gerbrandy (2017), p. 539. 85 Gerbrandy (2017), pp. 545 et seq. 86 Gerbrandy (2017), pp. 553 et seq. 87 Gerbrandy (2017), pp. 554 et seq. 88 Gerbrandy (2017), pp. 555 et seq. 89 Gerbrandy (2017), pp. 556 et seq. 90 In particular the so-called INNO doctrine: Case 13/77 INNO v. ATAB, ECLI:EU:C:1977:185 and subsequent case law. 81

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provisions.91 Gerbrandy labels this argument as “useful effect doctrine”.92 The latter case law concerned to this effect basically warrants that the competition provisions are not undermined by the Member States by means of regulation or the law. Put differently, a Member State can be held responsible for a breach of the duty of sincere cooperation pursuant to Article 4(3) TFEU in conjunction with Article 101 TFEU if a state measure is to require or favour the adoption of agreements, decisions or concerted practices contrary to Article [101] or to reinforce their effects, or to deprive its own legislation of its official character by delegating to private traders responsibility for taking decisions affecting the economic sphere.93

The aim of this case law is to hold responsible (1) the State for an infringement of the competition provisions, given it requires an undertaking to enter into an anticompetitive agreement, or (2) the State and the respective undertaking engaged in an anticompetitive practice together, given the State merely encourages the undertaking’s anticompetitive conduct.94 Therefore, as this strand in the case law serves as defence for undertakings allegedly infringing Article 101(1) TFEU, it is also known as “state action defence” or “state action defence doctrine”.95 Moreover, Gerbrandy also emphasises the need to revise the fundamentals of competition law and thus the commitment to reinterpret existing doctrines in order to fit sustainability concerns into the competition law assessment framework,96 a topic which is also considered by some of the other authors in their elaborations on values, goals and objectives of competition law.97 Furthermore, Monti and Mulder, identify four “avenues” within the case law of the EU courts that would be available for sustainability initiatives to escape the competition provision of Article 101 TFEU.98 Their categories can broadly be divided into two groups. First, there are ways to let private sustainability initiatives escape from Article 101 TFEU, that is, (1) no infringement of Article 101(1) TFEU due to a lack of anticompetitive effects, (2) the Wouters line of the case law, and (3) exceptions according to Article 101(3) TFEU.99 Second, they identify “statesupported sustainability initiatives”100 which can be defined by means of the “state action defence doctrine”,101 that is, the line in the case law shedding light on the interplay of Article 101 (and 102) TFEU with 4(3) TFEU, potentially providing a Gerbrandy labels this reasoning as the “useful effect doctrine”: Gerbrandy (2017), pp. 558 et seq. Gerbrandy (2017), p. 558. 93 Case C-267/86 Van Eycke/Aspa, ECLI:EU:C:1988:427, para. 16. 94 Monti and Mulder (2017), p. 651. 95 see de la Torre (2005). 96 Gerbrandy (2017), pp. 559 et seq. 97 Holmes (2020), pp. 359 et seq.; Monti and Mulder (2017), p. 649. 98 Monti and Mulder (2017), p. 644. 99 Monti and Mulder (2017), p. 644. 100 Monti and Mulder (2017), p. 651. 101 Also known as State Action Defence or State Action Defence Doctrine; see de la Torre (2005). 91 92

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suitable tool to escape the competition provisions by means of procedural defence.102 As already mentioned, this argument has been raised by Gerbrandy and labelled as “useful effect doctrine”103 to a similar extent.104 Finally, Nowag, with his extensive analysis of environmental integration in competition and free-movement laws, identifies two main forms of environmental integration, that is, supportive and preventive integration. Under these headings he basically provides for a matrix structure that can be used to solve the “sustainability gap” in the competition law context which mainly covers all the routes as illustrated in the preceding paragraphs.105

3.3 3.3.1

The Four Categories to Consider Environmental and Sustainability Aspects Under Article 101 TFEU General Remarks

In light of the above, for the analysis hereinafter, the following classifications shall be used. As a preliminary comment, it is worth emphasising that the subsequent examination is guided by the question whether, to what extent and on which legal basis environmental considerations and sustainability aspects can be taken account of within the current assessment framework of Article 101 TFEU. Hence, the categories scrutinised in the following clearly focus on primary law and the respective relevant case law of the EU courts. Hence, it is aimed to outline and discuss the various levels with respect to Article 101 TFEU by means of which one could take account of environmental and sustainability aspects and considerations, that is at the level of Article 101(1) TFEU itself as well as Article 101(3) TFEU. Secondary law and thus how the Commission reads and interprets the aforementioned provisions shall be considered where appropriate, however, this article will not provide a separate category to shed light on the Commission’s view. Moreover, it is presumed that the competition provisions are, in principle, potentially applicable and not fostered or supported by any state measure. This means, first, that it is presupposed that there is an entity engaged in an economic activity and thus that it qualifies as undertaking. Put differently, cases where the competition provisions shall not apply due to the lack of an entity being engaged in economic activity and thus due to a lack of qualification as undertaking are not the focus dealt with in the subsequent sections. Second, the case law excluding

102

Monti and Mulder (2017), p. 651. Gerbrandy (2017), p. 558. 104 Gerbrandy (2017), pp. 558 et seq. 105 Nowag (2016). For an overview of the matrix structure and main line of arguments: Nowag (2019), pp. 4 et seq. 103

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agreements from the ambit of the competition provisions based on the interplay of Article 101 TFEU and the duty of sincere cooperation according to Article 4 (3) TFEU is also not within the scope of this article, as both of the latter “escapescenarios” do not provide a direct answer to the guiding question whether, to what extent and on which legal basis environmental considerations and sustainability aspects can be taken account of when conducting an assessment under Article 101 TFEU. Having said this, possible routes under primary law provide (1) agreements that are not by object restrictions of competition but also lack an appreciable effect on competition, (2) agreements falling outside Article 101(1) TFEU due to their effects being ancillary to achieve a legitimate aim (the “ancillary regulatory restraints route”), (3) agreements falling outside Article 101(1) TFEU due to reasoning of the ECJ in Albany and (4) agreements meeting the criteria of Article 101(3) TFEU and thus not constituting a breach of Article 101(1) TFEU.

3.3.2

Agreements that Are Not by Object Restrictions of Competition but Lack an Appreciable Effect on Competition

The first argument lies at the heart of the differentiation of “by object” and “by effect” infringements of competition. Object restrictions are per definitionem inherently detrimental, harmful to competition by their very nature and unambiguous from a competition law perspective.106 Hence, it is inherent to the concept of an object restriction that it cannot serve a legitimate aim. In Generics,107 for example, one of the more recent decisions as regards the notion of restrictions by object, the ECJ clarified that an agreement qualifies as object restriction if it cannot have any explanation other than the commercial interest of [the parties to the respective agreement] not to engage in competition on the merits.108

Therefore, as also pointed out by the Commission in its new Draft Horizontal Guidelines 2022,109

106

See, for example, Case C-8/08 T-Mobile Netherlands BV v. Raad van Beestuur van de Nederlandse Mededingingsautoriteit, ECLI:EU:C:2009:343, paras 26–30; Case C-32/11 Allianz Hungária, ECLI:EU:C:2013:160, para. 33. 107 Case C-307/18 Generics (UK) and Others, ECLI:EU:C:2020:52. 108 Case C-307/18 Generics (UK) and Others, ECLI:EU:C:2020:52, para. 87. 109 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en.

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[s]ustainability standards that do not genuinely pursue a sustainability objective but cover up price fixing, market or customer allocation, limitations of output or limitations of quality or innovation, restrict competition by object.110 (emphasis added)

However, where an agreement does not qualify as object restriction of competition as it genuinely does serve a legitimate aim, it may still infringe Article 101(1) TFEU if it can be subsumed under the notion of a restriction of competition by effect.111 Hence, an agreement that produces a negative effect on competition that is appreciable112 also constitutes an infringement of Article 101(1) TFEU.113 Undoubtedly, also acknowledged by the Commission,114 sustainability agreements may well contribute to sustainable development, i.e. activities that support the economic, environmental and social development.115 Hence, in light of the above the possible routes for a sustainability or environment-enhancing agreement to escape Article 101(1) TFEU in this respect are twofold. First and foremost, the measure must not qualify as an object restriction of competition. Therefore, it may, if at all, only be subsumed under the notion of a by effect infringement. In the first scenario there are no restrictive effects of a practice at all thereby making it fall outside Article 101(1) TFEU due to a lack of an infringement as the agreement produces no negative effects on competition. The fact that there are sustainability agreements between competitors that do not have an impact on any of the parameters of competition and thus, as a consequence, are not caught by Article 101 TFEU at all, is very well recognised by the Commission in its Draft Horizontal Guidelines.116

110 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en, para. 570. 111 The notions of by object or effect infringements of competition are undoubtedly to be read disjunctively, see: Case 56/65 Société Technique Minière v. Maschinenbau Ulm, ECLI:EU:C:1966: 38. 112 The concept of appreciability is also known as de minimis doctrine and was first established by the Court in Case C-5/69 Völk v. Vervaecke, ECLI:EU:C:1969:35. 113 Case C-382/12 P MasterCard and Others v. Commission, ECLI:EU:C:2014:2201, para. 93. 114 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en, para. 543 et seq. 115 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en, para. 543. 116 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en, para. 551.

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The second scenario covers situations where there is an effect on competition, however, the effect being only minor and thus non-appreciable (de minimis doctrine). The Commission provides guidance in order to determine whether an agreement produces effects that are considered being non-appreciable in its Draft Horizontal Guidelines.117 It outlines seven cumulative conditions which make it very unlikely for a sustainability agreement to produce negative effects.118 By doing this, the Commission might have arguably reacted to the criticism119 related to the lack of guidance as regards environmental agreements that has existed since removing the dedicated chapter by revision of its Horizontal Guidelines 2001,120 as an equivalent of the latter’s section seven was not included in the Horizontal Guidelines 2011.121 However, with the guidance in its Draft Horizontal Guidelines 2022,122 the Commission arguably provides for more legal certainty. Moreover, Gassler is right when noticing123 that the new section on sustainability agreements can well be interpreted as a move towards competition law (or at least the interpretation of competition law) [. . .] getting greener.

However, time will tell how sustainability and environment-enhancing agreements will actually be dealt with by the Commission in the future.

117 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en. 118 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en, para. 572. 119 Holmes (2020), p. 369. 120 Commission Notice—Guidelines on the applicability of Article 81 of the EC Treaty to horizontal cooperation agreements, OJ 2001 C3/2. 121 Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, OJ 2011 C11/1. 122 Draft Communication from the Commission—Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements, 1 March 2022, https://ec.europa.eu/competition-policy/public-consultations/2022-hbers_en. 123 Gassler M, Analysis: “The new sustainability chapter in the draft revised Horizontal Guidelines of the European Commission”. EU Law Live, 4 March 2022, https://eulawlive.com/analysis-thenew-sustainability-chapter-in-the-draft-revised-horizontal-guidelines-of-the-european-commis sion-by-martin-gassler/.

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Agreements Falling Outside Article 101(1) TFEU Due to Their Effects Being Ancillary to Achieve a Legitimate Aim (Ancillary Regulatory Restraints Route: Wouters)

The second category provides the strand in the case law of the ECJ that considers practices that are ancillary to some other legitimate purpose being capable to fall outside Article 101(1) altogether. The landmark judgement of the ECJ in Wouters124 provides for the basis of this line in the case law followed by cases such as, to name some examples, Meca-Medina,125 OTOC,126 Italian Geologists127 or API.128 In principle, if an agreement pursues a legitimate, non-economic objective, it might fall outside the scope of Article 101(1) TFEU, given the effects restrictive of competition are inherent in the pursuit of the legitimate objectives claimed and are proportionate to them.129 As observed by Monti,130 the reasoning of the Court in Wouters and its subsequent case law following this reasoning basically echoes the approach to public policy justifications in the free movement case law.131 Moreover, borrowed from Gerbrandy it apparently allows for a balancing between economic interests and non-economic interests.132

Hence, where there is a legitimate objective pursued by the measure presumably restrictive of competition, there is a balancing exercise and thus proportionality test necessarily to be conducted in order to determine whether the effects restrictive of competition and inherent to the legitimate aim pursued are proportionate and thus do not go beyond what is necessary to obtain the legitimate objective claimed. If so, one would conclude that the respective practice does not fall within the prohibition laid down in Article 101(1) TFEU, as there were reasonable grounds making the restrictive effects of competition necessary in order for a legitimate objective to be achieved.133 In Wouters it was the necessity of the rules

124

Case C-309/99 Wouters and Others, ECLI:EU:C:2002:98. Case C-519/04 P Meca-Medina, ECLI:EU:C:2006:492. 126 Case C-1/12 Ordem dos Técnicos Oficias de Contas, ECLI:EU:C:2013:127. 127 Case C-136/12 Consiglio nazionale dei geologi and Autorità garante della concorrenza del mercato, ECLI:EU:C:2013:489. 128 Joined Cases C-184/13 to C-187/13, C-194/13, C-195/13 and C-208/13 API and Others, ECLI: EU:C:2014:2147. 129 Case C-519/04 P Meca-Medina, ECLI:EU:C:2006:492, para. 42; Case C-309/99 Wouters and Others, ECLI:EU:C:2002:98, para. 97 and 109, 110. 130 Monti (2002), pp. 1088 et seq.; Gerbrandy (2017), p. 555. 131 Arguing similarly (with reference to Monti): Gassler (2021), p. 434. 132 Gerbrandy (2017), p. 556. 133 Case C-309/99 Wouters and Others, ECLI:EU:C:2002:98, para. 107; Case C-519/04 P MecaMedina, ECLI:EU:C:2006:492, para. 45. 125

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to ensure the proper practice of the legal profession.134

In Meca-Medina, a case concerning sporting rules, it was to combat drugs in order for competitive sport to be conducted fairly, including the need to safeguard equal chances for athletes, athletes’ health, the integrity and objectivity of competitive sport and ethical values in sport135

that constituted such legitimate aim. Moreover, in OTOC the case concerned training regulation for accountants. In this context the legitimate aim was that the regulation seeks to guarantee the quality of the services offered by chartered accountants by putting into place a system of compulsory training.136

Furthermore, in Italian Geologists in the context of a code of conduct concerning the exercise of the profession of geologists the legitimate objective consisted in ensuring that the ultimate consumers of the services in question are provided with the necessary guarantees.137

Hence, legitimate objectives might undoubtedly play a role in the assessment under Article 101(1) TFEU. However, upon closer look at the facts of the respective cases, it becomes apparent that the rules at stake in all of the latter cases were of, as Whish and Bailey put it, “regulatory ancillarity”.138 Hence, the respective agreements concerned cooperation measures of professional or sports associations to selfregulate and administer issues relating to the respective profession or the respective sports and its athletes and competitions concerned. Put differently, the restrictions of competition, i.e. in particular the effects restrictive of competition of the relevant agreements and rules concerned, were inherent to a legitimate regulatory objective and thus ancillary to a “regulatory function”.139 Hence, according to some voices in the literature, sustainability or environment-enhancing agreements would be subject to the Wouters reasoning only if they carried out an “environmental regulatory task”.140 However, it appears, in this author’s view, rather controversial and difficult that such regulatory dimension and function can easily be attributed to agreements between private undertakings aimed to further environmental and sustainability objectives by means of, for example, measures reducing carbon emissions.

134

Case C-309/99 Wouters and Others, ECLI:EU:C:2002:98, para. 107. Whish and Bailey (2018), p. 140. 136 Case C-1/12, Ordem dos Técnicos Oficiais de Contas, ECLI:EU:C:2013:127, para. 68. 137 Case C-136/12, Consiglio nazionale dei geologi and Autorità garante della concorrenza e del mercato, ECLI:EU:C:2013:489, para. 53. 138 Whish and Bailey (2018), pp. 138 and 139. 139 Whish and Bailey (2018), pp. 138 and 139. 140 Holmes (2020), p. 371; Gassler (2021), p. 434. 135

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Moreover, as identified by the German Federal Cartel Office (Bundeskartellamt)141 it is unclear whether the Wouters reasoning could be applied in a sustainability context given state power has been delegated to undertakings or associations of undertakings only (thereby triggering the applicability of the “state action defence doctrine”), or also due to “autonomy rights” of the latter, notwithstanding the fact that it is anything but clear how such autonomy could be established.142 Considering the case law to date, the rules and agreements of those associations that have been subject to an analysis of the Court following its reasoning in Wouters so far were all empowered by the State to safeguard the public goods that their members generate.143

Another issue in this respect relates to the fact that it is not entirely clear what makes an objective be considered legitimate. According to AG Mazak the legitimate objective sought must be of a public law nature and therefore aimed at protecting a public good and extend beyond the protection of the image of the products concerned or the manner in which an undertaking wishes to market its products.144

Hence, as correctly identified by Monti and Mulder,145 following the latter would make sustainability agreements to reduce carbon emissions plausibly fall within the realm of the Wouters strand of the case law. Nonetheless, as rightly observed in the literature,146 sustainability and environmental aspects and considerations following the ECJ’s reasoning in Wouters have not yet been subject to scrutiny of the EU courts.147 Hence, many questions regarding how to apply this line of case law to sustainability or environmentenhancing agreements continue, undoubtedly, to be open.148 Therefore, it remains to be seen whether one could use similar reasoning also in the context of agreements having restrictive effects of competition while, however, pursuing legitimate environmental or sustainability objectives.

141

Bundeskartellamt (German Federal Cartel Office), Offene Märkte und nachhaltiges Wirtschaften—Gemeinwohlziele als Herausforderung für die Kartellrechtspraxis— Hintergrundpapier zur Sitzung des Arbeitskreises Kartellrecht am 1. Oktober 2020, https://www. bundeskartellamt.de/SharedDocs/Publikation/DE/Diskussions_Hintergrundpapier/AK_ Kartellrecht_2020_Hintergrundpapier.html, p. 19. 142 Bundeskartellamt (German Federal Cartel Office), Offene Märkte und nachhaltiges Wirtschaften—Gemeinwohlziele als Herausforderung für die Kartellrechtspraxis— Hintergrundpapier zur Sitzung des Arbeitskreises Kartellrecht am 1. Oktober 2020, https://www. bundeskartellamt.de/SharedDocs/Publikation/DE/Diskussions_Hintergrundpapier/AK_ Kartellrecht_2020_Hintergrundpapier.html, p. 19. 143 Monti and Mulder (2017), p. 646. 144 Opinion of AG Mazak in Case C-439/09 Pierre Fabre Dermo-Cosmétique, ECLI:EU:C:2011: 113, para. 35. 145 Monti and Mulder (2017), p. 646. 146 Holmes (2020), p. 371; Gassler (2021), p. 434. 147 Gerbrandy (2017), p. 556; Gassler (2021), p. 434. 148 Gassler (2021), p. 434.

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Agreements Falling Outside Article 101(1) TFEU Due to the Reasoning of the ECJ in Albany

A third potential category identified in the literature149 for sustainability or environment-enhancing agreements to escape Article 101(1) TFEU, provides the reasoning of the ECJ in its decision in Albany.150 Those voices, while also being sceptical as regards this route being the most adequate one,151 apply—per analogiam—the Court’s reasoning in Albany, which means that it could follow from an interpretation of the Treaty provisions as a whole that sustainability agreements concluded in pursuit of legitimate Treaty objectives, i.e. environmental and sustainability goals,152 must, by virtue of their nature and purpose, be regarded as falling outside the scope of Article [101(1) TFEU].153

Such approach would essentially lead to the conclusion that Article 101 does not apply to sustainability agreements, the scope of the latter however—as rightly emphasised by Gassler154—being too vast. The case in Albany concerned the assessment of a collective agreement concluded between the respective organisations representing employers and employees in order to set up a single pension fund responsible for managing a supplementary (sectoral) pension scheme. Moreover, the affiliation to the fund was made compulsory by the authorities.155 As outlined above, the Court concluded, while taking account of the social policy agenda encompassing labour market considerations as stipulated in the EU Treaties,156 that the respective collective labour agreement concerned were, due to their nature and purpose, to be regarded as falling outside the scope of Article 101 (1) TFEU.157 Moreover, the ECJ recognised that [i]t is beyond question that certain restrictions of competition are inherent in collective agreements between organisations representing employers and workers. However, the social policy objectives pursued by such agreements would be seriously undermined if

149

Holmes (2020), p. 368; Gassler (2021), p. 433; different view: Monti and Mulder (2017), p. 644. Case C-67/96 Albany, ECLI:EU:C:1999:430. 151 Holmes (2020), p. 370; Gassler (2021), p. 433. 152 See Article 3 TEU, Article 11 TFEU, Article 37 CFR as well as Article 7 TFEU; also see to this effect, i.e. regarding the various goals of the EU Treaties and their meaning in the context of the interpretation of the competition provisions, Sect. 2.1. 153 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 60. 154 Gassler (2021), p. 433. 155 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 5. 156 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 54 et seq. 157 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 60. 150

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management and labour were subject to Article [101(1)] of the Treaty when seeking jointly to adopt measures to improve conditions of work and employment.158

Furthermore, as the agreement warranted a certain level of pension for workers in a specific sector thereby contributing directly to the improvement of their working conditions,159 the Court reiterated at a later stage in the judgement that [c]onsequently, the agreement at issue in the main proceedings does not, by reason of its nature and purpose, fall within the scope of Article [101(1)] of the Treaty.160

The Albany judgement can arguably be seen as more radical version of the ancillary regulatory restraints route as established in Wouters.161 However, on the one hand the reasoning of the Court must be seen against the backdrop of the specificities of the labour market. Put differently and borrowed from Whish and Bailey it might be thought inappropriate (or politically impossible) to expose the labour market to the full discipline of the competitive process.162

On the other hand, also the specifics of the case and, in particular, the respective questions asked by the referring court, that is, in particular question one, which concerned the qualification of the sectoral pension fund as undertaking pursuant to Article 101(1) TFEU, were crucial for the assessment of the Court and thus the outcome of the case. The ECJ affirmed the qualification of the sectoral pension fund as undertaking as it considered its activity being based on the principle of capitalisation163 rather than on the principle of solidarity.164 This means, in other words, that the facts, i.e. in particular the way the sectoral pension fund was set up, did not allow the Court to deny its being engaged in an economic activity. Therefore, it might have needed to find another route to escape the competition provisions. Furthermore, also the more recent decision of the ECJ in FNV165 speaks in favour of a narrow reading of the Albany exception. In the latter case, the question referred to the Court concerned provisions within a collective labour agreement setting up minimum fees for the supply of independent services of musicians substituting for members of orchestras.166 The respective fees were applicable to service providers hired by employment contract as well as musicians engaged on a self-employed basis,167 as the collective labour agreement was concluded between an employers’ organisation and an employees’ organisation of mixed composition (also covering 158

Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 59. Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 63. 160 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 64. 161 Holmes (2020), p. 368. 162 Whish and Bailey (2021), p. 11. 163 Case C-67/96 Albany, ECLI:EU:C:1999:430, para. 81. 164 Like in cases such as Joined Cases C-159/91 and C-160/91 Poucet and Pistre, ECLI:EU:C:1993: 63. 165 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411. 166 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 2. 167 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 7, 8. 159

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self-employed musicians).168 The Court denied that such agreement was excluded from the scope of Article 101 TFEU by means of its nature,169 as the self-employed service providers qualified as undertakings within the meaning of Article 101 (1) TFEU.170 However, it recognised that if the self-employed were rather to be qualified as “false-employees”171 and not undertakings,172 an assessment up to the national court to conduct, the Albany exception might nevertheless apply. In the words of the ECJ it is only when self-employed service providers who are members of one of the contracting employees’ organisations and perform for an employer, under a works or service contract, the same activity as that employer’s employed workers, are ‘false self-employed’, in other words, service providers in a situation comparable to that of those workers, that a provision of a collective labour agreement, such as that at issue in the main proceedings, which sets minimum fees for those self-employed service providers, does not fall within the scope of Article 101(1) TFEU.173

Hence, having said this, Monti and Mulder have a point arguing that the exclusion of collective labour agreements and social security solidarity mechanisms from the scope of Article 101(1) TFEU does not appear to be perfectly suitable to let sustainability initiatives escape from Article 101(1) TFEU.174 Therefore, there seem to exist serious doubts as regards the Albany reasoning being a viable way for sustainability or environment-enhancing agreements to escape Article 101 (1) TFEU.

3.3.5

Article 101(3) TFEU

The final route to consider environmental and/or sustainability aspects and considerations within the framework of Article 101 TFEU provides the latter’s paragraph 3, which stipulates four criteria (two negative and two positive ones)175 that need to be met in order for an agreement to fall outside Article 101(1) TFEU. Hence, agreements which – contribute to improving the production or distribution of goods or to promoting technical or economic progress, – while allowing consumers a fair share of the resulting benefit,

168

Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 24. Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 30. 170 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 27. 171 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 38. 172 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 39. 173 Case C-413/13 FNV Kunsten Informatie en Media, ECLI:EU:C:2014:2411, para. 42. 174 Arguing similarly in the context of the Dutch sustainability initiatives Monti and Mulder (2017), p. 644. 175 Whish and Bailey (2021), p. 155. 169

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and furthermore – do not impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives, and – do not afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question meet the requirements as set out in Article 101(3) TFEU. As a consequence, they are deemed justified and thus considered falling outside Article 101(1) TFEU. As already mentioned, the debate as regards whether economic and non-economic considerations opposed to economic considerations only should be taken account of under Article 101(3) TFEU is not new.176 However, in light of the EU Green Deal and the environmental objectives related thereto, the debate as regards non-economic considerations has arguably flared up again. In principle, before the implementation of Regulation 1/2003,177 the Commission’s approach to Article 101(3) TFEU was of a broader nature.178 The Commission decision in CECED179 serves as prime example to this effect (for details see below). Since then, however, a clear focus in the Commission’s approach towards interpreting Article 101(3) TFEU on the basis of efficiency considerations only is clearly visible.180 As emphasised above, this counter-development and narrow reading of Article 101(3) TFEU can be attributed to the Commission’s commitment to the so-called “more economic approach”.181 Yet, as argued in parts of the literature,182 if we changed our approach to the law, Article 101(3) TFEU would provide a solid legal basis for individual exceptions of sustainability and environment-enhancing agreements. Hence, it is all about how one reads and understands the conditions to be met under Article 101(3) TFEU in order to make it applicable. Essentially, it all depends on our interpretation of which consumers need to obtain a fair share, and what we consider being a fair share.183

176 See Whish and Bailey (2021), pp. 161 et seq.; Gerbrandy (2019), p. 129; Jones et al. (2019), pp. 265 et seq.; Petit (2009); Schweitzer (2007); Komninos (2005); Semmelmann (2008a, b). 177 Council Regulation (EC) No 1/2003 of 16 December 2002 on the implementation of the rules on competition laid down in Articles 81 and 82 of the Treaty, OJ 2003 L1/1. 178 For example: as regards environmental considerations see Commission Decision in COMP/ 36.718 CECED, OJ 1999 L187/47; Case COMP.F.1/37.893 CECED II, OJ 2001 C250/4; Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. Taking account of social benefits see Commission Decision in COMP/30.810 Synthetic fibres, OJ 1984 L207/17; Whish and Bailey (2021), p. 163. 179 Commission Decision in COMP/36.718 CECED, OJ 1999 L187/47. 180 Council Regulation (EC) No 1/2003 of 16 December 2002 on the implementation of the rules on competition laid down in Articles 81 and 82 of the Treaty, OJ 2003 L1/1, Whish and Bailey (2021), p. 166. 181 See above, p. 6. 182 Holmes (2020), p. 371; Gassler (2021), pp. 436 et seq.; Van den Brink and Ellison (2021), pp. 45 et seq.; Van Dijk (2021), pp. 57 et seq. 183 Van Dijk (2021), p. 55.

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Put differently, it is all about the nature of the benefit184 and the relevant beneficiaries.185 According to the prevailing, traditional approach of the Commission, it is economic efficiencies only that may outweigh the negative economic effects for the consumers of the same relevant market only that are considered.186 Hence, according to such understanding the latter must be fully compensated in order to receive a “fair share” of the benefits.187 Consequently, such narrow understanding does not allow benefits of non-economic nature (e.g. environmental, social and employment considerations) as well as out-of-market efficiencies, i.e. benefits to consumers outside the respective relevant market and thus to society as a whole, to be taken into account in the assessment of Article 101(3) TFEU.188 However as advocate for in parts of the literature189 and proved by the Commission’s administrative practice preceding the decentralised enforcement era by means of Regulation 1/2003,190 i.e. in the environmental context in particular cases like CECED191 and Exxon/Shell,192 such an understanding and thus a broader approach to Article 101(3) TFEU is indeed possible. CECED The case in CECED,193 for example, concerned an agreement between 90%194 of the producers of domestic washing machines195 operating within the EU market being members of the association of the Conseil Européen de la Construction d’appareils Domestique196 (CECED agreement) that was exempted under Article 101(3) TFEU. The CECED agreement was held to restrict competition as it prevented the parties from producing or importing categories of washing machines of a certain category of energy-efficiency (i.e. the categories D to G).197 Hence, the parties to the CECED

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Gassler (2021), p. 437; Brook (2019), p. 128. Gassler (2021), p. 438; Brook (2019), p. 129. 186 Gassler (2021), p. 438; Van Dijk (2021), p. 55. 187 Van Dijk (2021), p. 55. 188 Gassler (2021), p. 438; Van Dijk (2021), p. 57. 189 Gassler (2021), p. 436; Van Dijk (2021), p. 57; Holmes (2020), pp. 362 et seq., 371. 190 Examples of Commission decisions considering other than economic ones in the assessment under Article 101(3) TFEU and thus individual exemption: as regards environmental considerations see Commission Decision in COMP/36.718 CECED, OJ 1999 L187/47; Commission Decision COMP.F.1/37.893 CECED II, OJ 2001 C250/4; Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. Taking account of social benefits see Commission Decision in COMP/30.810 Synthetic fibres, OJ 1984 L207/17; 191 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47. 192 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. 193 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47. 194 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 8. 195 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 3. 196 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 1. 197 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 37. 185

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agreement were limited in their choice of which washing machine to produce (or import)198 and thus restricted in their previously held autonomy to this effect.199 Consequently, the CECED agreement reduced consumer choice,200 as well as might have increased—at least in the short term—consumer prices.201 However, the Commission concluded that the CECED agreement, being designed to reduce the potential energy consumption of new washing machines by at least 15–20%,202 satisfied the exemption according to Article 101(3) TFEU due to lower energy costs for consumers (individual economic benefit)203 as well as on the basis of lower CO2 emissions (collective environmental benefits).204 Hence, by affirming Article 101(3) TFEU being applicable to the CECED agreement, the latter fell outside Article 101(1) TFEU and thus did not constitute a competition infringement, notwithstanding the fact that the agreement was anticompetitive as participants to the agreement were restricted with respect to their freedom to manufacture specific types of washing machines or import them into the EU.205 Exxon/Shell Another decision of the Commission that illustrates that environmental and sustainability concerns could be decisive and taken account of under its former, wider approach to Article 101(3) TFEU is Exxon/Shell.206 The case concerned a production joint venture, namely Companie Industrielle des Polyéthylènes de Normandie (CIPEN), and related agreements between the Exxon and the Shell group in the market for polyethylene. The purpose of the joint venture agreement was to jointly operate a facility for the production of linear polyethylene.207 Considering the oligopolistic market structure, market transparency208 and the fact that the respective parent companies were and remained active in the sale and production of the same or similar products,209 the Commission concluded that the agreements between Exxon and Shell fell within the ambit of Article 101 (1) TFEU.210 However, the agreements were exempted as they would lead to a reduction of pollution due to the promotion of technical and economic progress211

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Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 30. Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, paras. 30 and 33. 200 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 32. 201 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 34. 202 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, para. 47. 203 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, paras. 52 et seq. 204 Commission Decision COMP/36.718 CECED, OJ 1999 L187/47, paras. 55 et seq. 205 European Commission Press Release, IP/00/148 (11 February 2000). 206 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20. 207 European Commission Press Release, IP/94/407 (18 May 1994). 208 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 23. 209 European Commission Press Release, IP/94/407 (18 May 1994). 210 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 42. 211 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, paras. 67 et seq. 199

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while also benefitting consumers.212 In other words, borrowed from the Commission, the agreements exempted not only allowed for the first plant within the EU utilizing a new technology to be built and operated, but also would result in a reduction of costumers’ use of raw materials, their costs and the volume of plastic wastes.213

Furthermore, the agreements would also lead to an elimination of health and environmental risks connected to the transport of ethylene (needed for the production of linear polyethylene), as no transport between Exxon and Shell (both being ethylene producers) was necessary anymore.214 Moreover, apart from these “favourable effects to costumers”,215 the fair share granted to consumers was basically found in the fact that the availability of significant volumes of a low-cost high-quality linear polyethylene in the market will benefit consumers.216

Hence, as the restrictions were also held indispensable217 and did not lead to an elimination of competition (for a substantial part of the products)218 the Commission concluded that the respective agreements met the conditions as set out under Article 101(3) TFEU219 and thus fell outside Article 101(1) TFEU. Hence, as the Commission decisions in CECED and Exxon/Shell prove, a wide approach to Article 101(3) TFEU is anything but impossible. Moreover, as identified by Monti [t]here have been considerable efforts improving the tools of cost-benefit analysis to better capture the gains to be expected from measures that reduce pollution220

in the recent years. Therefore, also the measuring of potential benefits—irrespective of the various issues related thereto221—is, in principle, feasible. Furthermore, such wider approach does not run counter to the case law of the EU courts too. Rather, it might even be supported by the latter.222 Moreover, one of the initial aims of a narrow understanding of Article 101 (3) TFEU was owed to the fact that the latter became directly applicable by means

212

Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, paras. 70 et seq. Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 67. 214 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 68. 215 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 70. 216 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 70. 217 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, paras. 72 et seq. 218 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, paras. 79 et seq. 219 Commission Decision COMP/33.640 Exxon/Shell, OJ 1994 L144/20, para. 65. 220 Monti (2020), p. 128 and the references cited. 221 Monti (2020), p. 128 and the references cited. 222 See Gassler (2021), pp. 438 et seq. building his argument on the General Court Decision in Case T-86/95 Compagnie générale maritime and Others v. Commission, ECLI:EU:T:2002:50 as well as the ECJ’s judgement in Case C-382/12 P Master Card, ECLI:EU:C:2014:2201. 213

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of Regulation 1/2003. Hence, a narrow interpretation and economic approach should prevent friction in the application of Article 101(3) TFEU when applied by the national competition authorities (NCA). However, as identified by Brook,223 divergence in the substantive national interpretations has existed ever since the implementation of the decentralised enforcement era.224 Moreover indirect, non-economic considerations have nevertheless been considered by some NCAs.225 However, there are of course arguments against adopting a wide approach of Article 101(3) TFEU too. Namely, legal certainty considerations,226 the risk that measures to combat climate change and reduce environmental damage will be outsourced entirely from the public sphere to private initiatives with all the disadvantages related thereto227 as well as to open floodgates for other agreements, meant to reduce negative external effects in other areas.228

Moreover, one can also question whether legal certainty at any cost, that is, at cost of other, non-economic benefits is indeed the right approach to interpret the competition provisions and in particular Article 101(3) TFEU in light of (1) the EU Treaties goals, as well as (2) the challenges imposed by global warming and climate change. Hence, considering a pragmatic perspective Gassler has a point arguing that in the context of assessing non-economic benefits one has to be pragmatic in order to not demobilise investment.229

Moreover, also the concern that NCAs do seem “ill-placed” to interpret Article 101 (3) TFEU in a too broad manner is articulated as an argument in favour of the adoption of a narrow approach to Article 101(3) TFEU. However, as the approach of NCAs appears to be a “hotchpotch” anyway,230 such argument seems hardly convincing.

4 Conclusion This piece illustrated the role competition law can play to foster and support the goals and objectives as set out by the EU Green Deal by means of an adaption of its approach to Article 101 TFEU. As illustrated, competition law has never and still is not blind to considerations other than economic ones. Moreover, in light of the 223

Brook (2019), pp. 138 et seq. Brook (2019), p. 141. 225 Brook (2019), p. 142. 226 Whish and Bailey (2021), p. 165. 227 Van Dijk (2021), p. 59. 228 Van Dijk (2021), p. 59. 229 Gassler (2021), p. 438. 230 Brook (2019), pp. 138 et seq. 224

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constitutional provision of the Treaties to consider environmental and sustainability aspects and considerations appears mandatory also in the context of the competition provision and in particular with respect to Article 101 TFEU. Moreover, against this broader backdrop, it has been shown that there are various possible levels on which one could take into account environmental aspects in the competition law assessment under Article 101 TFEU, that is at the level of Article 101(1) TFEU itself as well as Article 101(3) TFEU. Possible routes outlined and discussed provide (1) agreements that are not by object restrictions of competition but also lack an appreciable effect on competition, (2) agreements falling outside Article 101(1) TFEU due to their effects being ancillary to achieve a legitimate aim (the “ancillary regulatory restraints route”), (3) agreements falling outside Article 101(1) TFEU due to reasoning of the ECJ in Albany and (4) agreements meeting the criteria of Article 101(3) TFEU and thus not constituting a breach of Article 101 (1) TFEU. Hence, there are ways to cope with the issues and challenges as imposed by climate change. What we need, however, is an approach to make competition law “greener”, that is, a duty to apply Article 101 TFEU not only in a more economic but also ecological manner. Therefore, Article 101 TFEU indeed provides for a “fit and proper” competition law toolkit; we just have to use it accordingly. Acknowledgments Many thanks to my student assistant Jil Merlijn Abt for her assistance in proof reading.

References Baarsma B, Rosenboom N (2015) A veritable tower of Babel: on the confusion between the legal and economic interpretations of Article 101(3) of the Treaty on the Functioning of the European Union. Eur Compet J 11(2-3):402–425 Brook O (2019) Struggling with Article 101(3) TFEU: diverging approaches of the Commission, EU courts and five competition authorities. Common Mark Law Rev 56:121–156 De la Torre FC (2005) State action defence in EC competition law. World Compet 28(4):407–431 Ezrachi A (2017) Sponge. J Antitrust Enforc 5:49–75 Gassler M (2021) Sustainability, the Green Deal and Article 101 TFEU: where we are and where we could go. J Eur Compet Law Pract 12(6):430–442 Gerbrandy A (2017) Solving a sustainability-deficit in European competition law. World Compet 40(4):539–562 Gerbrandy A (2019) Rethinking competition law within the European economic constitution. J Common Mark Stud 57(1):127–142 Holmes S (2020) Climate change, sustainability, and competition law. J Antitrust Enforc 8:354–405 Iacovidis MC, Vettros C (2021) Radical for whom? Unsustainable business practices as abuses of dominance. In: Holmes S, Middelschulte D, Snoep M (eds) Competition law, climate change & environmental sustainability. Concurrences Books, New York Joerges C, Rödl F (2004) “Social Market Economy” as Europe’s social model? EUI working paper law no. 2004/8 Jones A, Sufrin B, Dunne N (2019) EU competition law. Oxford University Press, Oxford

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Kingston SEJ (2009) The role of environmental protection in EC competition law and policy. University Leiden Komninos AP (2005) Non-competition concerns: resolution of conflicts in the integrated Article 81 EC. The University of Oxford Centre for Competition Law and Policy, Working paper (L) 08/05 Luczak JM (2009) Die Europäische Wirtschaftsverfassung als Legitimationselement europäischer Integration. In: Magiera S, Merten D, Niedobitek M, Sommermann K (eds) Schriften zum Europäischen Recht. Duncker & Humboldt, Band 140 Middelschulte D (2020) Article 101 TFEU in the decisive decade, on-topic (special on-topic on sustainability and competition law) concurrences N° 4-2020, Art. N° 97390, pp 1–11 Monti G (2002) Article 81 EC and public policy. Common Mark Law Rev 39:1057–1099 Monti G (2020) Four options for a greener competition law. J Eur Compet Law Pract 11(3-4): 124–132 Monti G, Mulder J (2017) Escaping the clutches or EU competition law – pathways to assess private sustainability initiatives. Eur Law Rev 42(5):635–656 Nowag J (2016) Environmental integration in competition and free-movement laws. Oxford University Press, Oxford Nowag J (2019) Competition law’s sustainability gap? Tools for an examination and a brief overview. Lund University Legal Research Paper Series 3/19, pp 3–11 Odudu O (2005) The meaning of undertaking within 81 EC. Camb Yearb Eur Leg Stud 7:211–241 Pennings F (2019) How do social and economic rights relate to each other in the social market economy: an introduction to this special issue. Utrecht Law Rev 15(2):1–15 Petit N (2009) The guidelines on the application of Article 81(3) EC: a critical review. Working Paper Institut d’Etudes Juridiques Europeennes (IEJE), No. 4 Röpke W (1942) International economic disintegration. William Hodge, London Ruffert M (2022) Article 3 AEUV. In: Calliess C, Ruffert M (eds) EUV/AEUV Kommentar. C.H. Beck, München Sauter W (2015) Public services in EU law. Cambridge University Press, Cambridge Sauter W, Schepel H (2009) State and market in European Union law – the public and private spheres of the internal market before the EU courts. Cambridge University Press, Cambridge Schweitzer H (2007) Competition law and public policy: reconsidering an uneasy relationship. The example of Art. 8. Working paper, EUI law, 2007/30 Semmelmann C (2008a) The future role of the non-competition goals in the interpretation of Article 81 EC. Glob Antitrust Rev (1):15–47 Semmelmann C (2008b) Social policy goals in the interpretation of Article 81 EC. Nomos, BadenBaden Stucke M, Ezrachi A (2020) Competition overdose – how free market mythology transformed us from citizen kings to market servants. Harper Collins, New York Stylianou K, Iacovides M (2022) The goals of EU competition law: a comprehensive empirical investigation. Leg Stud:1–29 Van den Bergh R (2016) The more economic approach in European competition law: is more too much or not enough? In: Kovač M, Vandenberghe AS (eds) Economic evidence in EU competition law, European studies in law and economics. Intersentia, Cambridge, pp 11–42 Van den Brink W, Ellison J (2021) Article 101(3) TFEU: the roadmap for sustainable cooperation. In: Holmes S, Middelschulte D, Snoep M (eds) Competition law, climate change & environmental sustainability. Concurrences Books, New York Van Dijk T (2021) A new approach to assess certain sustainability agreements under competition law. In: Holmes S, Middelschulte D, Snoep M (eds) Competition law, climate change & environmental sustainability. Concurrences Books, New York Whish R, Bailey D (2018) Competition law. Oxford University Press, Oxford

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Bernadette Zelger is an Assistant Professor (Universitätsassistentin) at the Department of European Law and Public International Law at the University of Innsbruck, Austria. She holds a Dr. iur and Mag iur. from the University of Innsbruck as well as an LL.M. in Competition Law from Queen Mary University London, UK. Besides, Bernadette fulfils the requirements as a qualified lawyer in Austria. Her research focus lies with European Competition and Internal Market Law as well as International Economic Law.

Climate-Related Individual Rights Under EU Secondary Law and Limitations to Their Material Scope Julia Wallner and Emil Nigmatullin

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Climate-Related Individual Rights Under EU Secondary Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Preliminary Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 Individual Rights Under the Effort Sharing Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Interplay Between Individual and Fundamental Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Restrictions on Trade-Related Climate Protection Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Preliminary Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Conformity with WTO Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Conformity with EU Primary Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract In an Austrian climate lawsuit raised in 2021, the claimants demanded the adoption of a national ban on the sale of fossil fuels based on an ordinance pursuant to the National Trade Regulation Act. Thereby, the claimants derived their right to require the issuing of an ordinance on fossil fuel sales bans from EU Secondary Law, namely the Effort Sharing Regulation, which stipulates greenhouse gas emission reduction obligations for EU Member States. Given this lawsuit, the present article examines the existence of climate-related individual rights laid down in EU Secondary Law. It thereby presents a line of arguments indicating that the EU climate change framework may confer certain individual rights. Furthermore, the requested sales ban shall be examined as to its conformity with the General Agreement on Tariffs and Trade and EU Primary Law.

J. Wallner University of Graz, Institute of Public Law and Political Science, Graz, Austria e-mail: [email protected] E. Nigmatullin (✉) Haslinger / Nagele Rechtsanwälte GmbH, Vienna, Austria e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 443–476, https://doi.org/10.1007/8165_2022_92, Published online: 30 November 2022

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1 Introduction Although scientific evidence for climate change was already available in the last millennium,1 the climate crisis has only recently entered public consciousness and has thus become an issue of public interest.2 The public climate change awareness has not only accelerated due to the ever more alarming warnings by the scientific community,3 the reports of persistent non-compliance with internationally agreed climate obligations4 and nonviolent civil disobedience,5 but also due to climate litigation efforts worldwide.6 Through so-called climate lawsuits, claimants seek to enforce climate protection through courts and international fora.7 Climate litigants take legal action against legislative and administrative omissions and insufficient climate protection targets adopted by States8 and aim at enforcing climate-related injunctive relief and claims for damages against companies.9 Thereby, a variety of legal arguments are brought forward—while climate lawsuits against companies are mostly based on private law,10 climate lawsuits against States rest, for instance, on fundamental and human rights,11 the public trust doctrine12 or the rights of nature.13 An Austrian climate lawsuit raised by several natural persons and one environmental

1 Le Treut et al. (2007). The first IPCC report was published as early as 1990 and lead to the adoption of the UN Framework Convention on Climate Change in 1992. United Nations Framework Convention on Climate Change (adopted 9 May 1992, entry into force 21 March 1994) UNTC No 30822. 2 For an overview of the media coverage of climate change from 2004 until 2022 see: Media and Climate Change Observatory (2022). 3 See, for example, the contribution of Working Group II to the latest IPCC Report: Pörtner et al. (2022). 4 In fact, the climate policies in place worldwide would result in global warming of 2.7 °C; even the implementation of the nationally determined contributions (NDCs) agreed upon in the Paris Agreement would limit global warming only to 2.4 °C, see Climate Action Tracker (2021); on the problem of compliance with internationally agreed mitigation targets see Mayer (2018), pp. 218 ff. 5 A major example is the “Fridays for Future” movement—see Marquardt (2020). 6 According to the Sabin Center Climate Change Litigation Databases, almost 2000 climate cases have been raised worldwide, see Sabin Center for Climate Change Law (2022). 7 United Nations Environment Programme (2017), p. 6. 8 Setzer and Higham (2021), p. 6. 9 Setzer and Higham (2021), pp. 27–29. 10 On climate lawsuits against private companies see, for example, Wilde (2021), pp. 268 ff; Hinteregger (2018), pp. 197 ff; prominent examples of climate lawsuits against companies include the German case of Lliuya v RWE or the Dutch case of Milieudefensie et al. v. Royal Dutch Shell plc. 11 For example, fundamental rights play a focal role in the cases of Urgenda Foundation v State of the Netherlands and Neubauer et al. v. Germany. 12 The Public Trust Doctrine was, for example, invoked in the case of Juliana v. United States. 13 For example, in the Colombian case of Future Generations v. Ministry of the Environment the Colombian Constitutional Court acknowledged the legal subjectivity of the Amazon rainforest.

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non-governmental organisation (NGO) in 2021 suggested a novel approach.14 Therein, the claimants substantiated their legal standing inter alia by deriving an individual right to clean energy and climate protection from EU Secondary Law, namely from the Effort Sharing Regulation15 (ESR), which sets greenhouse gas (GHG) reduction obligations for Member States.16 In essence, the claimants argued that the purpose of the ESR—aimed at meeting the “Paris” climate target17—is to protect European citizens from the adverse impacts of climate change. Given the effet utile principle18 and the notions of the European Court of Justice (CJEU) developed in the case-law on the framework on ambient air quality and cleaner air laid down in Directive 2008/50,19 the ESR—supposedly—confers the right on natural persons and environmental NGOs to require the national authority20 to enact ordinances with a particular content.21 As to the latter, the right to bring proceedings follows from Article 9(3) Aarhus Convention,22 read in conjunction with Article 47 Charter of Fundamental Rights of the European Union (CFR).23 In substantive terms, the claimants required the competent authority to issue an

14

The application Fliegenschnee et al. v. Austria (in German) is available at https://www. global2000.at/sites/global/files/Antrag-Klimaschutzverordnung.pdf (last accessed 29 June 2022). 15 Regulation (EU) 2018/842 of 30 May 2018 on binding annual greenhouse gas emission reductions by Member States from 2021 to 2030 contributing to climate action to meet commitments under the Paris Agreement and amending Regulation (EU) No 525/2013. 16 According to Annex I ESR, Austria is obliged to reduce its GHG emissions in the Non-ETS Sectors by 36% until 2030 in 2030 in relation to their 2005 levels; however, the reduction levels may be increased (see COM[2021] 555 final). 17 Paris Agreement (adopted 12 December 2015, entered into force 4 November 2016) UNTC No 54113; according to Article 2(1) lit (a) of the Paris Agreement, the parties aim at “holding the increase in global average temperature to well below 2 °C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5 °C above pre-industrial levels (. . .)”. 18 According to this interpretation principle, national authorities shall give “full force and effect” to EU law. The claimants argue that the Effort Sharing Regulation aims at protecting European citizens from dangerous climate change and therefore establishes inalienable individual rights to enforce Austria’s obligation under the said regulation to “full effect”. On the effet utile principle see, e.g., Potacs (2009), pp. 465–487. 19 Directive 2008/50/EC of 21 May 2008 on ambient air quality and cleaner air for Europe; See CJEU, case C-237/07, Dieter Janecek v Freistaat Bayern, ECLI:EU:C:2008:447; CJEU, case C-404/13, ClientEarth v The Secretary of State for the Environment, Food and Rural Affairs, ECLI:EU:C:2013:805. Most recently, the case C-61/21 is subject to the question whether the Directive 2008/50/EC establishes a right of an individual to obtain compensation for damage to health resulting from an infringement of EU law; see Opinion of Advocate General Kokott, case C-61/21, JP v Ministre de la Transition écologique. Premier minister, ECLI:EU:C:2022:359. 20 The relevant authority is the Federal Minister of Digitalisation and Business Location. 21 See Fliegenschnee et al. v. Austria (application), pp. 29 ff. 22 Convention on access to information, public participation in decision-making and access to justice in environmental matters, signed at Aarhus on 25 June 1998 and approved on behalf of the European Community by Council Decision 2005/370/EC of 17 February 2005 (OJ 2005 L 124, p. 1). 23 Charter of Fundamental Rights of the European Union.

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ordinance that would introduce a gradual (national) ban on the sale of fossil fuels in different sectors until 2040.24 For this purpose, the Austrian Trade Regulation Act (Gewerbeordnung)25 should serve as the legal basis for the requested ordinance. According to the first intend of its Article 69, the Minister, “in order to avoid endangering the life or health of people or to prevent pollution of the environment, shall determine by ordinance which measures tradesmen shall take with regard to the goods they produce or sell”. In the first instance, the competent authority declared the claim inadmissible.26 It thereby relied on the constitutional division of competences and argued that it lacked competence to adopt the requested measure.27 Subsequently, the claimants brought an action before the Verwaltungsgericht (Administrative Court) Wien. The Verwaltungsgericht Wien dismissed the action as unfounded: It did not recognise the existence of individual rights arising from the ESR. According to the Verwaltungsgericht Wien, a regulation that only has binding effect for the Member States does not automatically grant individual rights enforceable by domestic courts. The court further endowed its view by outlining that the ESR’s wording does not reveal the legislator’s intention to confer individual rights on European citizens to require the implementation of the GHG reduction measures enshrined therein.28 Hence, it concluded that no individual rights arise from Article 1 ESR. Other than that, it held that climate-related individual rights do not exist under national constitutional law.29 The applicant’s appeal with the Austrian Constitutional Court and Supreme Administrative Court is currently pending. This article examines the legal foundations inherent to the present complaint, its cogency and related legal questions. Thereby, the focal target is to scrutinise whether or not individual rights are reconcilable with the normative tenets of EU

24

In concrete terms, the applicants requested the adoption of a ban on the sale of (1) solid fossil fuels from 1 January 2025, (2) fossil heating oil from 1 January 2030, (3) fossil fuels from 1 January 2035 and (4) fossil fuels for aviation from 1 January 2040. In eventu, the claimants requested the adoption of the same measures at other appropriate dates. 25 Trade Regulation Act 1994, Federal Law Gazette I No. 194/1994. 26 See Fliegenschnee et Al. v. Austria (application), pp. 21 ff. 27 In fact, the competent authority argued that the requested climate protection measure does not constitute a trade policy measure in the sense of its competences in the field of trade (Art 10, para. 1, no 8 of the Federal Constitutional Law, Federal Law Gazette No 1 1930 as amended by Federal Law Gazette I No 194/1999). It thus concluded that the adoption of the requested measure under the Trade Regulation Act would not be in conformity with the Austrian constitution. 28 Verwaltungsgericht Wien 25 April 2022, VGW-101/053/13231/2021-4 et al., pp. 36 ff. The decision is available at https://www.ris.bka.gv.at/Dokumente/Lvwg/LVWGT_WI_20220425_ VGW_101_053_13231_2021_00/LVWGT_WI_20220425_VGW_101_053_13231_2021_00.pdf (last accessed 29 June 2022). 29 The Verwaltungsgericht Wien argued that there was no legally tangible direct connection between the climate crisis and the State’s positive obligations arising from the right to life (Art 2 ECHR, Art 2 CFR); instead, it suggested that positive obligations only occur in case of natural disasters limited to a certain area. This view is, however, ambivalent to findings of the Dutch Supreme Court in the much-discussed judgement Urgenda.

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Climate Protection Law. Given the premise that climate protection measures ultimately serve to protect the life and health of people, this article provides a line of arguments in favour of the existence of certain climate-related individual rights. It further identifies potential obstacles to the protection of these rights de lege lata. In addition, since the actual adoption of the requested sales ban on fossil fuels would have significant economic impacts, this measure shall be analysed as to its conformity with International and European Economic Law. In this context, the General Agreement on Tariffs and Trade (GATT)30 and the free movement of goods under the Treaty on the Functioning of the European Union (TFEU)31 serve as legal limitations to the State’s discretion to implement climate protection measures sought to fulfil the requirements for (potential) individual rights.

2 Climate-Related Individual Rights Under EU Secondary Law This chapter examines the existence of climate-related individual rights under EU Secondary Law.32 For this purpose, the case-law developed by the CJEU on the establishment of individual rights in several environmental directives is considered. Given the dogmatic findings in this field, this chapter subsequently analyses the ESR as one of the core climate-related EU legal frameworks with regard to its capability to establish individual rights.33

2.1

Preliminary Remarks

The CJEU has acknowledged the existence of individual rights in various environmental directives, such as the Directive 2008/50 on ambient air quality. In essence individual rights aim at ensuring effective and efficient enforcement of EU directives in line with the effet utile of Secondary Law. According to Article 288(3) TFEU, directives have binding effect. It would be incompatible with the effet utile to

30

General Agreement on Tariffs and Trade (adopted 30 October 1947, entry into force 1 January 1948) UNTS vol. 64, p. 187; the applicability of GATT results from the fact that fossil fuels are considered as “goods” (see later); for the purpose of this article, the Energy Charter Treaty will not be considered. 31 Consolidated version of the Treaty on the Functioning of the European Union (2012) OJ C 326 (TFEU). 32 See in this context Wallner and Nigmatullin (2022), pp. 78 ff. 33 Other frameworks, such as the Directive (EU) 2018/2001 (“Renewable Energy Directive”), may also serve as a legal basis for climate-related individual rights. The examination of the entire EU climate change framework would go beyond the scope of the discussion, which is why the present articles focuses on the ESR.

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exclude the possibility of natural and legal persons directly concerned by an infringement of a directive provision to rely on the infringed obligation enshrined in that provision.34 Individuals shall serve as “guardians of the Community Law” and exercise a vertical control function.35 The CJEU has acknowledged this notion in multiple legal contexts with respect to Primary36 and Secondary Law.37 Both in the context of Primary and Secondary Law, the vertical control function of individuals shall complement the European Commission’s responsibility to control the Member State’s compliance with legal obligations from Secondary Law.38 Given this normative background, the CJEU developed two methodical approaches for conferring rights on individuals in EU directives:39 First, individual rights emerge from provisions that have direct effect.40 As the CJEU adjudicated on numerous occasions, a provision has direct effect when it appears, as far as the subject-matter is concerned, to be unconditional and sufficiently precise. The first condition is met where the respective provision sets forth an obligation, which is not qualified, by any condition, or subject, in its implementation or effects, to the taking of any measure by the Member States.41 Adversely, provisions of purely programmatic nature that merely lay down an objective and grant Member States wide discretion as to the means to be employed in order to reach that objective are not unconditional.42 If a provision displays the characteristics of a provision with direct effect, natural and legal persons may rely on them where the respective Member State has failed to (effectively) transpose the directive into domestic law.43 Second, the CJEU has recognised individual rights based on the substantive content of the provision in question. In order to determine individual rights from mandatory provisions, the CJEU applies, in essence, a “three-step test”:44 34 CJEU, joined cases C-165/09 to C-167/09, Stichting Natuur en Milieu, ECLI:EU:C:2011:348, para. 94. 35 See also CJEU, case 26/62, van Gend & Loos, ECLI:EU:C:1963:1, p. 26. 36 See for instance in the context of Procurement and State Aid Law CJEU, case C-433/93, Commission/Germany, ECLI:EU:C:1995:263, para. 17; CJEU, case C-174/02, Streekgewest Westelijk Noord-Brabant, ECLI:EU:C:2005:10, paras. 17 ff. 37 See CJEU, case C-426/05, Tele 2, ECLI:EU:C:2008:103, paras. 27, 34 ff; CJEU, case C-58/89, Commission/Germany, ECLI:EU:C:1991:391, para. 14. 38 CJEU, case 26/62, van Gend & Loos, ECLI:EU:C:1963:1, p. 26. 39 See for the difference of the two approaches Giera (2021), pp. 172 ff. 40 See for example CJEU, case C-445/06, Danske Slagterier, ECLI:EU:C:2009:178, paras. 22–26; CJEU, case C-429/09, Danske Slagterier, ECLI:EU:C:2010:717, paras. 49–50; CJEU, case C-501/ 18, Balgarska Narodna Banka, ECLI:EU:C:2021:249, paras. 63 and 86. 41 CJEU, case C-236/92, Comitato di coordinamento per la difesa della cava and Others, ECLI:EU: C:1994:60, para. 9. 42 CJEU, joined cases C-165/09 to C-167/09, Stichting Natuur en Milieu, ECLI:EU:C:2011:348, para. 97. 43 See for example CJEU, joined cases C-6/90 and C-9/90, Francovich and Others, ECLI:EU: C:1991:428, para. 11; CJEU, case C-62/00, Marks & Spencer, ECLI:EU:C:2002:435, para. 25. 44 This very structure may be derived from the line of arguments taken upon by the CJEU in its rulings; see Giera (2021), pp. 110 ff.

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1. Does the provision in question protect individual interests? 2. What is the group of individual and legal persons directly concerned by the Member State’s failure to comply with the obligations set in the provision in question? 3. What is the concrete scope of the Member State’s obligation under the respective provision? With regard to the first step, the CJEU assesses not only the wording but also the purpose of the provision in question, thus endowing a systematic-teleological interpretation approach.45 In particular, it is necessary to determine whether the respective provision is designated to protect (inter alia) the interests of natural and legal persons.46 The CJEU affirmed this condition in multiple environmental contexts: For instance, it held that provisions seeking to control and improve air quality, such as Article 22(1) Directive 2008/50, protect the public health. Therefore, the failure of a Member State to comply with mandatory air quality limits could endanger human health, which is why such provisions protect individual interests.47 Additionally, provisions that limit the nitrate levels in groundwater seek to protect the legitimate use of water. An infringement of such provisions thus constitutes an interference with individual interests.48 In the next step, the CJEU delimits the group of natural and legal persons directly concerned by the infringement of a certain provision that protects individual interests (step 2). This step corresponds to the recurring case-law of the CJEU in other legal contexts.49 In environmental matters, the CJEU takes a rather wide approach: For instance, natural or legal persons may be directly concerned by the exceedance of mandatory air pollution limit values.50 Furthermore, a natural or legal person having the (legal) option of drawing and using groundwater is directly concerned by the infringement of a provision that stipulates nitrate thresholds in groundwater.51 Additionally, environmental NGOs may be directly concerned if environmental interests are at stake.52 It follows that the CJEU acknowledges the factual and “idealistic” concern in particular interests as constituting individual rights.53

45

Giera (2021), pp. 110 f. Giera (2021), p. 111. 47 CJEU, case C-237/07, Dieter Janecek v Freistaat Bayern, ECLI:EU:C:2008:447, para. 38. 48 CJEU, case C-197/18, Wasserleitungsverband Nördliches Burgenland, CLI:EU:C:2019:824, para. 39. 49 See for instance in the context of Procurement Law CJEU, C-433/93, Commission/ Germany, ECLI:EU:C:1995:263, para. 17; in the context of equality CJEU, joint Cases C-87/90 and C-89/90, Verholen et al., ECLI:EU:C:1991:314, paras. 24 ff. 50 It is for the national court to settle in each particular case whether the condition of “direct concernment” is met. 51 CJEU, case C-197/18, Wasserleitungsverband Nördliches Burgenland, CLI:EU:C:2019:824, paras. 40, 45. 52 CJEU, case C-664/15, Protect, ECLI:EU:C:2017:987, para. 58. 53 See Giera (2021), p. 111. 46

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In the third step, the CJEU determines the scope of the individual rights in correspondence with the scope of the Member State’s obligation under the respective provision (“congruency between obligation and right”). In the case C-237/07, it held that the obligation of a Member State to draw up action plans both where there is a risk of the limit values being exceeded and where there is a risk of the alert thresholds being exceeded establishes the right of individuals to require the competent national authorities to draw up such action plans.54 In the case C-404/13, the CJEU substantiated this notion by adjudicating that individuals are entitled to require the competent authority to draw up air quality plans, which comply with the prerequisites enshrined in the respective directive. It thus acknowledged that individuals have a right to require the establishment of appropriate air quality action plans. However, since Member States have a degree of discretion in deciding which measures to adopt, individuals are not entitled to request an action plan with a particular content.55 In the light of the CJEU case-law presented in this chapter, it is fair to conclude that individual rights may under certain conditions be derived from environmentalrelated EU directives. Given the binding effect of directives under Article 288 (3) TFEU, it would be invalid to exclude the possibility of the obligation imposed by a directive being relied on by natural and legal persons directly concerned by an infringement of that directive.

2.2

Individual Rights Under the Effort Sharing Regulation

2.2.1

Formal and Material Differences Between the Effort Sharing Regulation and the Directive 2008/50 on Air Pollution Control

In the Austrian climate lawsuit at hand, the plaintiffs relied on the CJEU case-law on air pollution control to argue that Article 1 ESR entitles them to request the implementation of sales bans on fossil fuels. In essence, there are two pivotal differences between the framework on air pollution control and the ESR, which play a crucial role with respect to the establishment of individual rights: First, the ESR is a regulation, whereas the framework on air pollution control is enshrined in a directive. The latter source of law requires transposition to national law,56 while the former (usually) has general application and shall be directly applicable in all Member States.57 The question arises as to whether or not regulations may constitute

54

CJEU, case C-237/07, Dieter Janecek v Freistaat Bayern, ECLI:EU:C:2008:447, para. 42. CJEU, case C-404/13, ClientEarth v The Secretary of State for the Environment, Food and Rural Affairs, ECLI:EU:C:2013:805, para. 56. 56 See Article 288(3) TFEU. 57 See Article 288(2) TFEU; in general, regulations are not transposed to domestic law, unless otherwise provided for in the regulation in question. 55

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individual rights similiar to directives. The CJEU held on numerous occasions that regulations may confer rights on private parties, which the national courts must protect.58 This is due to “their nature and their function in the system of sources” of Union Law.59 However, certain provisions of regulations may explicitly or implicitly necessitate, for their implementation, the adoption of measures by the Member States specifying the application of the provisions in question and thus ensuring the effectiveness of the regulation. When implementing such “national application measures”, Member States are bound to certain limits.60 If Member States enjoy discretion as to the implementation of the respective provision (e.g. if they shall define certain terms based on predetermined criteria), the CJEU did not recognize individual rights from those provisions in the absence of national application measures adopted by the Member States.61 In order to determine whether a regulation confers individual rights, one has to interpret the relevant provisions of the respective regulation,62 namely its purpose, its historical context, its objective and its protective effects.63 If provisions laid down in an EU regulation indeed establish individual rights, these rights apply in the same way as rights granted by national law.64 Second, it is necessary to take into account that climate protection and air pollution control measures have different objectives: Whereas the latter protect specific persons (i.e. residents) due to the exceedance of mandatory air pollution limit values in a certain local territory, the former seeks to the prevent climate damage that affects the global community (e.g. health damages).65 Due to global nature of climate change, exceedances of binding GHG levels within a certain territory do not necessarily correspond with climate damages in that territory.66 Consequently, climate protection and air pollution measures are to be interpreted differently as to their capacity to establish individual rights. Against this background, it is fair to conclude that the EU frameworks on air pollution control and climate change are formally and materially different. The question arises as to whether the said differences have an impact on the emergence and scope of individual rights under the ESR. This is discussed in the following. 58

See for example CJEU, case C-34-73, Variola, ECLI:EU:C:1973:101, para. 7. CJEU, case 43/71, Politi, ECLI:EU:C:1971:122, para. 9. 60 See for the limits of measures of application by the Member States CJEU, case 34/73, ECLI:EU: C:1973:101, Variola, paras. 9 ff; CJEU, case 39/72, Commission/Italy, ECLI:EU:C:1973:13, paras. 14 ff; CJEU, case 94/77, ECLI:EU:C:1978:17, Zerbone, paras. 22 and 27. 61 CJEU, case C-403/98, Monte Arcosu, ECLI:EU:C:2001:6, paras. 26 f. 62 CJEU, case 43/71, Politi, ECLI:EU:C:1971:122, para. 9; Harratsch et al. (2020), p. 167. 63 See CJEU, case C-426/05, Tele 2, ECLI:EU:C:2008:103, paras. 27, 34 ff; CJEU, case C-222/02, Peter Paul, ECLI:EU:C:2004:606, paras. 39 ff. 64 Satzger and von Maltitz (2021), p. 3. 65 Wustlich (2003), pp. 328 ff. 66 Satzger and von Maltitz (2021), pp. 3 and 10. From a global perspective, the reduction of GHG emissions would be relatively small as in 2020, Austria only accounted for 0.32% of global CO2 emissions; see Ritchie and Roser (2020). 59

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Individual Rights of Natural and Legal Persons Under the Effort Sharing Regulation67

In order to determine whether a regulation establishes individual rights, one has to interpret the relevant provisions of the regulation in question.68 As shown above,69 the CJEU has recognized individual rights in environmental directives based on the direct effect of the relevant provisions and the “three-step test”. These two approaches are to be examined in the following with respect the provisions of the ESR. Presumably, the denial of individual rights based on the first approach does not necessarily exclude the possibility to confer individual rights based on the latter approach. Direct Effect of the ESR Provisions Provisions of a regulation may have direct effect under certain conditions.70 However, this is not the case with regard to Article 1 ESR: Comparable to Article 4 Directive 2001/81/EC,71 which according to the CJEU has no direct effect due to its programmatic character,72 Article 1 ESR addresses the objective of the ESR which is, inter alia, to lay down binding emission reduction targets for the Member States. The way in which the obligatory targets are achieved is left to the discretion of the Member States.73 Consequently, Art 1 ESR is neither unconditional nor sufficiently precise in terms of measures to be taken by the Member States in fulfilling GHG emissions reduction obligations.74 Therefore, individuals cannot (solely) rely on Article 1 ESR. Correspondingly, the CJEU held that Article 4 Directive 2001/81/ EC “does not lay down any unconditional and sufficiently precise obligation requiring the adoption of specific individual policies or measures intended to enable the result prescribed to be achieved”, which is, why “individuals cannot rely directly before a national court upon Article 4 of the NEC Directive”.

67

See in general Wallner and Nigmatullin (2022), pp. 78 ff. Harratsch et al. (2020), p. 167. 69 See Sect. 2.1. 70 In this sense Harratsch et al. (2020), p. 167. 71 According to Article 4 Directive 2001/81/EC, “Member States shall limit their annual national emissions of the pollutants sulphur dioxide (SO2), nitrogen oxides (NOx), volatile organic compounds (VOC) and ammonia (NH3) to amounts not greater than the emission ceilings laid down in Annex I”. 72 CJEU, joined cases C-165/09 to C-167/09, Stichting Natuur en Milieu, ECLI:EU:C:2011:348, paras. 96 ff; the CJEU hold that the relevant provision “does not lay down any unconditional and sufficiently precise obligation requiring the adoption of specific individual policies or measures intended to enable the result prescribed to be achieved”, which is, why “individuals cannot rely directly before a national court upon Article 4 of the NEC Directive”. 73 In this sense Schulev-Steindl et al. (2020), p. 14. 74 One may argue that the ESR requires the implementation of national measures by the Member States, since the objectives of the provisions laid down therein (the reduction of GHG emissions levels) cannot be achieved otherwise. 68

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“Three-Step Test” The three-step test developed by the CJEU in the light of the framework on ambient air quality has not yet been applied for the interpretation of provisions set out in (climate-change-related) regulations. However, for the purpose of this article, the said three-step-test shall be applied on the provisions of the ESR, since the present Austrian climate claim implicitly presupposes the validity of its application. Applying this test, one has to examine first whether the provisions of the ESR protect individual interests, especially human health.75 The wording of neither Article 1, 4 and Annex I ESR, nor the recitals of the ESR expressly give any indications in that respect. One could object that the ESR’s sole purpose is to distribute the necessary (climate change) efforts in the Non-ETS-Sectors between the Member States. However, the fact that a framework does not expressly issue the protection of human health is, according to the jurisdiction of the CJEU, not an obstacle to the establishment of individual rights.76 Indeed, it may follow both from the context of that provision and the aim pursued by the ESR that the said provisions can be interpreted to that effect: Article 1, read in conjunction with Article 4 and Annex I ESR, stipulates specific GHG reduction obligations for all EU Member States. The obligation to reduce the national GHG emissions is a measure to mitigate climate change damages and, therefore, to reduce risks for human health. Hence, one could argue that the infringement of the reduction obligations set out in the ESR would affect the interests of individuals, even though the individuals are not addressed in the ESR.77 EU Primary law may also provide for such interpretation: Article 191(1) TFEU stipulates that the Union’s environmental policy shall contribute to the protection of the quality of the environment and human health and shall be designed as to prevent dangerous climate change. Based on Article 192(1) TFEU, the European Parliament and the Council shall decide within the ordinary legislative procedure what action is to be taken by the Union to achieve the said objectives. In exercising this competence, the EU legislative organs enacted the ESR. Therefore, one may argue that it is the ESR’s objective to protect the human health and the environment. If one acceded cogency to the fact that the said provisions protect individual interests,78 the second step is to assess the group of people directly concerned by a potential infringement of the GHG reduction obligations set out in the ESR. In this

75

See Sect. 2.2.1. CJEU, case C-298/95, Kommission/Deutschland, ECLI:EU:C:1996:501, para. 15. 77 In the present case, the Verwaltungsgericht Wien argued that the ESR only defines the distribution of GHG reduction efforts and therefore does not have the capacity to interfere with individual’s interest. 78 Art 4(1) sentence 7 German Climate Protection Act, which serves the purpose of achieving the GHG reduction levels for Germany in the Non-ETS-Sectors, provides that Climate Protection Act does not confer any individual rights on natural and legal persons. This provision has declaratory effect; the academia has discussed effect and scope of this statutory right’s exclusion in the light of fundamental rights and EU law. See Frenz (2022), p. 687; Fellenberg and Guckelberger (2022), pp. 109 ff. 76

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regard, it is crucial to bear in mind that, due to the global nature of the carbon cycle, the exceedance of GHG reduction levels within one territory does not necessarily lead to climate damages within the respective territory.79 This very global nature of climate change, however, may not exclude the “direct concern” of certain individuals in the case of an infringement of climate-related frameworks.80 In the context of national emission ceilings, the CJEU held that natural and legal persons are directly concerned even if the measure in question has cross-border effects.81 As to the ESR, the “direct concern” of individuals could result from the fact that Member States do not achieve their GHG reduction obligations set out in Article 1, read in conjunction with Article 4 and Annex I ESR. This would, in turn, lead to an interference with—at least long-term82—individual interests. Due to the lacking regional nature of climate change, natural persons residing in the respective Member State and—by virtue of Article 9(3) Aarhus Convention—environmental NGOs recognized by the particular Member State could be directly concerned by the infringement of the GHG reduction obligations set out in the ESR. As to the scope of the individual rights granted under the ESR, one has to bear in mind the following: Article 1, read in conjunction with Article 4 and Annex I ESR, lays down mandatory GHG reduction targets for Member States for the period 2021–2030 in the Non-ETS sectors.83 The way in which Member States fulfill their specific obligations is left to their discretion.84 Hence, Member States have a wide range of climate protection instruments at hand to achieve their mandatory GHG reduction targets. For instance, they can introduce carbon pricing schemes, oil boiler installation bans or traffic restrictions, which are all capable of reducing GHG emissions in the relevant sectors. It becomes clear, that, while the EU provides a binding frame, the Member States are responsible for implementing the concrete GHG reduction measures most appropriate to their national short- and longterm situation. This very decision by the EU legislator has an impact on the establishment of individual rights under the ESR: Article 1, read in conjunction with Article 4 and Annex I ESR, does not grant individuals the right to require the competent national authority to implement specific climate protection measures, since the ESR in general does not prescribe any GHG reduction measures of a particular content. In the case C-216/02, the CJEU held that Secondary Law does not grant individual rights when the acceptance of such individual right would “amount

79

See Sect. 2.2.1. See CJEU, case C-565/19 P, Carvalho, ECLI:EU:C:2021:252, in which the CJEU denied the appellant’s claim due the lacking individual concern. The concept of “individual concern” under Article 263(4) TFEU is different from the concept of “direct concern” developed by the CJEU with regard to the establishment of individual rights in the framework on ambient air quality. See Giera (2021), pp. 106 ff. 81 CJEU, joined cases C-165/09 to C-167/09, Stichting Natuur en Milieu, ECLI:EU:C:2011:348. 82 Giera (2021), p. 136. 83 See Art 1 and 4 ESR. 84 Schulev-Steindl et al. (2020), p. 14. 80

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to doing away with the discretion” granted by the respective Secondary Law act.85 However, one may argue that the ESR provisions provide for a right to require the enactment of appropriate and effective measures, which ensure compliance of the relevant Member State with its GHG reduction obligations. This would not amount to doing away with the Member State’s discretion granted by the ESR. Which appropriate and effective measures are to be implemented, is left to the discretion of the Member State. In temporal terms, this individual right would arise when evidence-based forecasts indicate that the respective Member State will probably fail to meet its GHG reduction obligations (taking into account the flexibilities in Art 5, 6 and 7 of the ESR). In accordance with Article 288(2) TFEU, domestic courts must apply such right as a right granted by national law.

2.2.3

Interim Conclusion

Given the findings of this chapter, one may argue that the ESR confers certain individual rights on natural and legal persons directly concerned by a potential infringement of the GHG reduction obligations set out therein. When determining the scope of the Member State’s obligations and thus the scope of the said individual rights, one has to acknowledge that the Member State’s GHG reduction obligations are subject to the flexibilities provided for in Articles 5, 6 and 7 of the ESR. The scope of individual rights under the ESR is limited since the ESR itself grants the Member States a broad level of discretion when choosing the measures to fulfil their binding GHG emission reduction targets. However, one has to bear in mind that the level of discretion to regulate the GHG emission reduction measures in the non-ETSsectors may be limited in other sources of Secondary Law.86 In line with the jurisdiction of the CJEU concerning the creation of individual rights in regulations,87 the design and enforcement of specific national application measures is left to the Member State’s discretion.88 For instance, the ESR does not allocate the particular level of (annual) GHG reduction obligations within the non-ETS-sectors for each Member State. In the light of the ESR’s framework-setting character, it is in the Member State’s responsibility to decide whether or not and in which way to stipulate sectoral GHG reduction obligations (as long as the overall reduction obligation as set out in the ESR is achieved). It is thus not possible to require the issuing of specific national policies based on individual rights derived from the ESR. Rather, Member States are called upon to grant individual rights that allow for the

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CJEU, case C-216/02, Zuchtverband für Ponys, ECLI:EU:C:2004:703, para. 36. According to Article 6(5) of the Regulation (EU) 2018/858, Member States shall not prohibit the placing on the market, the registration or the entry into service of vehicles, systems, components or separate technical units that comply with the Regulation. 87 CJEU, case C-403/98, Monte Arcosu, ECLI:EU:C:2001:6, paras. 26 f. 88 See CJEU, case C-251/91, Teulie, ECLI:EU:C:1992:430, paras. 13 f. 86

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enforcement of specific national policies as individual rights from the ESR can only be invoked for enforcing the overall binding GHG reduction targets. The German legislator confirms this very “Member State-centred” notion: The German Federal Climate Change Act provides for national application measures and sets out annual GHG reduction obligations for the non-ETS-sectors. However, it outlines that no individual rights arise from the provisions of the German Federal Climate Change Act.89 If one acknowledges the above presented legal distinction between – individual rights to require compliance with the overall GHG reduction obligations as set out in the ESR and – individual rights to require specific national application measures, this very right’s exclusion on the national level does not hinder persons directly concerned by a potential infringement of the GHG reduction obligations from deriving individual rights from the ESR, albeit to a limited extent necessary to ensure effective and efficient enforcement of the Member State’s GHG reduction obligations. The acceptance of such individual right would not amount to doing away with the Member State’s discretion granted by the ESR. With regard to the present lawsuit, it is therefore valid to conclude that the requested measure—a specific sales ban on fossil fuels—is not covered by the individual right to require the competent national authority to implement appropriate and effective measures granted under the provisions of the ESR.

2.3

Interplay Between Individual and Fundamental Rights

In light of fundamental rights guaranteed in the Charta of Fundamental Rights (CFR) and the European Charta of Fundamental Rights (ECHR) and the (Member) State’s respective positive obligation to mitigate climate change effects,90 one might question the relevance of individual rights derived from EU Secondary Law. The (Member) State has a duty to prevent dangerous climate change effects both based on individual rights and fundamental rights; still, significant differences with regard to the nature, function and content of the respective rights obtain. The initial aim and objective of fundamental rights is to protect the individual,91 whereas EU individual rights—apart from protecting the individual—also serve to galvanise European citizens for furthering the enforcement of Union law, thereby ensuring the “effet 89

See the last sentence of Article 4(1) German Federal Climate Change Act. Positive obligations arguably oblige the state to comply with the Paris temperature target, compare Voigt (2022), p. 152. 91 Fundamental rights constitute fundamental legal positions that are essential for the equal recognition and development of the individual in a complex, multi-layered society; they primarily protect the individual and—in certain instances—also legal persons and groups (e.g. right to property, freedom of assembly), see Berka et al. (2019), pp. 3f. 90

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utile” of Secondary Law.92 In that sense, EU citizens act as proxies for guaranteeing Member State’s compliance with EU acts.93 This vertical control function shall complement the European Commission’s control duties.94 In substantive terms, fundamental rights provide protection against dangerous climate change effects that threaten and violate fundamental rights.95 Corresponding State obligations emerge irrespective of climate protection standards in EU Secondary Law and might entail a higher level of protection than the ESR, if the latter’s mitigation obligations prove insufficient to effectively protect fundamental rights. The necessity of higher standards may (also) emerge from the intertemporal nature of fundamental rights. Quite recently, the German Constitutional Court declared fundamental rights to be “intertemporal guarantees of freedom”96 which “afford protection against the greenhouse gas reduction burdens [. . .] being unilaterally offloaded onto the future”.97 Fundamental rights thus require an early formulation of GHG reduction pathways up to the achievement of climate neutrality to provide orientation for “development and implementation processes”.98 From an intergenerational perspective, fundamental rights may necessitate higher GHG reductions until 2030 than the ESR provides in order to avoid “offloading” onto the future. Individual rights from the ESR, in contrast, are limited in terms of content and time. Due to the framework-setting character of the ESR, individual rights solely allow for the enforcement of the binding GHG reduction targets specified therein. However, as shown above, one cannot require the Member States to implement specific national GHG reduction measures on this basis. In contrast, other climaterelated Secondary Law acts may confer more extensive rights on individuals.99 The anchoring of climate-related individual rights at the national level yields significant benefits: It provides concretisation and legal certainty with regard to the admissibility of claims (e.g. in case of exceedance of annual/sectoral reduction targets), assertable claims and their legal form (e.g. adoption of an immediate action

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Müller (2020), pp. 295 (305). Giera (2021), p. 45. 94 CJEU, case 26/62, van Gend & Loos, ECLI:EU:C:1963:1, p. 26. 95 Knox (2009), p. 163. 96 BVerfG 24 March 2021, 1 BvR 2656/18 et al., recital 122, 183. 97 BVerfG 24 March 2021, 1 BvR 2656/18 et al., recital 183. 98 BVerfG 24 March 2021, 1 BvR 2656/18 et al., recital 249. 99 For instance, the Renewable Energy Directive may grant such rights (in future). The European Unions published a proposal on the amendment of the Renewable Energy Directive (COM/2022/ 222 final). The proposal entails a provision, according to which Member States shall adopt plans designating so-called “renewables go-to areas”. One could argue that concerned individuals may have the right to require the adoption of such plan, when Member States fail to meet their adoption obligation. 93

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programme) as well as the relevant procedure.100 It remains at the national legislator’s discretion to provide for such national legal basis. Despite substantive limitations, individual rights constitute a significant addition to fundamental rights. Although the latter confer more far-reaching protection against dangerous climate change effects, their practical enforcement has proven difficult. Respective litigation efforts have often failed due to strict admissibility criteria and problems in attributing climate change effects.101 Meanwhile, individual rights, though limited, may constitute key instruments for guaranteeing the implementation of EU reduction obligations, especially when they are anchored at the national level.

3 Restrictions on Trade-Related Climate Protection Measures 3.1

Preliminary Remarks

Section 2 has shown that individual rights can, in principle, be deduced from the climate protection framework enshrined in EU Secondary Law. However, higherranking (economic) law may limit the very State’s discretion with respect to climate protection measures adopted in fulfilment of those individual rights. In this context, the General Agreement on Tariffs and Trade (GATT) and the free movement of good under the Treaty on the Functioning of the European Union (TFEU) are of particular interest. Prior to looking at the required sales ban in the light of the said higher-ranking law in detail, it is necessary to outline the following: Notably, a sales ban is by far not the only means appropriate to achieve national GHG reductions. As far as the perspective of trade is concerned, a range of other less intrusive measures has been widely discussed and partly introduced.102 However, one has to acknowledge that climate protection measures have so far led to little success—at least in Austria, where GHG emission levels have not sustainably declined between 1990 and 2019.103 Against this background, one may ask for more ambitious or even drastic measures. A general prohibition on the sale of fossil fuels would undoubtedly constitute such a rigorous measure, though such prohibition comes with some 100 Compare, for example, the German Federal Climate Change Act 2021, Federal Law Gazette I Nr. 59, Section 4 in conjunction with Annex 2 and Section 8. 101 On this issue and possible solutions compare Stuart-Smith et al. (2021), p. 651. 102 Such measures include, for example, carbon pricing (either introduced through emission trading (“cap and trade”) or carbon taxation, possibly combined with a carbon border adjustment mechanism), subsidies for green energy sources, use of carbon capture technologies, establishment of carbon sinks or other, less-intrusive, regulatory measures. See in this context, Hufbauer (2021) and Tamiotti et al. (2009). 103 See the chart on p. 11 of Kirchengast et al. (2020).

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legal and practical obstacles. First and foremost, the adoption of a mere sales ban without additional climate protection measures (e.g., a ban on the extraction, importation or burning of fossil fuels) may open considerable loopholes: Citizens could resort to purchasing fossil fuels for domestic use abroad (“fuel tourism”) and companies may continue to import fossil fuels for combustion in Austria or may relocate their production facilities to third countries (“carbon leakage”104). As a consequence, the purpose of a large-scale GHG emission reduction would be jeopardised. In the present case, the claimants did not address this economic and legal issue. Supposedly, they opted for the sales ban for strategic reasons and due to relevant legal framework. They based their claim on Art 69 Austrian Trade Regulation Act pursuant to which the competent authority may issue ordinances concerning measures tradesmen shall take with regard to the goods they produce or sell.105 In the past, this provision has been invoked, amongst other things, to issue ordinances that ban heating oil with a certain amount of sulphur.106 Therefore, Article 69 Trade Regulation Act may serve as a ground to issue a sales ban for goods with a particular composition by means of an ordinance to avoid threats to life and health of people or to prevent environmental degradation. According to the applicants, climate change poses a threat to life and health of people living in Austria; as it is mainly caused by the combustion of fossil fuels, the competent authority should prohibit the sale of those “dangerous materials” for all sectors—thus far the claimant’s argument.107 A respective ordinance—had it been issued by the competent Minister—would have come with some limitations: It would be directed at and binding only for tradesmen,108 who would be required to refrain from selling fossil fuels. It goes without saying that Article 69 Trade Regulation Act cannot be invoked for the adoption of measures binding for the general public. A general ban on the combustion of fossil fuels, for example, would require legislative action rather than mere issuing of ordinances by administrative organs.109 The claimants nonetheless relied 104 Carbon leakage occurs if, due to costs associated with climate protection measures, businesses relocate production to other countries with laxer emission constraints; see: European Commission (2022). The Directive 2003/87/EC (“Emissions Trading Directive”) addresses the risk carbon leakage by allowing the Member States to apply the free allocation of emission allowances to a certain extent. 105 Haumer and Lindner (2015), pp. 1 ff. 106 Ordinance on the limitation of the sulphur content of heating oil, Federal Law Gazette 1989/94 as amended by Federal Law Gazette 1994/545. 107 In the context of sales bans, one has to distinguish between product requirements and related sales bans on the one hand and absolute bans on certain product groups on the other hand. For example, the EU takes the former approach in regulating the CO2 emission performance standards for new passenger cars and for new light commercial vehicles in the Regulation (EU) 2019/631. Adversely, the claimants took on the latter approach in the present climate litigation effort and requested an absolute sales ban on fossil fuels. 108 This is clear from the wording and purpose of Art 69(1) Trade Regulation Act; for a detailed analysis of this provision see: Haumer and Lindner (2015), pp. 1 ff. 109 See in detail Klaushofer (2021); Czech (2021); Berka (2022), pp. 546 ff and 554 ff.

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on Article 69 Trade Regulation Act. The reason for this could be the lack of legal protection against insufficient climate protection measures by the Austrian State.110 Should the claimants be successful, it would be necessary for the sake of legal certainty and coherence to create a comprehensive legal framework for phasing out fossil energy. This assumption will underlie the following analysis, as a sales ban will most likely achieve profound GHG emission reductions only when combined with a ban on the import and combustion of fossil fuels.111

3.2

Conformity with WTO Law

Modern world trade law traces back to the post-World War II era. Back then, the liberalisation of international trade was perceived to have mutually beneficial effects for international security and the global economy. This led to the adoption of the GATT, which constitutes the main agreement governing international trade in goods112 and might thus be relevant in the context of national bans on the sale of fossil fuels.113 The core objectives of the WTO, namely the prevention of protectionism and the furthering of trade liberalisation, manifest in two of the GATT’s guiding principles:114 non-discrimination and elimination of quantitative restrictions. Even though WTO members may determine their own environmental objectives,115 trade-related environmental measures might require justification for being inconsistent with the said rules.116

3.2.1

Violation

The present claim seeks to implement a sales ban on fossil fuels. It is crucial to first clarify whether this measure falls within the scope of the non-discrimination

110

See the chart on p. 11 of Kirchengast et al. (2020). Since the EU emission reduction framework for the EU-ETS is a market-based mechanism, the introduction of a statutory ban on the combustion of fossil fuels in the relevant sectors might be incoherent. The Austrian Emission Trading Act, which transposes the provisions of Directive 2003/ 87/EC (“Emissions Trading Directive”), allows the competent authority to implement GHG emission limits for direct emissions only in certain environmental pollution scenarios. 112 Lester and Mercurio (2008), p. 66. 113 It has been argued that energy has the elements of both goods and services. This distinction is particularly relevant under WTO law as “goods” fall within the scope of the GATT whereas “services” are covered by the GATS. With regard to (extracted and tradable) oil, gas and coal, it has been argued that they constitute “goods” in the sense of the GATT, see Cottier et al. (2011), pp. 213 f; Marhold (2021), p. 89; World Trade Organization (2022), p. 13, paras. 51 f. 114 Birnie et al. (2009), p. 757. 115 This was highlighted by the Appellate Body in US – Gasoline, p. 30. 116 On this issue see Cosbey and Mavroidis (2014), pp. 288 ff; Bäumler and Dorwig (2022), p. 38. 111

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principles or the prohibition of quantitative restrictions. While Article XI GATT is generally understood to cover only measures imposed at the border of a member, Article III GATT relates to internal measures that discriminate against foreign products.117 Article V GATT could further be relevant in this context. It guarantees freedom of transit of goods through the territory of one WTO Member to another and—in a broad understanding—covers transportation of energy through fixed infrastructures such as pipelines.118 However, for the sake of length, further elaborations on Article V GATT will not be conducted here. Non-Discrimination Formally speaking, a sales ban poses an internal measure as the import of fossil fuels to Austrian territory is still permitted, whereas the sale within the Austrian territory is prohibited.119 It is thus necessary to examine whether the requested measure violates the principles of non-discrimination. Both, a violation of Article I (“MFN principle”) or of Article III (“NT principle”) are conceivable. In essence, while the MFN principle prohibits discrimination between like products stemming from different Members by means of national measures,120 the NT principle requires that national regulatory measures to treat imported products no less favourable than like domestic products.121 In short, the following criteria are relevant in both cases: 1. National measure122 2. Like products (either like domestic and imported products or like imported products from different Members) 3. Discrimination (de jure or de facto) If the sales ban in question was to be adopted by an ordinance or law, it would constitute a regulatory measure covered by Article I and Article III:4 GATT.123 The sales ban would also affect internal trade in the most drastic way possible, namely by prohibiting it completely.

117

See on this distinction: Lester and Mercurio (2008), p. 262. Marhold (2021), pp. 73 f. 119 Naturally the attractiveness of importing fossil fuels to Austria decreases considerably when imported goods cannot be sold on Austrian territory; this will be discussed later. 120 In more detail see: Lavdari (2021), pp. 16–29. 121 A violation of Art III:2 GATT does not occur as the measure at hand does not constitute a tax measure; however, a violation of Art III:4 GATT is possible—it occurs if a regulatory measure grants less favourable treatment to imported products than to like domestic products so as to afford protection to domestic production; in more detail see: Ming Du (2015), pp. 139–163. 122 Article III:4 GATT refers to regulatory measures whereas Art I GATT has a broad scope and refers to “duties and charges of any kind” as well as to “all rules and formalities in connection with importation and exportation” and all measures covered by Art III:2 and Art III:4 GATT, see Lester and Mercurio (2008), p. 324. 123 Article III:4 GATT explicitly refers to regulatory measures and the MFN principle in Art I GATT is understood to cover such measures. 118

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Next, one must observe whether the affected products—fossil oil, gas and coal from different origin—constitute like products. The analysis of likeness involves consideration of the following factors: (1) physical properties, (2) end-uses, (3) consumer tastes and habits and (4) tariff classification.124 Thereby, likeness is to be examined on a case-by-case basis.125 In this reading, imported and domestic coal, oil and gas constitute like products126—their physical properties and end-uses are similar, as are respective consumer’s tastes and habits.127 Furthermore, a violation of Article I or Article III:4 GATT only occurs in case of a discrimination. A de jure discrimination can be ruled out as the sale of fossil fuels shall generally be prohibited regardless of the country of origin. De facto discrimination requires that formally equivalent rules result in “less favourable treatment” of imported products compared to domestic products or a discrimination of products from certain Members compared to those of other Members. A look at the energy statistics for Austria128 reveals that in 2020, oil gas and coal constitute the major components of the Austrian energy supply—in total, they account for roughly 64% of gross domestic energy consumption. Thereby, majority of fossil energy sources consumed in Austria in 2020 were imported: In the case of oil, 566.1 PJ of imports compared with domestic production of 23.9 PJ; similarly, 572.6 PJ of imported gas compared to only 26.4 PJ of domestic gas. The comparably lower consumption of coal of 98.8 PJ was even covered 100% by imports.129 In 2020, oil was imported to Austria from a total of 16 countries. Thereby, the main suppliers were Kazakhstan (2.7 million tonnes or 36.6% of total oil imports130) followed by Iraq and Russia.131 In light of this, one may conclude that a violation of the non-discrimination principles occurs as imported products—due to their larger share in total consumption— are de facto more affected by the measure than domestic products. Simultaneously, countries that export high quantities of fossil fuels to Austria will be affected more severely than countries that export little or no fossil fuels to Austrian territory.

This definition of likeness was adopted by the Appellate Body in EC – Asbestos, see the Report, para. 101; see further Tamiotti et al. (2009), pp. 106 f; Lester and Mercurio (2008), p. 319. 125 EC – Asbestos, para. 101. 126 Naturally, products can only be considered “like” in their group, meaning that e.g. domestic and imported gas constitute “like products” and so on. 127 Likeness of fossil fuels and renewable energy sources, such as solar energy or hydropower cannot be established. Likeness appears arguable with regard to the final product “electricity”: Electricity from fossil fuels and electricity from renewable sources might be considered as “like”. However, as to primary energy sources, “likeness” can be ruled out with a view to differing physical properties (water or wind can hardly be considered “like” fossil oil or gas), but also with a view to energy generation. While energy from fossil fuels is obtained through combustion, combustion processes are not involved in the generating of energy from water, wind or the sun. 128 Federal Ministry for Climate Protection (2021). 129 Federal Ministry for Climate Protection (2021), pp. 56–48. 130 See Schlager (2022). 131 Federal Ministry for Climate Protection (2021), p. 38. 124

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However, the general aim of the non-discrimination principles is to provide equal market opportunities for products, independent of their origin. Those market opportunities will be reduced to “zero” once the sale of fossil fuels is prohibited. It could therefore be argued that a discrimination does not occur as there are no protectionist intentions or effects.132 Prohibition of Quantitative Restrictions In terms of the effects, a general ban on the sale of fossil fuels may pose a similar restriction as an import ban.133 It thus appears worth asking whether a sales ban might amount to a violation of Article XI GATT. In this context, Lester/Mercurio adopted a broad understanding of quantitative restrictions:134 as suggested by the Panel in India – Auto, Article XI GATT shall apply not only to border measures in the strict sense. Instead, it is the “nature of the measure as a restriction in relation to importation which is the key factor to consider in determining whether a measure may properly fall within the scope of Article XI:1”135 In this understanding, the sales ban would fall within the scope of Article XI:1 and thus violate it. This is because a sales ban constitutes an import restriction (in the broader sense) other than a duty, tax or charge, which is made effective through “other measures”, namely a prohibition of the sale of fossil fuels. As shown above, in order to implement coherent framework aimed at achieving drastic GHG emission reductions, it would be necessary to not only implement a sales ban, but also a ban on the import of fossil fuels and their combustion within the Austrian territory. Given such comprehensive framework, Article XI GATT may be violated. In fact, an import ban as part of this comprehensive framework would be the “most obvious type of measure covered”136 by Article XI GATT. However, such violation may be justified due to the following reasons.

3.2.2

Justification

As indicated above, national bans on the sale of fossil fuels could violate either the non-discrimination principles or the prohibition of quantitative restrictions. Such violation might be justified under the general exceptions of Article XX GATT, which allow Members to act inconsistently with the GATT to pursue certain policy goals.137 If a certain measure falls within one of the listed exceptions, it is

132

See on this question Kluttig (2003), pp. 15 ff. Of course, when introducing sales, but not import bans, the imported goods could still be used by the importing person. However, the sale of the imported goods would be prohibited. This would pose a significant obstacle to the current value chain. 134 Lester and Mercurio (2008), p. 262. 135 See the Panel Report India – Auto, para. 7.261. 136 Lester and Mercurio (2008), p. 262. 137 In US – Gasoline, the Appellate Body held that Members “have a large measure of autonomy to determine their own policies on the environment [. . .], their environmental objectives and the 133

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“provisionally justified”. Further, it must satisfy the terms of the “chapeau”—this introductory clause to Art XX provides that a measure, even if it falls under one of the exceptions of Article XX GATT, would be illegal if it constitutes “a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail or a disguised restriction on international trade”.138 In the environmental context, two of the exceptions listed in Article XX GATT are particularly relevant: “Measures that are necessary for protecting human, animal or plant life or health” fall under the exception of lit (b), whereas “measures relating to exhaustible natural resources” are covered by lit (g).139 In the following, it shall be scrutinized whether or not one of the said exceptions would apply. Measures Necessary for Protecting Human, Animal or Plant Life or Health For a measure to fall under Article XX (b) GATT, the following criteria must be met:140 1. Measure protects human, animal or plant life or health 2. Measure necessary for this purpose (“necessity”) 3. Consistency with the chapeau The broad concept of “measures protecting life or health” seems to be predestined for environmental protection measures, which tend to pursue at least one of the mentioned objectives. The measure at hand, a sales ban on fossil fuels, seeks to prevent dangerous climate change, which threatens the life of humans, animals and plants.141 It would thus constitute a measure that protects human, animal or plant life. Necessity of a measure is determined by a weighing and balancing process, which considers (a) the relative importance of the common interest or value pursued by the measure, (b) the contribution made by the measure to the realisation of the ends pursued by it and (c) the restrictive impact of the measure on international commerce.142 Then, a comparison between the challenged measure and possible alternatives has to be conducted. Together, the weighing and balancing and the comparison determine whether the measure is necessary or whether another WTO-consistent measure is reasonably available.143 In the case at hand, the

environmental legislation they enact and implement”, of course, provided that the requirements of GATT are respected, see the Appellate Body report, p. 30. 138 Article XX GATT; for further information on the chapeau see Bartels (2017), pp. 95–125. 139 For an overview of environmental disputes see: World Trade Organization (2022). 140 Lester and Mercurio (2008), p. 390; Birnie et al. (2009), p. 760. 141 Climate change will cause the extinction of one-third of Earth’s animal and plant species by 2050, if current GHG emission trajectories continue; it is projected that between 2030 and 2050 climate change will cause about 250,000 additional deaths per year; see: Center for Biological Diversity (2022) and World Health Organization (2022). 142 Tamiotti et al. (2009), p. 108; Appellate Body Report in Korea – Various Measures on Beef, paras. 163–164; Appellate Body Report in Brazil – Retreaded Tyres, para. 178. 143 Brazil – Retreated Tyres, para. 178.

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importance of the common interest pursued is conceivably high: climate change constitutes the biggest threat to human life144 and causes mass extinction of animal and plant species.145 If the required sales ban is embedded in a comprehensive framework, it would entail a drastic reduction in (national) GHG emissions.146 The restrictive impact is a drastic one as trade in fossil fuels would be prohibited completely. When comparing the comprehensive prohibition of fossil fuels to other measures available, one has to acknowledge, that—as of today—other less intrusive measures are available for pursuing the goal of GHG emission reduction. Such measures could include a comprehensive system of carbon pricing either through an emissions trading scheme or through carbon taxation,147 (other) regulatory measures, the creation of extensive carbon sinks148 or the use of carbon capture technologies.149 As such measures would partly not fall within the scope of WTO law or would at least be less inconsistent with the GATT than a comprehensive prohibition of trade in fossil fuels, one has to conclude that the said sales ban is not “necessary” and therefore does not fall under the exception of lit (b). Naturally, this assessment may change as climate change progresses. A phasing out of fossil fuels followed by a prohibition of their usage is inevitable. Yet, from the perspective of world trade law, a globally coordinated effort would, apart from greater efficiency, prove less problematic than unilateral measures. Measures Relating to the Conservation of Exhaustible Natural Resources In order to fall under Article XX (g) GATT, the measure in question must meet the following four criteria: 1. Measure concerns conservation of exhaustible natural resources 2. Measure related to conservation of resource in question150

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United Nations (2021). Center for Biological Diversity (2022). 146 According to our World in Data, the overwhelming majority of CO2 emissions in Austria stem from the burning of coal, oil and gas; from a global perspective, the reduction of GHG emissions would be relatively small as in 2020, Austria only accounted for 0.32% of global CO2 emissions; see Ritchie and Roser (2020). 147 The idea behind carbon pricing is to internalise the environmental costs of GHG emissions by setting a price on such emissions either my means of a carbon tax or by a “cap and trade” system. In the latter case, a cap on total emissions is fixed which then translates into emission allowances that can be traded on an allowance market. See in more detail Tamiotti et al. (2009), pp. 88 ff. 148 A carbon sink is “anything that absorbs more carbon from the atmosphere than it releases”; carbon sinks include, for example, plants, soil or the ocean, see ClientEarth (2020). 149 The geological storage of carbon dioxide is regulated in the Directive 2009/31/EC. According to its Article 4, it is within the Member States discretion to not allow any storage in the whole of their territory. 150 According to the Appellate Body, the means must be reasonably related to the ends, see US – Shrimp, para. 141. 145

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3. Measure made effective in conjunction with restrictions on domestic production or consumption151 (“even-handedness”-requirement) 4. Consistency with the chapeau The content of exhaustible natural resources is understood to be non-static and broad: Living and non-living resources are covered and the resource at issue does not need to be rare or endangered to be considered exhaustible.152 In the present case, one might suggest that the sales ban relates either to fossil fuels or to clean air153 and the atmosphere.154 Even though a sales ban would lead to a decrease in extraction and combustion of fossil fuels, the conservation of these resources is not the primary aim. The measure rather seeks to protect life and health from the adverse impacts of climate change. Climate change results from the large-scale combustion of fossil fuels, which leads to the release of GHG emissions into the atmosphere. The natural resource protected by the sales ban in question could thus arguably be clean air or the atmosphere rather than the fossil fuels. A measure “relates to” the conservation of exhaustible natural resources, if the means and ends of the measure are reasonably related.155 It has to be determined whether the design and structure of the measure are closely related to its goal.156 This analysis is naturally not possible in the present case—the discussion remains hypothetical, as a sales ban on fossil fuels has not been adopted yet. However, some of the general realisations mentioned above might guide such analysis: Not only is the prevention of dangerous climate change a common objective of the global community and the call for urgent mitigation efforts supported by scientific evidence, but the measure in question is also related to that goal. A departure from the practice of burning fossil fuels for energy purposes would considerably lower GHG emissions. Depending on the concrete design and structure of the respective legislative framework, one might argue that it is “not disproportionally wide in scope and reach in relation to the policy objective”157 and thus pass the “means-ends” test. The “even-handedness” requirement demands that the sales ban is made effective in conjunction with restriction on domestic production or consumption. Accordingly, the Member must impose restrictions on both imported and domestic goods.

151

The so-called even-handedness requirement requires a certain amount of even-handedness but not identity of treatment; instead, restrictions either on domestic production or consumption are satisfactory, see the Appellate Body Report in US – Gasoline, p. 21; Birnie et al. (2009), p. 773. 152 See the Appellate Body report in US – Shrimp, paras. 130–131. 153 In US – Gasoline the Panel found that “clean air” constitutes an exhaustible natural resource, see the Panel report, para. 6.37; accordingly, Marhold (2021), p. 78 argued that measures inconsistent with the GATT that promote clean air and curb CO2 emissions may be justified under Art XX (g) GATT. 154 Already in 2007, Pauwelyn suggested that “it would be surprising if the WTO would not accept that the planet’s atmosphere [. . .] is an “exhaustible natural resource”, see: Pauwelyn (2007), p. 35. 155 See the Appellate Body report in US – Shrimp, para. 383. 156 US – Shrimp, para. 141. 157 US – Shrimp, para. 141.

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Thereby, identity of treatment is not required; restrictions have to be imposed on either domestic production or consumption.158 This criterion would not pose any problems, as the sale, import and combustion of fossil fuels is to be banned for imported and domestic products alike. Depending on the outcome of the means-ends test, the measure would be “provisionally justified”. The Chapeau For a justification under Article XX GATT, the measure must further satisfy the terms of the chapeau. Thus, it must not be applied “in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade”. According to this wording, the chapeau rather refers to the manner of application than to the concrete content or design of a certain measure. It entails the principle of good faith.159 Thereby, the discriminatory element under Article XX GATT differs from discrimination under the general principles. The general logic of GATT suggests that a measure is discriminatory under Article I or Article III GATT, but still is consistent with the chapeau.160 In this respect, Lester/Mercurio suggest that discrimination under Article III only requires “discriminatory effect”, whereas discrimination in the sense of Article XX GATT requires “discriminatory intent” as well.161 In this reading, an appropriate design and employment of the sales ban could most likely avoid the intended discriminatory application of the measure. A disguised restriction on international trade occurs when a measure that falls under Article XX (a)–(j) GATT seeks to protect domestic production. A final assessment is naturally not viable without presence of the—merely hypothetical—measure. However, one may conclude that the chapeau does not constitute a general obstacle to the justification of an environmentally motivated sales ban on fossil fuels.

3.2.3

Interim Result

In principle, the WTO allows its Members to determine their national level of (environmental) protection. However, any national measure that interferes with GATT principles requires justification. Thereby, the general exemptions provided in Article XX lit. (b) and (g) GATT are of particular relevance in the environmental context. The threshold for justification in lit. (g) is comparably low, since measures only are required to relate to the protection of exhaustible natural resources. The term

See the Appellate Body Report US – Gasoline, p. 21; Birnie et al. (2009), p. 773. Appellate Body in US – Shrimp, para. 158; the principle of good faith prohibits abuse of the exceptions in Article XX GATT, see Kluttig (2003) p. 24. 160 See Lester and Mercurio (2008), p. 388. 161 Lester and Mercurio (2008), p. 414. 158 159

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“exhaustible natural resources” has been interpreted broadly. Therefore, the exemption under Article XX lit. (g) provides a possible justification for trade-related climate protection measures.

3.3

Conformity with EU Primary Law

The European Union, with its predecessors founded in the aftermath of World War II,162 builds upon the notion that economic integration secures peace. Accordingly, its founding treaties establish the European internal market.163 This market builds upon the fundamental freedoms that ensure the free movement of goods, persons, services and capital and guarantee the right of establishment in other Member States. Austria is a Member State of the European Union and as such, it is bound by European Law. A violation of European Law in any legislative or other regulatory projects might result in infringement proceedings.164 In the present case, one has to consider whether a comprehensive ban on the sale of fossil fuels would infringe the free movement of goods under Article 34 TFEU. The said fundamental freedom prohibits quantitative restriction on imports and exports as well as all measures having equivalent effect.165 In the spirit of free competition, it aims at providing equal and unhindered market access for domestic and foreign EU products.166

3.3.1

Free Movement of Goods

If the requested sales ban were in force, the scope of application of the free movement of goods would be opened: Fossil fuels—like electricity and gas—are “goods” within the meaning of EU law, i.e., “products which can be valued in money and which are capable, as such, of forming the subject of commercial transactions”.167 A cross-border element168 is also undoubtedly present, as fossil fuels are

162 The European Coal and Steel Community was founded as early as 1951, in 1957, the European Energy Community (Euratom) and the European Economic Community (EEC) followed, see Kaczorowska (2011), pp. 2 ff. 163 Articles 26–28 TFEU. 164 On the infringement proceedings see Article 258 f TFEU; Frenz (2010), pp. 739 ff; Harratsch et al. (2020), recital 507 ff. 165 Articles 34–46 TFEU; Frenz (2012), p. 259. 166 See Piska (2019), recital 2. 167 CJEU, case 7/68, Commission v Italy, ECLI:EU:C:1968:51. 168 According to CJEU, case 8/74, Dassonville, ECLI:EU:C:1974:82, para. 5, a cross-border element is present whenever a measure is capable of either “directly or indirectly, actually or potentially” hindering intra-EU trade.

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regularly transported across internal borders.169 Further, the requested sales ban would be an act attributable to the Austrian State, irrespective of whether it would ultimately be enacted as a legislative act or as an administrative decision.170 In concrete terms, the sales ban constitutes a measure of equivalent effect as it does not prohibit the import of certain products but only their sale. According to the CJEU’s Dassonville formula, a measure of equivalent effect exists if a (trade) regulation of the Member States is “capable of hindering, directly or indirectly, actually or potentially, intra-Community trade”.171 As to a sales ban, this would clearly be the case—trade in fossil fuels is directly affected, and a sales ban might even represent the most restrictive measure a Member State can take.172 Thereby, it is irrelevant whether the sales ban would bind domestic and foreign suppliers equally, since non-discriminatory measures that hinder market access still constitute measures of equal effect.173 Other than that, a general sales ban does not merely regulate sales and distribution modalities.174 Therefore, it is valid to conclude that the adoption of the sales ban would constitute an interference with Article 34 TFEU.

3.3.2

Justification

However, like all fundamental freedoms, the free movement of goods is not absolute—interferences can be justified under certain conditions. According to Article 36 TFEU, the free movement of goods shall not preclude quantitative restrictions or measures of equivalent effect that serve the “protection of health 169

According to Statista (2022a), Austria imported roughly 60% of its energy in 2020, fossil fuels (oil, gas and coal) accounted for approximately 90% of those imports, see Statista (2022b). 170 In this regard, the CJEU takes a broad interpretation. In essence, it acknowledges that acts of legislative, judicial and administrative bodies are attributable to the Member State and may as such violate the free movement of goods; see Commission Notice, Guide on Articles 34–46 of the Treaty on the Functioning of the European Union (TFEU) 2021/C 100 100/03, p. 6, https://eur-lex.europa. eu/legal-content/EN/TXT/PDF/?uri=CELEX:52021XC0323(03)&from=EN (last accessed 29 June 2022). 171 CJEU, case 8/74 Dassonville, ECLI:EU:C:1974:82, para. 5. 172 Commission Notice Guide on Articles 34–46 of the Treaty on the Functioning of the European Union (TFEU) 2021/C 100 100/03EU, p. 15. 173 CJEU, case 120/78, Rewe Zentrale v Bundesmonopolverwaltung für Branntwein, ECLI:EU: C:1979:42. 174 According to the CJEU’s landmark judgment Keck and Mithouard, sale and distribution modalities do not constitute measures of equivalent effect. By restricting its earlier Dassonville judgement, the CJEU held that “the application to products from other Member States of national provisions restricting or prohibiting certain selling arrangements is not such as to hinder directly or indirectly, actually or potentially, trade between Member States within the meaning of the Dassonville judgment (Case 8/74 [1974] ECR 837), so long as those provisions apply to all relevant traders operating within the national territory and so long as they affect in the same manner, in law and in fact, the marketing of domestic products and of those from other Member States”; see CJEU, joined cases C-267/91 and C-268/91, Keck and Mithouard, ECLI:EU:C:1993:905, para. 16.

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and life of humans, animals or plants”.175 Moreover, the CJEU recognised environmental protection as a “mandatory requirement” as it is “one of the [Union’s] essential objectives, which may as such justify certain limitations of the principle of free movement of goods”.176 Interference with the free movement of goods can thus be justified. Whether the requested sales ban would be justified has to be determined by means of the proportionality test.177 There is scientific consensus of the climate crisis being man-made. GHG emissions, which are released in particular by the combustion of fossil fuels, are mainly responsible for the global rise in temperature.178 Climate change leads to a variety of adverse effects on humans, animals and plants, and the environment as a whole, which is why swift and decisive action is required. Against this background, one may argue that the State is obliged to implement drastic measures to prevent the climate crisis.179 A ban on the sale of fossil fuels would certainly accelerate the reduction of GHG emissions in Austria and thus contribute to combating the climate crisis.180 Consequently, it can be assumed that it is fundamentally suitable for achieving the goal. Hence, the appropriateness of the measure is given. However, it is crucial to bear in mind that the CJEU has so far assessed the necessity of sales bans, which constitute particularly strong encroachments on the free movement of goods, rather restrictively.181 The court has regularly denied the proportionality of a measure if less intrusive alternatives are available for achieving the objective in question.182 This cannot be ruled out in the case of the requested sales ban, as one might argue that, as of today, other less restrictive measures are available for the protection of human, animal and plant life

175

Article 36 TFEU. CJEU, case 302/86, Commission v Denmark, ECLI:EU:C:1988:421, para. 8. 177 The proportionality test requires a measure to be appropriate (measure suitable for attaining the desired objective) and necessary (measure does not restrict free movement of goods more than necessary); further, Member States are required to pursue the stated objectives in a “consistent and systematic manner”; see e.g. CJEU, case C-320/03, Commission v Austria, ECLI:EU:C:2005:684, para. 85 and CJEU, case C-319/05, Commission v Germany (Garlic), ECLI:EU:C:2007:678, para. 87; for further information see Harbo (2015), pp. 20 ff. 178 For an overview of the development of CO2 and other GHG emission levels and their impacts see https://ourworldindata.org/co2-and-other-greenhouse-gas-emissions (last accessed 29 June 2022). 179 See for example Mayer (2019), pp. 107–121; he discusses how the State’s mitigation obligation under international and domestic law can be interpreted and thereby distinguishes between the top-down and bottom-up approach. 180 For an overview of CO2 emission levels in Austria see Ritchie and Roser (2020). 181 See Commission Notice Guide on Articles 34–46 of the Treaty on the Functioning of the European Union (TFEU) 2021/C 100 100/03, p. 16, https://eur-lex.europa.eu/legal-content/EN/ TXT/PDF/?uri=CELEX:52021XC0323(03)&from=EN (last accessed 29 June 2022). 182 See e.g. CJEU, case C-421/09, Humanplasma GmbH v Republic of Austria, ECLI:EU:C:2010: 760, para. 45. 176

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and human health. For example, GHG emissions could be reduced through the realisation of true costs,183 installation bans184 and traffic restrictions,185 provided that the measures in question are implemented in an efficient way. To a limited extent, adaptation measures may also provide less intrusive measures to protect life and health.186 Therefore, it appears highly unlikely that the CJEU would consider the adoption of a national ban on the sale of fossil fuels to be the least intrusive and thus a necessary measure to achieve the objective of climate protection. It is fair to conclude that the requested sales ban would most probably violate the free movement of goods guaranteed under the TFEU. Yet, what has been said in the context of Article XX(b) GATT, also applies here: A rapid and effective reduction of GHG emissions is essential and needs to be realised. Thereby, coordinated efforts by Member States not only yield greater impacts than unilateral activities, implementation at the supranational level also facilitates conformity of measures with European Law and its guiding principles.

4 Conclusion Given the findings in this article, one may conclude that the climate-related individual rights may be derived from EU-Secondary Law to a certain extent. In particular, the ESR confers certain individual rights on natural and legal persons directly concerned by a potential infringement of the GHG reduction obligations set out therein. However, the scope of these rights is limited since the ESR grants the Member States a broad level of discretion when choosing the measures to fulfil their GHG emission reduction obligations set out in the ESR. With regard to the present lawsuit, it is valid to conclude that the requested measure—a specific sales ban on fossil fuels—is, therefore, not covered by the individual right to require the competent national authority to implement appropriate and effective measures granted under the provisions of the ESR.

183

In many cases, the production and consumption of goods causes GHG emissions; those emissions constitute so-called “negative externalities” since their negative effects are often not represented in the product’s or service’s price; carbon pricing (carbon taxation and emissions trading) seeks to establish cost truth by attributing a price to GHG emissions. For the Austrian carbon pricing scheme, see the Emissions Certificate Trading Act 2022 (“Nationales Emissionszertifikatehandelsgesetz 2022”). 184 See for example a ministerial proposal regarding an Austrian “Renewable Heat Act” (212/ME), which inter alia entails the statutory obligation to set aside fossil heat generation systems within a certain period of time. 185 For examples of other traffic restrictions see Schulev-Steindl et al. (2021), p. 237. 186 This has been suggested by the German Constitutional Court in the case “Neubauer” BVerfG 24 March 2021, 1 BvR 2656/18 et al., paras. 143 ff.

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In order to require the relevant State to adopt certain climate protection measure, one has to consider the limitations resulting from higher-ranking law. In terms of sales bans on fossil fuels, the WTO and EU Law may challenge the validity of such trade-related measures. Under both regimes, it is at the Member State’s discretion to determine its national level of (environmental) protection. However, any national measure that interferes with trade requires justification. Thereby, measures that protect life and health qualify for justification both under the GATT and the TFEU. The GATT additionally justifies measures aimed at the conservation of exhaustible natural resources, whereas “environmental protection” is a mandatory requirement and thus a possible justification clause under EU Law. It is striking that the required relation between the justification and the measure in question is different in both trade regimes: While European Law generally requires proportionality of any measure capable of hindering intra-community trade (i.e., the measure must be suitable, necessary and adequate), the GATT applies different standards: Measures that protect life and health must be “necessary”. A “necessary” measure corresponds to the less trade-restricting measure available for life and health protection reasons. With regard to measures protecting exhaustible natural resources, the threshold is somewhat lower since such measures (only) have to “relate to” the desired goals. Through the lens of the European proportionality test, this could mean that the measure in questions must only be “suitable” for achieving the goal of protecting a certain exhaustible natural resource. The threshold for justification is thus set comparably low. Simultaneously, a wide interpretation of “exhaustible natural resources” prevails and clean air explicitly qualifies as an exhaustible natural resources. In the light of this, Article XX (g) GATT could be of utmost importance for justifying trade-related climate protection measures that usually seek to lower GHG emission levels. Provided that States adopt climate protection measures not for protectionist reasons and in compliance with the “chapeau”, far-reaching interventions may be justified on this ground.

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Julia Wallner is a Research and Teaching Assistant at the Institute of Public Law and Political Science at the University of Graz and works as a Researcher at the Research Center ClimLaw: Graz. She is a Doctoral Student in the field of Constitutional and Administrative law with a particular focus on climate change law. Emil Nigmatullin is an Associate at the law firm Haslinger / Nagele Rechtsanwälte GmbH and has specialized in Environmental, Energy, Regulatory and Climate Change Law. Prior to that, he worked as a Research and Teaching Assistant at the Institute of Public Law and Political Science at the Karl-Franzens-Universität (Graz, Austria).

Reducing GHG Emissions in a Constitutional Democracy: When EU Civil Courts Adjust the EU Emission Trading System Ina Frieling

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Climate Change Disputes Against Private Companies in the Netherlands and Germany: A Summary of Case-Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 Shell Decision, The Hague District Court (2021) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 RWE Decision, Higher Regional Court of Hamm (2017) . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Comparison of the Shell Decision and the RWE Decision . . . . . . . . . . . . . . . . . . . . . . . . . . 3 The Influence of Public Law on the Liability in Tort Law: A Comparative Analysis of German and Dutch Tort Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Breach of a Duty of Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 No Justification for the Interference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The Effect of the ETS on the Liability of Private Companies in EU Climate Change Disputes: A Critical Analysis of Current Case-Law on Private Companies’ Liability . . . . 4.1 The Influence of ETS Allowances on the Duty of Care and the Justification for the Interference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Limits of the ETS’ Effects on Climate Change Disputes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Conclusion: Who Is Responsible for Reducing GHG Emissions in the EU? . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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Abstract The climate crisis triggers debates about climate policies on all levels— from parliaments to civil courts. The EU legislature has introduced the EU Emission Trading System (ETS) to reduce greenhouse gas (GHG) emissions and mitigate the consequences of global heating. Through this cap and trade system, companies receive and trade ETS allowances which they can use to cover their GHG emissions. However, two civil courts in the EU recently went one step further: they held private companies liable for GHG emissions and its effects on the environment although they had the necessary ETS allowances. This paper compares and critically analyses the 2021 Shell decision by The Hague District Court and the 2017 RWE decision of

The author thanks Anna Masser, Partner at Allen & Overy LLP and head of the arbitration group in Germany, for her critical review and comments. I. Frieling (✉) Berlin, Germany © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 477–506, https://doi.org/10.1007/8165_2022_99, Published online: 1 January 2023

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the Higher Regional Court of Hamm. In doing so, the paper asks what role the ETS has in proceedings for injunctive relief and claims for removal of an interference, more specifically how it shapes the duty of care and how it can serve as a justification of an interference with the rights of others. Through a comparison of Dutch and German Civil law, this paper depicts the powers and limits of German and Dutch civil courts in the interplay with the legislature when making EU climate change policy.

1 Introduction To solve the climate crisis, the economy must become climate neutral as soon as possible. In the EU, the transition from one of the most greenhouse gas (GHG) emitting economies to a net zero-emitting economy shall mainly be achieved through the Emission Trading System (ETS).1 This cap and trade mechanism sets a limit on the total amount of GHG produced by companies in the EU. The cap is reduced every year so that total emissions fall. Within the cap, companies buy or receive allowances to cover their GHG emissions or trade them with others. Due to its limited availability, the allowances have value.2 As the ETS covers around 40% of GHG emissions in the EU,3 it is the most effective instrument at the EU legislature’s hands to reduce GHG emissions. However, the EU legislature’s climate policy and the ETS specifically have been criticised for failing to address the climate crisis effectively.4 Therefore, climate activists and NGOs found a new stage to advertise ambitious climate policies before the courts of the EU and its Member States. First, they challenged the ETS and other provisions of the EU legislative package before the General Court of the EU in an action for annulment under Article 263 TFEU (Carvalho case).5 However, the General Court never came to an assessment of this legislative package because it already dismissed the claim on the basis that it was inadmissible for lack of the

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Directive 2003/87/EC of 13 October 2003 establishing a system for greenhouse gas emission allowance trading within the Union and amending Council Directive 96/61/EC (EU ETS Directive). 2 Commission, EU ETS, https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_ en (last accessed 27 September 2022). 3 Commission, EU ETS, https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_ en (last accessed 27 September 2022). The sectors covered are CO2 from electricity and heat generation, energy-intensive industry sectors, and commercial aviation within the European Economic Area; nitrous oxide (N2O) from production of nitric, adipic and glyoxylic acids and glyoxal; and perfluorocarbons (PFCs) from production of aluminium (Annex I and II). 4 Climate Action Tracker, EU. https://climateactiontracker.org/countries/eu/#:~:text=We%20rate% 20the%20EU's%20policies,the%20effect%20of%20the%20pandemic (last accessed 27 September 2022). 5 CJEU, case T-330/18, Carvalho, ECLI:EU:T:2019:324.

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appellant’s legal standing.6 In parallel to the Carvalho case, climate activists and NGOs targeted EU Member States for their lack of ambitious climate policies before national courts. These cases have become increasingly successful since the Urgenda decision in 2015. In this case, a national court, for the first time, ordered a national government to set more ambitious climate targets.7 Since then, more national courts in the EU have followed the example.8 The Urgenda case also fuelled a new kind of dispute: climate change disputes against private companies. For the purposes of this paper, this term refers to civil law disputes brought before state courts that seek to hold private companies liable for alleged damages incurred due to the climate crisis because of the companies’ GHG emissions. Climate change disputes brought before EU dispute resolution bodies vary both in their aims and their legal basis. The claim can be directed at injunctive relief, removal of an interference, or compensation based on the general provision under the respective national civil laws (tort law claims).9 But it can also be based on a provision that specifically contains environmental obligations10 or be rooted in corporate law targeting managers of a private company for mismanagement of climate risk.11 Some claims even resort to soft law instruments by targeting private

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CJEU, case T-330/18, Carvalho, ECLI:EU:T:2019:324, para. 33. Dutch Supreme Court, case 19/00135, Urgenda Foundation v State of the Netherlands, NL: HR:2019:2007. 8 Belgium (Brussels Court of First Instance, case no. 2015/4585/A, VZW Klimaatzaak v Kingdom of Belgium & Others), Germany (German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618), France (Conseil d’État, Association Friends of the Earth, n° 394254; Conseil d’État, Municipality of Grande-Synthe, n° 427301; Conseil d’État, July 1, 2021, Municipality of Grande-Synthe, n° 427301, n° 427301; Paris Administrative Court, Association notre affaire à Tous et autres, n° 1904967, 1904968, 1904972, 1904976/4-1), Ireland (Irish Supreme Court, appeal no. 205/19, Friends of the Irish Environment CLG v The Government of Ireland). 9 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118; The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339. 10 In Poland, the claim is based on Article 323 Polish Environmental Protection Law: Regional Court of Lodz, ClientEarth v. Polska Grupa Energetyczna, filed September 2019; Regional Court of Lodz, Greenpeace Poland v. PGE GiEK, filed 11.03.2020 (accessible via http://climatecasechart. com/non-us-case-category/ghg-emissions-reduction/). In France, the legal basis is Article 225-1024 French Commercial Code: Nanterre Court of Appeal, Friends of the Earth et al. v. Total, filed 23.10.2019 (accessible via http://climatecasechart.com/non-us-case-category/ghg-emissions-reduc tion/). 11 ClientEarth started legal actions against the Board of Shell by alleging that it breached its duties under the UK Companies Act because it failed to adopt and implement a climate strategy that truly aligns with the Paris Agreement, https://www.clientearth.org/latest/press-office/press/clientearthstarts-legal-action-against-shell-s-board-over-mismanagement-of-climate-risk/ (last accessed 27 September 2022). 7

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companies based on OECD Guidelines for Multinational Enterprises before the National Contact Point at the Italian Ministry of Economic Development.12 Although all these claims represent creative approaches and raise interesting legal questions,13 this paper will focus on two aspects: First, it deals only with tort law claims. They were the first climate change disputes brought before EU civil courts and the only ones that resulted in successful decisions so far. In 2017, for the first time, a German Civil Court found the tort law claim against RWE to be well-founded in an intermediate decision and opened the stage for the parties to prove their positions (RWE decision by the Higher Regional Court of Hamm).14 In 2021, then, a second premiere: a Dutch civil court rendered a final judgement that upheld the climate change claim and obliged a private company to reduce its GHG emissions (Shell decision by The Hague District Court).15 In both cases, the claims were based on general tort law provisions of the respective national legal system. This makes it more manageable to compare both legal systems and establish general statements for climate change disputes in the EU. In addition, those findings can be transposed to other EU Member states as general tort law provisions exist in all national civil law systems in the EU.16 Second, this paper only assesses the role of the ETS in climate change disputes against private companies in the EU. This assessment becomes relevant when private companies are held liable although they emitted GHG with the necessary ETS allowances. Are such emissions still unlawful? And do they, as a result, require actions by the defending companies despite having the necessary allowances? The answer to these questions is not a simple yes or no. They lead back to the question of how civil courts should and may intervene in climate change politics when the legislature fails to act. To determine the private companies’ liability for climate change despite having the necessary ETS allowances, this paper critically analyses and compares the current case-law of Dutch and German courts. After

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Legality for Climate Network, Press release to the Application to the OECD NCP against ENI, 15.02.2022 (accessible via http://climatecasechart.com/non-us-case/rete-legalita-per-il-clima-legal ity-for-climate-network-and-others-v-eni/). OECD National Contact Point, Rete Legalità per il Clima (Legality for Climate Network) and others v. ENI, filed 26.07.2021; OECD National Contact Point, Rete Legalità per il Clima (Legality for Climate Network) v. Intensive livestock farming multinational companies operating in Italy, filed 06.12.2021 (accessible via http://climatecasechart. com/non-us-case-category/ghg-emissions-reduction/). 13 For example, the possibility to prove the causal link between a company’s GHG emissions and the violation of rights of others due to climate change, and the rights protected under tort law: Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118; The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL:RBDHA:2021: 5339; Börstra and Römling (2022); Kahl and Weller (2021); Setzer and Higham (2022). 14 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118. 15 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339. 16 Magnus, Principles of European Tort Law. https://max-eup2012.mpipriv.de/index.php/Princi ples_of_European_Tort_Law_(PETL)#c.29_Causation (last accessed 27 September 2022), para. 1, 5d.

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summarising the case-law in climate change disputes against private companies in the Netherlands and Germany (Sect. 2), this paper demonstrates the influence of public law on the liability in tort law (Sect. 3). Based on the requirements set out in this section, this paper then discusses the effects of the ETS on the liability of private companies in EU climate change disputes (Sect. 4).

2 Climate Change Disputes Against Private Companies in the Netherlands and Germany: A Summary of Case-Law So far, only in two cases, civil courts in the EU have held private companies responsible for their GHG emissions: The Hague District Court in its Shell decision in 2021 and the Higher Regional Court of Hamm in the RWE decision in 2017. Even though no highest court in the EU has spoken the last word, these decisions guide how civil law and notably tort law can be used to fight the climate crisis. The legal ideas developed by the courts may not only be useful to other cases in their own national legal frameworks but also for climate change disputes in other EU Member States. After all, the tort law principles at the core of these decisions are familiar to other EU jurisdictions in two main aspects:17 on the one hand, tort law is designed to protect the right to life, the right to physical and mental integrity, and property rights.18 On the other hand, all jurisdictions deal with the essential grounds of responsibility that may lead to liability, namely damage caused inter alia by conduct constituting a fault or an abnormally dangerous activity.19 The cross-national relevance of these two decisions already became obvious when Greenpeace placed a climate change claim against Volkswagen before German Civil Courts and referred to the reasoning of the Shell decision.20 To apply the supporting principles of the Shell decision and the RWE decision to other cases, this paper first summarises the two decisions (Sects. 2.1 and 2.2) and then compares them (Sect. 2.3).

17 Magnus, Principles of European Tort Law. https://max-eup2012.mpipriv.de/index.php/Princi ples_of_European_Tort_Law_(PETL)#c.29_Causation (last accessed 27 September 2022), para. 4. 18 In Comandé et al. (2005), The European Group on Tort Law compares tort law in EU Member States and elaborated common principles. Art. 2:102 Principles of European Tort Law contains a list of protected rights. 19 Comandé et al. (2005), Art. 1:101 Principles of European Tort Law. 20 Günther M (2021), Application and Claim by Greenpeace et al., p. 7. http://climatecasechart.com/ wp-content/uploads/sites/16/non-us-case-documents/2021/20211111_16019_petition.pdf (last accessed 27 September 2022).

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Shell Decision, The Hague District Court (2021)

In the Shell decision of 26 May 2021, The Hague District Court had to decide on a request for injunctive relief submitted by Vereniging Milieudefensie, six other NGOs and more than 17,000 individual claimants against, at the time still, Royal Dutch Shell (RDS).21 Shell is a top holding company that establishes the general policy of the Shell Group.22 The Shell Group comprises over 1100 separate companies established all over the world which conduct their activities according to the general policy of Shell.23 The companies of the Shell Group emit a significant amount of CO2 that exceeds CO2 emissions of many states such as e.g. The Netherlands. This calculation includes CO2 emissions of Scope 1, 2, and 3.24 Scope 1 emissions are direct emissions from company-owned and controlled resources, while Scope 2 and 3 emissions are indirect emissions. The two forms of indirect emissions differ in that Scope 2 emissions result from the generation of purchased energy from a utility provider, whereas Scope 3 emissions occur in the value chain of the reporting company, including both upstream and downstream emissions.25 These emissions contribute to global warming which, in turn, according to The Hague District Court leads to health risks and deaths due to climate change-induced hot spells as well as health problems and an increased mortality risk due to increasing infectious diseases, deterioration of air quality, increase of UV exposure, and an increase of water-related and foodborne diseases, [. . .] flooding along the coast and rivers, excess water, water shortage, deterioration of water quality, salinization, raised water levels and drought.26

Milieudefensie et. al based the injunctive relief (rechterlijk bevel) on Section 6:162 Dutch Civil Code (DCC). It provides that injunctive relief can be directed at a person who “commits a tortious act (unlawful act) against another person that can be attributed to him”.27 An unlawful act can inter alia be an infringement of the unwritten standard of care, meaning “what is generally accepted according to RDS changed its name to “Shell plc”. However, this does not change the fact that the legal proceedings in this matter before the Dutch Courts work for and against Shell plc (thereafter: Shell). 22 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 2.5.1. 23 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 2.2.2. 24 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.5. 25 Bernoville T. (2022) What are Scopes 1, 2 and 3 of Carbon Emissions? https://plana.earth/ academy/what-are-scope-1-2-3-emissions/#:~:text=Scope%202%20emissions%20are%20indi rect,%2C%20steam%2C%20heat%20and%20cooling (last accessed 27 September 2022). 26 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.6. 27 Translation by http://www.dutchcivillaw.com/legislation/dcctitle6633.htm. Dutch original version: “Hij die jegens een ander een onrechtmatige daad pleegt, welke hem kan worden toegerekend, is verplicht de schade die de ander dientengevolge lijdt, te vergoeden.” 21

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unwritten law”.28 The Hague District Court established the unwritten standard of care “on the basis of the relevant facts and circumstances, the best available science on dangerous climate change and how to manage it, and the widespread international consensus that human rights offer protection against the impacts of dangerous climate change and that companies must respect human rights”.29 The Court relied on three types of unwritten law: international human rights,30 the UN Guiding Principles on Business and Human Rights,31 and the Paris Agreement.32 Even though they do not bind private parties, they become binding on Shell through the unwritten standard of care.33 In its decision, The Hague District Court found the injunctive relief to be genuine because Shell infringed the unwritten standard of care by emitting too much GHG. The Court recognised Shell’s responsibility not only for Scope 1 emissions but also for Scope 2 and 3 emissions. The later accounts for 85% of its total emissions.34 This responsibility applies despite the fact that Shell complied with the ETS and all other applicable binding legal rules.35 Thus, the Court ordered Shell to reduce its CO2 emissions with regard to all three scopes set out above by at least net 45% by the end of 2030, relative to 2019 levels.36 Shell has appealed the decision by The Hague District Court before the Dutch Court of Appeal in The Hague.37 However, the decision of First Instance was

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The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.1. 29 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.1.3. 30 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.9. 31 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.18. 32 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.27. 33 The Hague District Court, C/09/456689/HA ZA 13-1396, Urgenda, ECLI:NL:RBDHA:2015: 7196, para. 4.46; Jagers and van der Heijden (2008), pp. 855, 857; Macchi and van Zeben (2021), p. 412. 34 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.19. 35 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 36 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 5.3. 37 Shell plc (2022), Frequently asked Questions (FAQ) on Dutch District Court legal case. https:// www.shell.com/media/news-and-media-releases/2021/shell-confirms-decision-to-appeal-courtruling-in-netherlands-climate-case/_jcr_content/par/grid_copy_copy_copy_/p0/textimage.stream/1 647925854400/460167304a697f411be1b9f80c6e05be0ac057fb/dutch-district-legal-case-faq.pdf (last accessed 27 September 2022).

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declared immediately enforceable against Shell and should not be suspended pending an appeal.38

2.2

RWE Decision, Higher Regional Court of Hamm (2017)

In the RWE case, which is still pending at the time of writing, the Higher Regional Court of Hamm has to decide on a declaratory action (Feststellungsklage) whether RWE is obliged to bear the costs for adequate preventive measures to protect the property of the Peruvian farmer Saúl Lliuya against a flood caused by RWE’s contribution to climate change. Even though the Court has not pronounced its final judgement yet, it already gave its view on the main legal issues in an intermediate decision and ordered the Parties to provide evidence for their statements (Hinweisund Beweisbeschluss).39 The decision is based on the following facts: The Claimant owns a house located under a lagoon that collects melted water from a glacier in Peru. The water level in the lagoon is rising constantly. While it contained 10–12 Mio m3 in the 1930s, it rose to 17.4 Mio m3 in 2016. The rising level is caused by the melting of the glacier due to global heating. As the area around the lagoon is affected by earthquakes and landslides, there is a high risk of an ice avalanche hitting the lagoon and causing a severe flood. This would destroy the Claimant’s house. The Respondent, in turn, is a mother company of many subsidiaries in the energy sector. Its subsidiaries emit a large amount of CO2 which contributes to global warming.40 It is undisputed that RWE has the necessary ETS allowances to emit GHG.41 The Claimant asks the Higher Regional Court of Hamm to declare that RWE must bear the costs for preventive measures to protect the Claimant against a glacial flood from the lagoon, proportionally to its contribution to the damage (share of global GHG emissions). The claim for removal of an interference (Beseitigungsanspruch) is based on Section 1004(1) sentence 1 German Civil Code (GCC).42 It provides: If the ownership is interfered with by means other than removal or retention of possession, the owner may require the disturber to remove the interference.43

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The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 5.8. 39 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118. 40 District Court of Essen, 2 O 285/15, Luciano Lliuya v. RWE, ECLI:DE:LGE:2016: 1215.2O285.15.00, para. 4-12. 41 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. III. 42 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.2. 43 Official translation of Section 1004 (https://www.gesetze-im-internet.de/englisch_bgb/englisch_ bgb.html#p3984). German original version: “(1) Wird das Eigentum in anderer Weise als durch Entziehung oder Vorenthaltung des Besitzes beeinträchtigt, so kann der Eigentümer von dem Störer die Beseitigung der Beeinträchtigung verlangen. Sind weitere Beeinträchtigungen zu besorgen, so kann der Eigentümer auf Unterlassung klagen.”

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While the Claimant only asks for a declaratory action in this proceeding, a corresponding judgment would form the basis for further claims against RWE, according to which the Claimant could demand reimbursement of expenses for the protective measures he carried out himself.44 In the first instance, the District Court of Essen rejected the main claim on the basis that it was not admissible by lack of specificity of the claim.45 The Court found the alternative motion to be admissible but it rejected the claim on the merits because there was no causal connection between RWE’s actions and the infringement of the Claimant’s rights.46 The Claimant appealed this decision to the Higher Regional Court of Hamm. In its order, the Higher Regional Court of Hamm rejected the judgement of the District Court of Essen and held that the declaratory action was well founded. Accordingly, RWE could have an obligation under Section 1004(1) sentence 1 GCC to remove the interferences caused by its GHG emissions.47 This obligation existed although RWE acted lawfully.48 The Higher Regional Court of Hamm assessed two requirements to come to this conclusion. First, it found that the breach of the Claimant’s rights does not result from an indirect interference but rather from a direct interference. In that case, the risk of a flood for the Claimant’s house can causally be linked back to the GHG emissions by RWE.49 As a consequence, the liability of RWE does not require an additional breach of a duty of care.50 Secondly, the Higher Regional Court of Hamm assessed the unlawfulness of the state of nuisance instead of the unlawfulness of RWE’s emissions. This can be deduced from its explanation that it would have decided otherwise if the case concerned a claim regarding the restriction of the respondent’s activities or even a closure of the power plants operated for the provision of the general interest.51 Thereby, the Higher Regional Court of Hamm distinguished between a claim directed at the removal of an interference (Section 1004(1) sentence 1 GCC) and an injunctive relief (Section 1004(1) sentence 2 GCC). According to the Court, when the claim was directed at the removal of an interference, the respondent’s actions may be lawful while the state of nuisance caused by the lawful action is not. In the RWE case, the state of

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Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE II, 1 March 2018, para. 2: A claim for reimbursement of expenses would be based on Sections 683, 670, 677, or Sections 684, 812, para. 1, sentence 1 GCC. While these legal bases are mutually exclusive, the Higher Regional Court of Hamm left unanswered which of them it would apply as it is not relevant for this case. 45 District Court of Essen, 2 O 285/15, Luciano Lliuya v. RWE, ECLI:DE:LGE:2016: 1215.2O285.15.00, paras. 28, 31, 32. 46 District Court of Essen, 2 O 285/15, Luciano Lliuya v. RWE, ECLI:DE:LGE:2016: 1215.2O285.15.00, paras. 41 seq. 47 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.1. 48 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.2. 49 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE II, 1 March 2018, para. 3. 50 German Supreme Court, V ZR 230/03, BGHZ 160, 232, para. 7. 51 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.2.

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nuisance is the risk of the Claimant’s house being affected by global heating which GHG emissions are contributing to. In contrast, injunctive relief required the respondent’s act itself to be unlawful. In this case, the Respondent’s act would be the emission of GHG. However, the RWE case concerned the removal of an interference. Hence, the Higher Regional Court of Hamm found that despite RWE’s lawful behaviour, the state of nuisance remained unlawful.52 Hence, according to the Court, ETS allowances could render the emissions lawful, but at the same time, it might not legalise its negative impacts on the environment. By providing this reasoning in its intermediate decision, the Higher Regional Court of Hamm found that the remaining issues, in this case, were questions of fact. It ordered the Parties to prove especially whether there was a causal chain between the risks for the Claimant’s property and RWE’s share in global GHG was since industrialisation.53 From this fact depends whether the claim is based on a direct or indirect interference. As a reaction to the Higher Regional Court of Hamm’s order, RWE filed a counter-motion. In a second order on 19 February 2018, the Higher Regional Court of Hamm rejected the counter-motion and provided more substance to its previous decision.54 Thus, the discussion on the legal issues seems concluded.

2.3

Comparison of the Shell Decision and the RWE Decision

The Claimants in the Shell case and the RWE case used different approaches to target the companies. The first main difference relates to the aim of the claim. The Shell case dealt with an injunctive relief and Shell was ordered to generally reduce its GHG emissions by 45% until 2030. In the RWE case, in contrast, the claim was directed at the removal of the risks for the Claimant’s property (and not at the reduction of RWE’s GHG emissions). The second difference concerns the timeline of the targeted emissions. While Shell must reduce its GHG emissions in the future, RWE is sued for its emissions in the past which cause a state of nuisance in the present. The third difference is that the Shell case deals with a class action, while the RWE case deals with a claim by a singular person who suffers from a specific threat deriving from global heating. For these reasons, the Claimant in the RWE case has a higher burden to prove the merits of his claim. He has to prove the causal link between RWE’s emissions and the risk to his house. In the Shell case, a predictive decision sufficed to determine the effects of the companies’ emissions on the climate.55

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Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.2. Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. III. 54 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE II, 1 March 2018. 55 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.5. 53

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However, both cases are comparable with regard to three decisive points. First, from a factual point of view, both claims are directed against large mother companies of energy suppliers acting worldwide and emitting GHG on a similar scale. They are listed among the top 90 companies that are responsible for two-thirds of historical GHG emissions: Shell ranked ninth place with a contribution to atmospheric carbon dioxide rise (1880–2010) of 1.85 ppm (1.79% of total emissions) and RWE ranked 31st with a contribution to atmospheric carbon dioxide rise (1880–2010) of 0.432 ppm (0.42% of total emissions).56 However, both Shell and RWE have complied with national and EU provisions that allow them to emit a certain amount of CO2 within the EU. More specifically, they had the necessary allowances under the ETS.57 Secondly, from a legal point of view, both the unwritten standard of care under Section 6:167 DCC and Section 1004(1) sentence 1 GCC require unlawfulness. In both cases, the Courts found this requirement to be fulfilled although the companies had the necessary allowances under the ETS. This aspect is relevant in both cases, even though the unlawfulness refers to different points: the lawfulness of the company’s actions in the future (Shell case) and the lawfulness of the state of nuisance in the present caused by the companies’ actions in the past (RWE case). And thirdly, the rulings have a large impact on the companies’ economic policies. This seems obvious for the Shell decision as it was ordered to reduce the entirety of its GHG emissions worldwide by at least a net 45% by 2030. But also a successful claim in the RWE case would have tremendous consequences for the company. Even though it concerns only a specific situation of one individual, it would become a precedent for other claims. Thus, RWE could be held liable for the consequences of its GHG emissions in its various forms worldwide—the destruction of houses, businesses, livelihoods, and lives due to floods, storms, fires, and diseases caused by global heating.

3 The Influence of Public Law on the Liability in Tort Law: A Comparative Analysis of German and Dutch Tort Law According to Section 1004 GCC, the claimant can ask for the removal of an interference (Section 1004(1) sentence 1 GCC) or ask for injunctive relief (Section 1004(1) sentence 2 GCC). The equivalent provision in Dutch tort law can be 56

Gupta A. (2021), The 90 companies responsible for two-thirds of historical greenhouse gas emissions. https://stacker.com/stories/3971/90-companies-responsible-two-thirds-historical-green house-gas-emissions (last accessed 27 September 2022). 57 In the RWE case, the Court did not mention the ETS specifically, its decision addressed the question of RWE’s lawful behaviour in general. RWE’s GHG emissions fall within the scope of the ETS and require allowances (RWE (2021), Climate Change 2021. https://www.rwe.com/-/media/ RWE/documents/09-verantwortung-nachhaltigkeit/2021-rwe-response-to-cdp-climate-change.pdf (last accessed 27 September 2022), para. C.11.1b, C11.1d).

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found in Section 6:162 DCC.58 It is the legal basis for both types of claims as well as claims for damages. Common to Dutch and German tort law is that it does not only create liability for direct but also for indirect interferences.59 An indirect interference refers to a situation in which the respondent’s behaviour infringes the rights of the claimant through a chain of events that are not in its powers such as forces of nature and acts of third parties.60 To hold the respondent liable for an indirect interference, the interference must breach a duty of care (Sect. 3.1). Regardless of whether the claim is based on a direct or indirect interference, there must be no justification for the interference (Sect. 3.2). Both requirements can be influenced by public law.

3.1

Breach of a Duty of Care

The legal concept of the duty of care is not explicitly mentioned in Section 6:162 DCC and Section 1004 GCC but was established by the Dutch and German Supreme Courts in their respective case law.61 The responsibility derives from the obligation to prevent harm to others from a source of danger and to take the necessary and reasonable precautions (safety measures).62 The duty of care is determined by civil law provisions but also by the entire legal order. In particular, norms of public law such as fundamental rights take effect in tort law claims.63 The reason behind it is that fundamental rights create an objective system of values that influences the relationship between private persons even if they do not directly contain obligations for individuals.64 But also EU law influences tort law in the EU Member States based on the EU’s principle of primacy of application.65

58

The wording of Section 6:162 DCC refers only to claims for damages, but it is also the legal basis for the claim directed at the restoration of the original condition and the omission of an act (Sieburgh (2019), paras. 151, 153). Concerning claims for damages, the equivalent provision in German law is Section 823(1) GCC (Börstra and Römling (2022), p. 37). 59 German Supreme Court, V ZR 230/03, BGHZ 160, 232, para. 7; Dutch Supreme Court, No. 9885, Kelderluik, ECLI:NL:HR:1965:AB7079. 60 Wagner and Arntz (2021), para. 88. 61 In Dutch law, the term is known as zorgvuldigheidsnorm (in the English translation of the Shell decision: “standard of care”). In German law, the term is known as Sicherungspflicht (“duty of safety”; German Supreme Court, V ZR 218/18, para. 8). The German Supreme Court distinguished it from the term Verkehrspflicht under Section 823(1) GCC. However, the distinction is not entirely clear (Pöttker (2014), pp. 93, 107; Wagner and Arntz (2021), para. 88). For simplicity’s sake, this paper uses the term “duty of care” as a reference to all three terms. The findings in this paper should in principle apply to all. 62 Dutch Supreme Court, No. 9885, Kelderluik, ECLI:NL:HR:1965:AB7079; Börstra and Römling (2022), p. 32. 63 Raff (2020), paras. 209, 218–221; Sieburgh (2019), para. 57. 64 Raff (2020), para. 209. 65 CJEU, C-6/64, Flaminio Costa v E.N.E.L., ECLI:EU:C:1964:66.

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However, both jurisdictions shape the duty of care differently. Section 6:162 (2) DCC defines the unlawful act as follows: a violation of someone else’s right (entitlement) and an act or omission in violation of a duty imposed by law or of what according to unwritten law has to be regarded as proper social conduct.66

The explicit reference to unwritten law allows courts to establish the duty of care from a synopsis of legal and factual sources.67 What it entails is not defined conclusively,68 but it includes provisions of international public law, fundamental rights, and scientific research.69 Thus, even laws and facts that do not contain binding obligations for private actors become obligations through the unwritten standard of care.70 Courts assess on a case-by-case basis which circumstances are relevant.71 Section 1004 GCC differs from Section 6:162(2) DCC in this aspect. The German Supreme Court defines the duty of care as an obligation to take the necessary and reasonable safety measures in order to prevent injury to others according to the degree required by the prevailing objective opinion. The required standard of care is deemed to be fulfilled when a reasonable and cautious person of the same kind as the respondent ex ante considers the measure to be sufficient.72 The prevailing objective opinion is determined by the public interests.73 To this end, the courts assess whether public law contains mandatory requirements for the duty of care and thus provide a conclusive risk assessment in their scope of application.74 Insofar it is similar to the “proper social conduct” under Section 6:162 DCC. However, the German duty of care is subject to stricter limits as it does not contain a reference to unwritten law. It is not possible through Section 1004 GCC to put obligations on private actors that in themselves are not binding to them. The function of the standard of care is not to extend the general clause to include unwritten grounds for liability; rather, they

66 Translation by http://www.dutchcivillaw.com/legislation/dcctitle6633.htm. Dutch original version: “Als onrechtmatige daad worden aangemerkt een inbreuk op een recht en een doen of nalaten in strijd met een wettelijke plicht of met hetgeen volgens ongeschreven recht in het maatschappelijk verkeer betaamt, een en ander behoudens de aanwezigheid van een rechtvaardigingsgrond.” 67 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.1; Sieburgh (2019), para. 57. 68 Sieburgh (2019), para. 57. 69 The Hague District Court, C/09/456689/HA ZA 13-1396, Urgenda, ECLI:NL:RBDHA:2015: 7196, para. 4.46; Jagers and van der Heijden (2008), pp. 855, 857; Macchi and van Zeben (2021), p. 412. 70 Börstra and Römling (2022), p. 37. 71 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.1. 72 German Supreme Court, VI ZR 311/11, BGHZ 195, 30, para. 8. 73 Thöne (2022), p. 331. 74 Pöttker (2014), p. 117.

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merely assign a concrete risk, a source of danger, to the sphere of the responsible person.75

3.2

No Justification for the Interference

To trigger liability for an interference, there must be no justification for the breach of duty.76 This requirement is anchored both in Dutch and German tort law. Section 6: 162(2) DCC states that an act is unlawful “as far as there was no justification for this behaviour”.77 A similar provision can be found in Section 1004(2) GCC: “The claim is excluded if the owner is obliged to tolerate the interference”.78 Such an obligation exists if there is a justification for the interference with the claimant’s rights.79 However, Dutch and German law differ in two aspects. The first aspect regards the reference point of the justification. The wording of Section 6:162(2) DCC refers to an act or omission. Hence, it is the respondent’s behaviour that cannot be justified for a successful claim. In German law, the same applies for the injunctive relief under Section 1004(1) sentence 2.80 But under Section 1004(1) sentence 1 GCC, the state of nuisance must be unlawful, independently of whether the respondent’s action were justified. Hence, a claim can be successful despite the respondent acting lawfully.81 The second difference between Dutch and German law concerns the importance they attach to public-law permits. Public-law permits, in this context, are legal acts that explicitly allow the respondent to carry out a certain behaviour. Usually, such permits are issued by a public authority such as building permits or emission permits.82 The issuing public authority can be the EU Commission or most commonly the public authorities of one of the Member States. The legal act is based on either EU or national law.

75

Börstra and Römling (2022), p. 36. Section 6:162(2) DCC. 77 Translation by http://www.dutchcivillaw.com/legislation/dcctitle6633.htm. Dutch original version: “een en ander behoudens de aanwezigheid van een rechtvaardigingsgrond.” 78 German original version: “(2) Der Anspruch ist ausgeschlossen, wenn der Eigentümer zur Duldung verpflichtet ist.” 79 German Supreme Court, III ZR 198/98, BGHZ 142, 227, para. 20; Berger (2021), para. 21. 80 Fritzsche (2022), para. 107. The question to what the requirement of unlawfulness refers is highly debated among German commentators. The view presented here corresponds to the dominant view among commentators. Ahrens gives a full picture of the debate in the context of an analysis of the RWE decision: Ahrens (2019), pp. 652 seq. 81 German Supreme Court, V ZR 38/74, BGHZ 66, 37, para. 13; Raff (2020), paras. 199–200; Fritzsche (2022), para. 107. 82 Dutch Supreme Court, C04/142HR, ECLI:NL:HR:2005:AT8823; Fritzsche (2022), para. 119. 76

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The Dutch Supreme Court recognised that public-law permits have an indemnifying effect on the tort law claim (vrijwarende werking).83 This means that the permit prevents the respondent’s liability for its interference. The Dutch Supreme Court set the following guidelines to determine the scope of the indemnifying effect on a case-by-case basis: The answer to the question of whether and to what extent a permit issued by the government has an influence on the assessment of the liability in tort of the person who acts in accordance with the permit issued to him, but causes damage or nuisance to third parties in doing so, depends on the nature of the permit and the interest pursued by the regulation on which the permit is based, in connection with the circumstances of the case [. . .]. In this context, it should be noted that the holder of a permit may generally trust that the permit has been granted in accordance with the law and that the interests to be taken into consideration in accordance with the law have been fully and correctly considered by the licensing authority, and that he is entitled to make use of this permit.84

The German Supreme Court, in turn, did not recognise the indemnifying effect of public-law permits (Legalisierungswirkung). In fact, it explicitly rejected the idea that public-law permits conclusively determine the relationship of persons in private law cases.85 Public-law permits neither extend private rights nor do they restrict the private rights of others, even if the authorising authority took into account the private rights of third parties when weighing up the interests at stake.86 However, the rejection of the indemnifying effect in German law does not mean that public-law permits do not have any effect on tort law claims. They still play a determining factor when establishing the duty of care. In fact, they can substantiate civil law obligations when public law provisions contain a conclusive regulation on the same matter. On a case-by-case basis, courts have to assess whether the tort law obligation contains a more or less comprehensive obligation than the public-law permit. In case the tort law obligation is more comprehensive, the respondent must take further actions despite its public-law permit.87

83

The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 84 Dutch Supreme Court, C04/142HR, ECLI:NL:HR:2005:AT8823, para. 3.5.1, translated to English by authors. 85 German Supreme Court, V ZR 78/58, Dance café, NJW 1959, 2013, para. 17; German Supreme Court, VI ZR 233/93, Owner’s duty to ensure safety in the event of dangerous glazing in an apartment building, NJW 1994, 2232, para. 14. Further also: Hinteregger (2017), paras. 238, 253 f.; Ipsen et al. (2021), p. 1849; Wagner (2020), para. 80. 86 German Supreme Court, V ZR 78/58, Dance café, NJW 1959, 2013, para. 17. 87 German Supreme Court, V ZR 78/58, Dance café, NJW 1959, 2013, para. 17; Ipsen et al. (2021), pp. 1850 seq.

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4 The Effect of the ETS on the Liability of Private Companies in EU Climate Change Disputes: A Critical Analysis of Current Case-Law on Private Companies’ Liability In both the Shell and the RWE decision, the Courts concluded that the private companies unlawfully infringed the claimant’s rights. According to the Courts, the right to be safeguarded from the interference outweighs the right to carry out the interference. However, in both cases, it is undisputed between the Parties that the respondents had the necessary public-law permits for the GHG emissions within the EU.88 In the Shell decision, The Hague District Court expressly addressed Shell’s compliance with the ETS and its consequences for the requirement of unlawfulness.89 The Higher Regional Court of Hamm, has thus far, not addressed the ETS specifically, but it can be inferred from its decision that it assessed regulations of emission control under public law, including the ETS.90 Both Courts decided under their respective legal systems that compliance with the ETS did not affect the claim. The remainder of this paper critically analyses their assessment concerning the effect of the ETS on climate change disputes in Dutch and German tort law. Therefore, Sect. 4 first addresses the influence of ETS allowances on the duty of care and the justification for the interference (Sect. 4.1). Thereafter, this paper discusses the limits set out by the Dutch and German Courts (Sect. 4.2).

4.1

The Influence of ETS Allowances on the Duty of Care and the Justification for the Interference

Allowances under the ETS are public-law permits that allow private companies to emit a certain amount of GHG. ETS allowances are based on the EU ETS Directive and the national provisions implementing this Directive. ETS allowance means “an allowance to emit one tonne of carbon dioxide equivalent during a specified 88

The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.45. In the RWE case, the Court did not mention the ETS specifically, its decision addressed the question of RWE’s lawful behaviour in general. But RWE’s GHG emissions fall within the scope of the ETS and require allowances (RWE (2021), Climate Change 2021. https://www.rwe.com/-/media/RWE/documents/09-verantwortung-nachhaltigkeit/2021-rweresponse-to-cdp-climate-change.pdf (last accessed 27 September 2022), para. C.11.1b, C11.1d). 89 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, paras. 4.4.44–4.44.48. 90 RWE submitted in its Response to the Higher Regional Court’s order that it complied with ETS (http://climatecasechart.com/wp-content/uploads/sites/16/non-us-case-documents/2017/2017112 7_Case-No.-2-O-28515-Essen-Regional-Court_na.pdf, para. B). The Higher Regional Court of Hamm replied that it had already discussed this point in the oral hearings and in its order (Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE II, 1 March 2018, para. 5).

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period”.91 They are either provided directly by the EU Member States or through the auctioning platform European Energy Exchange (EEX).92 EEX trades allowances provided by the EU Member States or by installations that do not use the allowances to cover their emissions.93 Nonetheless, all allowances on the market can be linked back to the EU and its Member States which exercise the monopoly of control over the number of allowances on the carbon market.94 Under Dutch and German law, the legal characterisation of ETS allowances in climate change disputes differ. Under Dutch law, public-law permits such as ETS allowances can generally serve as a justification for the interference if they allow that indirect interference. In its Shell decision, The Hague District Court—even though it ultimately rejected the indemnifying effect of the ETS in the Shell case due to its strict limits—recognised that the ETS system has an indemnifying effect. The indemnifying effect of the ETS system means that – insofar as it concerns the reduction target of the ETS system – RDS does not have an additional obligation.95

Under German law, in contrast, public-law permits such as ETS allowances do not have an indemnifying effect. Instead, ETS allowances determine the duty of care.96 The Higher Regional Court of Hamm has not explicitly taken position yet which legal effect ETS allowances have in climate change claims. This is because it considered the interference to be direct and thus did not require the breach of a duty of care. However, it is not proven yet whether there is, in fact, a causal chain between RWE’s behaviour and the risks for the Claimant’s house which causes a direct interference. Moreover, the Regional Court of Stuttgart and commentators rather qualify the emissions by private companies as an indirect interference.97 For this reason, this paper also addresses the influence of the ETS on the duty of care under German law. ETS allowances should influence climate change disputes in both jurisdictions whether under the indemnifying effect or the duty of care. While The Hague District Court acknowledged this, the Higher Regional Court of Hamm disregarded it so far. Admittedly, the ETS does not contain any mention of its effects on civil law claims. Its purpose is not to regulate the relationship between private persons and protect individual civil law rights.98 But it conclusively defines the obligations of private

91

Article 3(a) EU ETS Directive. Article 10(1) EU ETS Directive. 93 Article 12(1) EU ETS Directive. 94 Article 9 and 11 EU ETS Directive. 95 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 96 Chatzinerantzis and Appel (2019), p. 884; Ipsen et al. (2021), p. 1851; Spitzer and Burtscher (2017), pp. 162 seq.; Wagner and Arntz (2021), paras. 89, 90. 97 Regional Court of Stuttgart, 17 O 789/21, DUH v Mercedes-Benz Group AG, 13 September 2022, p. 7; Thöne (2022), p. 331; Wagner and Arntz (2021), para. 89. 98 Ipsen et al. (2021), p. 1851. 92

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companies in climate protection. In implementing the ETS, the legislature opted for a system that does not limit each company’s emissions on an individual basis. Instead, it followed the rationale of the Kyoto Protocol which is that “from the global environmental point of view, the place where the emission reduction takes place is of secondary importance provided that real emission reductions are achieved”.99 The ETS is a step-by-step transition of the EU economy towards climate neutrality.100 The EU ETS Directive sets a target for the entire industry and creates a carbon market where the affected companies trade their licenses. Thereby, it shall provide for a harmonised infrastructure of an EU-wide climate policy. Otherwise, different systems or other climate policies at Member State level would lead to a fragmented and costly situation for the regulated entities, as well as different ambition levels and carbon prices throughout the EU, leading also to administrative complexity.101

Through this system, companies are obliged to reduce their emissions while at the same time remaining flexible in their manner and pace of transitioning from GHG emissions to climate neutrality.102 Companies that comply with the ETS by purchasing all required certificates fulfill their obligations to protect the rights of others.103 It is not relevant whether a company would be able to reduce its emissions even more as only the total amount of GHG emissions is relevant for climate protection.104 In low concentrations, CO2 is harmless to the health of humans, animals, and plants. The dangers for the environment result from the high concentration of CO2 emissions in the atmosphere in combination with the destruction of carbon stocks such as forests and oceans.105 Only if a company emitted more than what is covered by its ETS allowances, it breaches the duty of care and does not have a justification for the indirect interference.106 By giving ETS allowances effect through the duty of care or as a justification, courts respect the EU’s legislative choice. The legislature is in a better position to take measures on such a highly political subject for two reasons. First, the legislature benefits from a higher democratic legitimacy. Parliamentary deputies are directly accountable to the people, as they are the only institution elected by the people.107 Therefore, essential questions must be addressed through legislative acts when they

99

Proposal for a Directive amending the Directive establishing a scheme for greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms (Proposal for the EU ETS Directive), COM/2003/0403 final, para. 1.1. 100 Commission, EU ETS Handbook. https://ec.europa.eu/clima/system/files/2017-03/ets_hand book_en.pdf, p. 5. 101 Proposal for a Directive amending Directive 2003/87/EC to enhance cost-effective emission reductions and low-carbon investments, COM(2015) 337 final, para. 3. 102 Proposal for the EU ETS Directive, COM/2003/0403 final, para. 1.1. 103 Ipsen et al. (2021), p. 1851. 104 Ipsen et al. (2021), p. 1851. 105 Wagner (2020), para. 1055. 106 Thöne (2022), p. 333. 107 Pöttker (2014), p. 438.

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include a balancing of fundamental rights.108 Climate change policies are essential questions. They take into account the fundamental rights of those suffering from climate change, especially the right to life, right to private life and family life, and property rights.109 These rights are then weighed against the rights of the companies emitting GHG, the competitiveness of the EU’s economy, and the right to benefit from energy supply.110 The legislature has considerable leeway in its climate protection policy.111 Even Constitutional Courts refrained from prescribing the legislature what exact measures to take.112 Such was not the task of courts according to the principle of separation of powers.113 Secondly, the legislature has more expertise than a court to balance conflicting interest. Climate protection policies still bring many uncertainties, they affect a large number of stakeholders worldwide and they are embedded in a multilevel legal framework.114 The Commission, the EU Parliament, and the governments of EU Member States are constantly in a dialogue with stakeholders on the subject of climate change policies. In meetings on national, EU, and global level they share their interests at stake through EU legislation. Courts, however, do not benefit from the same resources for information gathering.115 Neither The Hague District Court nor the Higher Regional Court of Hamm have sufficiently taken the ETS into account in tort law claims. Even though the Dutch Court first accepted the indemnifying effect of ETS allowances, it was ultimately rejected due to its strict limits. Thereby, the underlying principles and ideas of the ETS were not sufficiently represented in the judgement. The German Court left out 108 German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618, para. 26; Regional Court of Stuttgart, 17 O 789/21, DUH v Mercedes-Benz Group AG, 13 September 2022; Wagner (2021), para. 39. 109 Recital 27 EU ETS Directive; Proposal for amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/ 1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757 (Proposal for a renewed EU ETS), COM/2021/551 final, para. III. 110 Thöne (2022), p. 331; Wagner (2021), para. 47. 111 German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618, para. 152; Dutch Supreme Court, State of the Netherlands v Urgenda Foundation, NL:HR:2019:2007, para. 8.2.6; Brussels Court of First Instance, 2015/4585/A, VZW Klimaatzaak v. Kingdom of Belgium & Others, p. 80. 112 German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618, para. 266; Dutch Supreme Court, State of the Netherlands v Urgenda Foundation, NL:HR:2019:2007, para. 8.3.5. 113 German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618, para. 152; Dutch Supreme Court, State of the Netherlands v Urgenda Foundation, NL:HR:2019:2007, para. 8.2.6; Brussels Court of First Instance, 2015/4585/A, VZW Klimaatzaak v. Kingdom of Belgium & Others, p. 80. 114 German Constitutional Court, 1 BvR 2656/18, 1 BvR 78/20, 1 BvR 96/20, 1 BvR 288/20, Climate Protection, ECLI:DE:BVerfG:2021:rs20210324.1bvr265618, para. 162. 115 Pöttker (2014), p. 443.

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the assessment entirely. Its final judgement may provide more information on its reasoning. However, EU civil courts should not circumvent the ETS and respect the limits of courts in climate change policies set by the Constitutional Courts. By applying the same level of liability to companies than the legislature, their judgments do not interfere with interests weighed by the legislature and do not lead to a fragmented system of liabilities in the EU.

4.2

Limits of the ETS’ Effects on Climate Change Disputes

As neither The Hague District Court nor the Higher Regional Court of Hamm ultimately gave effect to the ETS, both Courts have drawn the limits of ETS’ effect on climate change disputes. The Hague District Court explicitly held Shell responsible for indirect emissions (Sect. 4.2.1) and emissions from installations outside of the EU (Sect. 4.2.2). The Higher Regional Court of Hamm found that ETS allowances did not justify RWE’s indirect interference in claims for removal of an interference (Sect. 4.2.3). Lastly, The Hague District Court and the Higher Regional Court of Hamm rejected the effect of the ETS on the claim entirely because of its inefficiency for climate protection (Sect. 4.2.4).

4.2.1

Indirect Emissions

The Hague District Court found that indirect emissions (Scope 2 and 3 emissions) were not covered by the indemnifying effect of ETS allowances.116 In the case of Shell, 85% of its emissions fall into Scope 3.117 The EU ETS Directive does not regulate indirect emissions, but only direct emissions (Scope 1 emissions).118 Nonetheless, The Hague District Court took indirect emissions into account in the duty of care.119 Based on the Oxford report from 2020,120 the Court found that “although there are nuances, it is internationally endorsed that companies bear

116 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 117 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 2.5.5. 118 Article 2(1) and Annex I EU ETS Directive. 119 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 120 Hale T., Oxford Net Zero (2020), Mapping of current practices around net zero targets. https://4 bafc222-18ee-4db3-b866-67628513159f.filesusr.com/ugd/6d11e7_347e267a4a794 cd586b1420404e11a57.pdf (last accessed 27 September 2022): The Oxford Report summarises the current practice of organisations within the climate action community. The report explained that “in general, targets should aim to cover all gasses and all activities and scopes, as data allows” (p. 1).

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responsibilities for Scope 3 emissions” under Section 6:162 DCC.121 The Court reasoned that the responsibility of Shell governed the entire value chain because it has a policy-setting influence on them.122 However, it is questionable whether this approach is compatible with the ETS. Even though the ETS does not explicitly justify indirect emissions, the EU ETS Directive might contain a different approach to dealing with indirect emissions that should be considered under the duty of care. Due regard has to be given to the purpose and functioning of the EU ETS Directive. The purpose is to create an individual responsibility for private companies to reduce GHG emissions so that the total amount of GHG emissions in the EU is reduced. To reduce the total amount, the EU ETS Directive functions by only taking direct emissions into the calculation. Adding indirect emissions to the calculation would not be compatible with the ETS.123 A cap and trade system is based on the idea that the total quantity of emissions is reduced.124 To determine the total amount, emissions can only be counted once. If indirect emissions were to be considered, some emissions would be double-counted. For instance, if a Shell installation processed its oil by using electricity produced by a coal-fired power plant of an RWE installation, the Shell installation would need ETS allowances for the emissions of the oil process and the RWE installation would need ETS allowances for the coalfired power plant. This would cover all emissions. If indirect emissions were counted as well, the Shell installation would also need ETS allowances for the electricity produced by the RWE installation (Scope 2 emissions). And the RWE installation would need ETS allowances for Shell’s emissions (Scope 3 emissions). In that case, the emissions would be counted twice in the ETS. The calculation becomes even more complex if all upstream and downstream emissions up until the end-user had to be covered by ETS allowances. The total amount of emissions in the EU would not correspond to the amount of ETS allowances. To avoid such a scenario, the Commission explained in its Proposal for the EU ETS Directive: As a result of the harmonised and consistent coverage of the power and heat generation sector, Member States may not allocate any allowances to installations generating power from carbon-free sources or to installations consuming power, heat or steam (indirect emitters).125

Moreover, the EU ETS Directive contains a legal evaluation that is contrary to the idea of holding companies responsible for indirect emissions. Article 10a(6) EU ETS Directive provides that

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The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.18. 122 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.18. 123 Proposal for the EU ETS Directive, COM/2003/0403 final, para. 3.2. 124 Annex III EU ETS Directive. 125 Proposal for the EU ETS Directive, COM/2003/0403 final, para. 3.2.

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Member States should adopt financial measures [. . .] in favour of sectors or subsectors which are exposed to a genuine risk of carbon leakage due to significant indirect costs that are actually incurred from greenhouse gas emission costs passed on in electricity prices.126

The legislature opts in the opposite direction than The Hague District Court. While the legislature chose a system that only holds companies responsible for direct emissions and even partially compensates installations for the indirect costs that they face due to the ETS, The Hague District Court extends the responsibility to indirect emissions. In doing so, the Court does not address how a company’s responsibility for indirect emissions is compatible with the ETS. How would the responsibility for indirect emissions be distributed among the companies? Would the companies share responsibilities? Or is every company fully responsible for all emissions? How would this affect the ETS economically and in its climate ambitions? The Hague District Court does not answer these questions, nor could it. EU Civil Courts do not have the apparatus available for knowledge and opinion exchange to decide on such highly political problems. But even if The Hague District Court had the answers to these questions, its competencies are limited to deciding on a dispute between two individuals. The EU legislature, in turn, sees and decides on the entire picture. This is important to decide who bears responsibility for indirect emissions. Unlike The Hague District Court, EU civil courts should, therefore, be cautious to consider indirect emissions unlawful in injunctive reliefs and claims for removal of an interference in order to preserve an effective and functioning carbon market.

4.2.2

GHG Emissions from Installations Outside the EU

The Hague District Court further limited the indemnifying effect of the ETS geographically. According to the Court, the indemnifying effect shall only apply to installations located in the EU127 or states that have an existing and planned cap and trade emission scheme.128 However, GHG emissions by installations that are not covered by a cap and trade system shall breach the duty of care.129 This raises problems in two respects. First, the ruling of The Hague District Court on issues outside of the EU might cause political and economic repercussions for the relationship of the EU and its Member States with third countries. Unilateral environmental measures by the EU and its Member States can trigger strong political opposition worldwide. An According to Article 1(12)(e) Proposal for a renewed EU ETS, COM/2021/551 final, the compensation for indirect costs shall not apply to companies anymore that receive free allowances. 127 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 128 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.47. 129 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.47. 126

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example is the EU’s attempt to implement the Aviation Directive130 in 2008. It aimed to apply the ETS to all flights from, to, and within the European Economic Area (EEA).131 The Commission’s proposal was followed by strong reactions of disapproval from many states and companies around the world. Among other things, China cancelled Airbus aircraft orders and banned all Chinese airlines from participating in the ETS.132 India and 26 other countries signed the “Delhi Declaration” which asked the EU to reverse its measure.133 Ultimately, this pressure led to a standstill in the Aviation Directive’s legislative process.134 Forcing companies with a global reach to reduce their GHG emissions—whether through a fixed reduction target or indirectly by putting compensation obligations on them—might affect the energy supply and the supply of CO2 intensive goods in states outside of the EU. That could cause strong opposition in the EU’s relationship with third countries and even affect the EU’s reliance on energy imports from third countries.135 Secondly, it is questionable how The Hague District Court’s decision on emissions outside of the EU will be compatible with the EU Carbon Border Adjustment Mechanism (EU CBAM). This mechanism shall be implemented by 2023 as a complementary measure for the ETS. Companies shall buy certificates for CO2 intensive goods that are imported into the EU.136 Thereby, the EU legalises those emissions outside of the EU the same way it legalised emissions under the ETS. Consequently, they should be equally considered as ETS allowances in climate change disputes. This is relevant for claims directed at future emissions—such as in the Shell case. But it would not change the assessment for emissions in the past as the EU CBAM only applies from 2023. All of this shows, that climate change mitigation—due to its global reach and multilevel legal framework—is a very complex matter. The right places for such discussions are not the court rooms of a proceeding between two private persons. Instead, politicians and diplomats should negotiate on a multilateral stage, e.g. by way of a “climate club”137 with all states involved.

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Directive 2008/101/EC of the European Parliament and of the Council of 19 November 2008 amending Directive 2003/87/EC so as to include aviation activities in the scheme for greenhouse gas emission allowance trading within the Community. 131 Commission, Reducing emissions from aviation. https://ec.europa.eu/clima/eu-action/transportemissions/reducing-emissions-aviation_en (last accessed 27 September 2022). 132 Bradford (2020), p. 221. 133 Bradford (2020), p. 221. 134 Bradford (2020), p. 222. 135 Kieninger (2022), p. 6. 136 Proposal for a Regulation establishing a carbon border adjustment mechanism, COM(2021) 564 final. 137 Nordhaus (2015).

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No Justification for the State of Nuisance

The Higher Regional Court of Hamm considered the claim to be well-founded despite the fact that RWE acted lawfully.138 Thereby, the Court implicitly rejected the influence of the ETS on claims directed at the removal of an interference (Section 1004(1) sentence 1 GCC). In contrast to injunctive reliefs, the ETS could only justify the respondent’s behaviour, not the state of a nuisance, namely the risk of floods. The decision of the Higher Regional Court of Hamm is comprehensible in that ETS allowances cannot justify the disastrous causes of global heating such as melting glaciers and floods caused by GHG emitted over decades. The ETS contains a conclusive regulation on the total amount of GHG that installations in the EU are allowed to emit each year, but not on global heating itself. The fight against global heating is twofold: mitigation and adaptation.139 While mitigation “means making the impacts of climate change less severe by preventing or reducing the emission of greenhouse gases (GHG) into the atmosphere”,140 adaptation “can be understood as the process of adjusting to the current and future effects of climate change.”141 Adaptation is crucial for climate protection as the concentration of GHG emissions in the atmosphere will continue to increase in the coming decades142 and some of the consequences will be irreversible.143 The EU ETS Directive does not deal with adaptation but is only a measure of mitigation.144 As such it only regulates GHG emissions since its implementation in 2005.145 Hence, the ETS can only justify a company’s behaviour in climate change disputes directed at reduction obligations but not for adaptation obligations. The same applies for GHG emissions previous to the implementation of the EU ETS Directive.

138 Higher Regional Court of Hamm, I-5 U 15/17, Luciano Lliuya v. RWE, ZUR 2018, 118, para. I.2. 139 Article 2(1)(a) and (b) Paris Agreement. 140 European Environment Agency, What is the difference between adaptation and mitigation? https://www.eea.europa.eu/help/faq/what-is-the-difference-between#:~:text=In%20essence%2C% 20adaptation%20can%20be,(GHG)%20into%20the%20atmosphere (last accessed 27 September 2022). 141 European Environment Agency, What is the difference between adaptation and mitigation? https://www.eea.europa.eu/help/faq/what-is-the-difference-between#:~:text=In%20essence%2C% 20adaptation%20can%20be,(GHG)%20into%20the%20atmosphere (last accessed 27 September 2022). 142 Commission, Adaptation to climate change. https://ec.europa.eu/clima/eu-action/adaptationclimate-change_en (last accessed 27 September 2022). 143 IPCC, Climate Change 2022—Impacts, Adaptation and Vulnerability—Summary for Policy Makers. https://www.ipcc.ch/report/ar6/wg2/ (last accessed 27 September 2022), para. B.1. 144 Article 2, 3(a), (b) EU ETS Directive. 145 Commission, Development of EU ETS (2005–2020). https://ec.europa.eu/clima/eu-action/euemissions-trading-system-eu-ets/development-eu-ets-2005-2020_en (last accessed 27 September 2022).

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However, the Higher Regional Court of Hamm should not stop at this point of the assessment. Justifications in tort law claims can also arise from fundamental rights.146 They have indirect effect on the relationship between private persons and need to be brought into a balance.147 The legislature’s climate protection policy as a whole is the result of a balancing act of fundamental rights. The EU legislature relies on scientific evidence such as IPCC reports which offer comprehensive fact base on climate change, its causes, potential impacts, and response options.148 The ETS is embedded in a larger set of regulations and policies that take into account adaptation measures and historic emissions.149 From this balancing act results the EU’s mitigation goal to transition from a reliance on sources that emit GHG to net zero by 2050.150 By allowing private companies to emit a certain amount of GHG emissions, the legislature pre-empted the court’s assessment on the indirect effect of fundamental rights in tort law claims. This justification not only applies to the respondent’s behaviour but also the state of nuisance.

4.2.4

Inefficiency of the ETS

Even though The Hague District Court generally recognised that the ETS could prevent the liability of GHG emitters, the Court ultimately rejected the idea because the ETS did not address the climate crisis efficiently enough. It held that “insofar as RDS’ reduction obligation extends beyond the reduction target of the ETS system, RDS will have to fulfill its individual obligation”.151 The Higher Regional Court of Hamm did not explicitly address the inefficiency of climate change policies. However, the Court must have had a more ambitious conception of climate protection than the legislative in order to hold RWE responsible for lawful actions. Both Courts are right in that the EU’s current legislative framework does not comply with the Paris Agreement and fundamental rights. The Paris Agreement sets out the global goal to limit global heating to 1.5 °C or at least below 2 °C compared to pre-industrial levels.152 If this goal is not met, the consequences of climate change will be irreversible and disastrous for the environment, humans, and animals.153 146

Raff (2020), paras. 209, 218–221; Sieburgh (2019), para. 57. Regional Court of Stuttgart, 17 O 789/21, DUH v Mercedes-Benz Group AG, 13 September 2022, p. 7; Raff (2020), para. 209. 148 IPCC (2022), Climate Change 2022—Impacts, Adaptation and Vulnerability—Summary for Policy Makers. https://www.ipcc.ch/report/ar6/wg2/ (last accessed 27 September 2022). 149 Communication from the Commission, The European Green Deal, COM(2019) 640 final, para. 2.1.1; Proposal for the EU ETS Directive, COM/2003/0403 final, para. 1.1. 150 Proposal for a renewed EU ETS Directive, COM/2021/551 final, para. 1. 151 The Hague District Court, C/09/571932/HA ZA 19-379, Climate case against RDS, ECLI:NL: RBDHA:2021:5339, para. 4.4.46. 152 Article 2(1)(a) Paris Agreement. 153 IPCC (2022), Climate Change 2022—Impacts, Adaptation and Vulnerability—Summary for Policy Makers. https://www.ipcc.ch/report/ar6/wg2/ (last accessed 27 September 2022), para. B.4. 147

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Consequently, fundamental rights such as the right to life, the right to private life and family life, and property rights are infringed.154 The EU and its Member States define their own mitigation goals in order to comply with the general goal in Article 2 (1)(a) Paris Agreement.155 In December 2020, the EU updated and enhanced its target of at least 55% reduction in GHG emissions by 2030 compared to 1990.156 Thereby, the EU responded to new scientific findings that the previous goal was insufficient to comply with the Paris Agreement.157 The EU ETS Directive will be adapted to this new reduction target.158 Currently, its legally binding target is still at 40%.159 But even the new reduction target might be insufficient to meet the goal under the Paris Agreement and hence lead to a violation of fundamental rights.160 Besides its low reduction target, the ETS has also been criticised for its functional weaknesses. It does not sufficiently make polluters pay and gives further incentives to reduce emissions.161 A large number of ETS allowances is still attributed to installations for free.162 Some installations even get compensated for indirect carbon costs.163 In 2017, the unambitious reduction targets led prices of ETS allowances to reach their lowest point.164 As a result, the EU ETS Directive does currently not comply with the Paris Agreement and infringes fundamental rights. However, EU civil courts are not competent to rule on the invalidity of the ETS. The CJEU has the exclusive sole competence to declare the invalidity of EU acts.165 Even though the EU ETS Directive cannot be challenged in an action for annulment under Article 263 TFEU by the persons affected,166 the CJEU could assess the EU ETS Directive in a preliminary ruling under Article 267 TFEU.167 The EU civil

154

Articles 2, 3, 7 and 17 Charter of Fundamental Rights of the EU. Article 3 Paris Agreement. 156 Council of the EU, Submission to the UNFCCC on behalf of the European Union and its Member States on the update of the nationally determined contribution of the European Union and its Member States, 14005/20. 157 Germany and the European Commission, Update of the NDC of the European Union and its Member States. https://unfccc.int/sites/default/files/NDC/2022-06/EU_NDC_Submission_ December%202020.pdf (last accessed 27 September 2022). 158 Recital 6 Proposal for a renewed EU ETS Directive, COM/2021/551 final. 159 European Commission, 2030 climate & energy framework. https://ec.europa.eu/clima/eu-action/ climate-strategies-targets/2030-climate-energy-framework_en (last accessed 27 September 2022). 160 Climate Action Tracker, EU. https://climateactiontracker.org/countries/eu/ (last accessed 27 September 2022). 161 Lehmann and Eichel (2019), pp. 86 seq.; Kieninger (2022), pp. 9–10. 162 European Commission, Free allocation. https://ec.europa.eu/clima/eu-action/eu-emissionstrading-system-eu-ets/free-allocation_en (last accessed 27 September 2022). 163 Article 10a(6) EU ETS Directive. 164 Lehmann and Eichel (2019), pp. 86 seq.; Kieninger (2022), pp. 9–10. 165 CJEU, C-314/85 Foto-Frost v Hauptzollamt Lübeck-Ost, ECLI:EU:C:1987:452, para. 15. 166 GC, T-330/18, Carvalho, ECLI:EU:T:2019:324, para. 33; CJEU, C-565/19 P, Carvalho, ECLI: EU:C:2021:252, para. 48. 167 CJEU, C-314/85, Foto-Frost v Hauptzollamt Lübeck-Ost, ECLI:EU:C:1987:452, para. 15. 155

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courts would then have to refer a question to the ECJ. Some argue that this legal remedy is not possible or necessary in climate change disputes.168 In the Urgenda case, the Advocate General explained that a preliminary ruling was not necessary because the Court did not assume “the legality, applicability and effect in the European and Dutch legal order of the ETS Directive”.169 This was true for the claim against The Netherlands which does not have ETS allowances and is allowed to take stricter measures for climate protection under Articles 192 and 193 TFEU. However, the situation of private companies is different as they are subjected to the ETS. Climate change disputes rely on the ETS’ effect on the duty of care and the existence of a justification is defined by the ETS. By placing its own legal judgment above the decisions in the ETS, EU civil courts make a statement on the invalidity of the EU ETS Directive. An assessment under Article 267 TFEU would allow the CJEU to finally take a position on the climate protection efforts of the EU. Moreover, it would allow consistent handling of climate change disputes against private companies across the EU.

5 Conclusion: Who Is Responsible for Reducing GHG Emissions in the EU? Targeting private companies is key to making a CO2 intensive economy climate neutral. The larger and more international the companies are, the more they have a far-reaching steering function on the reduction of GHG emissions. But solving a problem that infringes everyone’s rights and for which everyone is responsible needs legislative choices more than ever. Climate change disputes against private companies, in turn, are neither effective—nor democratic. The climate crisis is entangled in global connections and an economic framework. Transitioning the entire economy on world-wide level can only be achieved by those who have a full picture, are in dialogue with stakeholders, and negotiate on a multilateral level. The Commission, the EU Parliament, and the governments of EU Member States are best placed to implement a just and sustainable climate protection policy in accordance with the Paris Agreement and fundamental rights. As a result of this policy, the legislature implemented the EU ETS Directive. This cap and trade system allows to reduce the total amount of GHG emissions while at

168

Procurator General of the Dutch Supreme Court, case 19/00135, Urgenda Foundation v State of the Netherlands, NL:HR:2019:2007 (http://climatecasechart.com/wp-content/uploads/sites/16/nonus-case-documents/2019/20190913_2015-HAZA-C0900456689_opinion-1.pdf, last accessed 27 September 2022), paras. 4.1009–4.1119; Winter (2020), p. 159. 169 Procurator General of the Dutch Supreme Court, case 19/00135, Urgenda Foundation v State of the Netherlands, NL:HR:2019:2007 (http://climatecasechart.com/wp-content/uploads/sites/16/nonus-case-documents/2019/20190913_2015-HAZA-C0900456689_opinion-1.pdf, last accessed 27 September 2022), para. 4.1116.

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the same time leaving flexibility to private companies in their transition towards climate neutrality. EU civil courts, in contrast, are not able to assess the complexity and magnitude of the climate crisis. They do not have the necessary resources to assess the consequences of their decisions inter alia regarding indirect emissions or installations outside of the EU. Their assessment is limited to disputes between two parties.170 Instead of risking the malfunctioning of the ETS and the climate protection policy in general, the decisions of EU civil court should rely on the legislative assessment. In Dutch and German tort law, the legislative choices can be reflected in climate change disputes in the assessment of the duty of care. In Dutch tort law, ETS allowances can even serve as a justification for the indirect interference. Through these mechanisms, the democratic legitimacy of EU civil courts’ decisions can be maintained. The Higher Regional Court of Hamm and The Hague District Court overstepped their democratic legitimacy by disregarding the EU’ climate protection policy. Instead of establishing their own threshold when GHG emissions become unlawful, they should have oriented their decision along the EU’s and national climate protection policy. Even though it seems refreshing to have a state institution acknowledging the urgency of climate protection, it is the EU legislature that needs to act. If it fails to act, the ECJ has the exclusive competence to put the EU legislature in its place and to push for more ambitious climate targets. At this stage in climate change, the EU legislature still has some margin to decide on the pace and discretion it gives companies under the ETS. But the latest IPCC report is alarming.171 Stricter measures will be required soon and the later we act, the worse will be the consequences for the economy and our planet.

References Ahrens HJ (2019) Außervertragliche Haftung wegen der Emission genehmigter Treibhausgase? Versicherungsrecht, pp 645–654 Berger C (2021) § 1004 BGB. In: Jauernig O (ed) Sachenrecht. Bürgerliches Gesetzbuch, vol 3. C. H. Beck, Munich Börstra B, Römling D (2022) Klimaklagen gegen Unternehmen. Zeitschrift für europäische Umwelt- und Planungsrecht 1:30–43 Bradford A (2020) The Brussels effect: how the European Union rules the world. Oxford University Press, Oxford Chatzinerantzis A, Appel M (2019) Haftung für den Klimawandel. Neue Juristische Wochenschrift 72(13):881–886 Comandé G, Faure M, Moreteau O et al (2005) Principles of European tort law: text and commentary. European Group on Tort Law. Springer, Vienna

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Fritzsche J (2022) § 1004 BGB. In: Hau W, Poseck R (eds) BeckOK BGB. C.H. Beck, Munich Hinteregger M (2017) Civil liability and the challenges of climate change: a functional analysis. J Eur Tort Law 8(2):238–259 Ipsen N, Waßmuth G, Plappert L (2021) Klimawandel als Haftungsrisiko. Zeitschrift für Wirtschaftsrecht:1843–1853 Jagers N, van der Heijden MJ (2008) Corporate human rights violations: the feasibility of civil recourse in The Netherlands. Brooklyn J Int Law 33(3):833–870 Kahl W, Weller MP (2021) Climate change litigation. C.H. Beck, Munich Kieninger EM (2022) Das international Privat- und Verfahrensrecht der Klimahaftung. Praxis des internationalen Privat- und Verfahrensrechts, pp 1–12 Lehmann M, Eichel F (2019) Globaler Klimawandel und Internationales Privatrecht. Rabel J Comp Int Priv Law 83(1):77–110 Macchi C, van Zeben J (2021) Business and human rights implications of climate change litigation: Milieudefensie et al. v Royal Dutch Shell. Rev Eur Comp Int Environ Law 30(3):409–415 Nordhaus W (2015) Climate clubs: overcoming free-riding in international climate policy. Am Econ Rev 105(4):1339–1370 Pöttker E (2014) Klimahaftungsrecht. Mohr Siebeck, Tübingen Raff T (2020) § 1004. In: Gaier R (ed) Sachenrecht, §§ 854-1296, WEG, ErbBauRG. Münchener Kommentar, vol 8. C.H. Beck, Munich Setzer J, Higham C (2022) Global trends in climate change litigation: 2022 snapshot. Grantham Research Institute on Climate Change and the Environment and Centre for Climate Change Economics and Policy. London School of Economics and Political Science, London Sieburgh CH (2019) De Verbintenis uit de wet. In: Sieburgh CH (ed) Verbintenissenrecht. Mr. C. Assers Handleiding tot de beofening van het Nederlands Burgerlijk Recht, vol 6(4). Wolters Kluwer, Deventer, pp 1–568 Spitzer M, Burtscher B (2017) Liability for climate change: cases, challenges and concepts. J Eur Tort Law 8(2):137–175 Thöne M (2022) Klimaschutz durch Haftungsrecht – vier Problemkreise. Zeitschrift für Umweltrecht 66(6):323–333 Wagner G (2020) § 823. In: Habersack M (ed) Schuldrecht – Besonderer Teil IV, §§ 705-853, Partnerschaftsgesellschaftsgesetz, Produkthaftungsgesetz. Münchener Kommentar zum Bürgerlichen Gesetzbuch, vol 7. C.H. Beck, München Wagner G (2021) Klimaschutz durch Gerichte. Neue Juristische Wochenschrift 31:2256–2263 Wagner G, Arntz A (2021) Liability for climate damages under German law of torts. In: Kahl W, Weller MP (eds) Climate change litigation. C.H. Beck, Munich, pp 405–427 Winter G (2020) Armando Carvalho and Others v EU: invoking human rights and the Paris Agreement for better climate protection legislation. Transnatl Environ Law 9(1):137–164

Ina Frieling is a trainee lawyer at the Higher Regional Court of Berlin. As part of her traineeship, she worked for Noerr in the Regulatory and Governmental Affairs Department and for the German Federal Ministry of Foreign Affairs in the field of international climate protection. She studied law at the Humboldt University of Berlin, the University Panthéon Assas in Paris and the University of Amsterdam. During her studies, she specialised in EU, international and comparative law.

The Proposed EU Regulation on Trade in Forest-Risk Commodities (FRCs): A First Assessment Concetta Maria Pontecorvo

Contents 1 Preliminary Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The Relevance of EU’s Import and Consumption of Forest-Risk Commodities to Global Deforestation “Footprint” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 International Initiatives on Forests: The Legal Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 EU Action on Forests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Current EU Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Future EU Action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 A First Assessment of the Recent Commission’s Proposal of Regulation . . . . . . . . . . . . . . . . . 5.1 Appropriateness and Necessity of EU Action on FRCs’ Trade . . . . . . . . . . . . . . . . . . . . . 5.2 Shortcomings and Limits (of Ambitions) in the Commission’s Proposal . . . . . . . . . . . 6 Prima facie Considerations on the WTO-Compatibility of the (Proposed) Regulation . . . 6.1 Possible Tension with Core WTO Disciplines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Possible Justification Under WTO Exception Clauses (Article XX GATT) . . . . . . . . 7 Concluding Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

508 509 511 515 515 518 526 527 529 531 531 533 538 539

Abstract The European Union is a significant importer of “forest-risk commodities” (FRCs) and consequently bears an equally significant responsibility for the on-going worldwide and dangerous trend of deforestation and forest degradation. Last November 17, 2021 the EU Commission, by undertaking an important (and very courageous) initiative aimed at reducing the EU’s global deforestation “footprint”, put forward a legislative proposal to regulate trade in FRCs. This article analyses such a proposal—within the context of previous EU regulatory steps against global forest loss and to promote sustainable forest management; and it explains why the new EU regulatory initiative seems both appropriate and necessary. Notwithstanding some important limits (of ambition) and shortcomings in the

The author is indebted to Valentina Grado (Professore Associato of International Law, University of Naples ‘L’Orientale’) for her stimulating and insightful comments on earlier drafts. C. M. Pontecorvo (*) University “Federico II” of Naples, Naples, Italy e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 507–540, https://doi.org/10.1007/8165_2022_86, Published online: 30 September 2022

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Commission’s proposal (mainly in relation to land tenure rights’ protection) the article argues that the EU has (in fact) a (moral) duty to avoid contributing (by its FRCs imports) to the global destruction and degradation of forests. The article also underlines that the proposed regulation is in need to be better designed with WTO law (particularly, as to its country benchmarking system and as regards cooperation with affected exporting countries).

1 Preliminary Remarks Threats to the world’s forests have been widely recognised as one of the major sustainability challenges of our time, given the indispensable role that forests play in sustaining life on Earth and human well-being.1 Notwithstanding, this has received relatively little attention by legal scholars, perhaps because of the lack of a comprehensive international treaty on forests. This article is aimed at filling such a gap specifically focusing on the regulatory steps that the European Union (EU) has taken and is considering taking to address its (share of) responsibility for this relevant global problem.2 In what follows, after briefly explaining how (global and) EU import and consumption of “forest-risk commodities” (FRCs) is a significant driver of deforestation and forest degradation problems worldwide and after discussing how the regulation of FRC’s trade might (and should) play a crucial role in their solution (Sect. 2), the article will first give a quick overview of the initiatives and commitments that have been adopted over the last three decades at the international and regional (EU) levels to reverse the rising trend of global forest loss and promote sustainable forest management worldwide (Sect. 3). Against this background our

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Healthy forest ecosystems provide us with essential services (e.g., clean air, carbon reduction, habitats for animals and plants and water flow regulation), are sources of livelihood and income for about 25% of the world’s population (including indigenous and vulnerable communities) and hold intrinsic cultural and spiritual values for many people. See further Pontecorvo (2011), above all pp. 17–37; and recently, Pearce (2021). 2 It is no secret that the world’s forests are in serious danger. According to the latest joint report by the UN Environment Programme (UNEP) and Food and Agriculture Organisation (FAO), global deforestation and forest degradation continued to take place at alarming rates in 2015–2020: see UNEP/FAO (2020) The State of the World’s Forests, at xvi, available at www.fao.org/documents/ card/fr/c/ca8642en/ accessed 25 March 2022. During this period the rate of deforestation was estimated at 10 million hectares per year, compared to 16 million hectares per year in the 1990s. Over the past decades, it is estimated that some 420 million hectares of forest have been lost through conversion to other land uses, above all in some regions of the world (i.e., South America, Central Africa and Southeast Asia): see UNEP/FAO (2020) The State of the World’s Forests, at xvi and pp. 9–10. In Europe, forest cover has instead continuously increased by 9% over the period 1990–2020: see Forest Europe (2020) State of Europe’s Forests 2020, at 15 (available at https:// foresteurope.org/wp-content/uploads/2016/08/SoEF_2020.pdf accessed 25 March 2022).

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subsequent analysis will be specifically devoted to an examination of EU interventions aimed to reduce its global deforestation “footprint”. In particular, we begin with a brief overview of existing EU legislation to combat illegal logging and related trade in illegally harvested timber (Sect. 4) to analyse then more broadly the recent (17 November 2021) Commission’s legislative proposal to regulate trade in (several) forest-risk agricultural commodities (Sect. 5). In this respect, on the one hand we argue that i) the EU proposed action to regulate trade in FRC’s seems to be appropriate and necessary on ground that the Union (de facto) has a (moral) “duty” not to contribute to environmental damages in third countries through its demand for such commodities. On the other hand, we underline that ii) the Commission’s proposal shows a few shortcomings, particularly from a human rights perspective; and it is also—in fact—less ambitious than the earlier recommendations of the European Parliament (EP). Moreover, we argue that certain elements of the Commission’s proposal need to be reviewed to bring it (better) in line with the law of the World Trade Organisation (WTO) and that such a change can also improve the environmental benefits of the proposed regulation (Sect. 6). Finally, we conclude our analysis with identifying some key issues to be (suitably) addressed during the ongoing legislative process the Commission’s proposal is experiencing at the EU level (Sect. 7).

2 The Relevance of EU’s Import and Consumption of Forest-Risk Commodities to Global Deforestation “Footprint” Over recent years, significant progress has been made in understanding both the impact and the scale of the EU’s global deforestation “footprint”, including deforestation that is embodied in products imported into the EU.3 As recently observed by the European Environment Agency (EEA) in its State of the Environment Report 2020, “through trade European production and consumption patterns contribute significantly to environmental pressures and degradation in other parts of the world”.4 This report consequently found that “Europe, to an increasing degree, is externalising its pressure on key environmental issues [to other countries]”.5 As to the scale of the EU’s global “footprint”, a study prepared on behalf of the EU Commission shows that, during the period 1990–2008, EU consumption was responsible for about 10 percent of global deforestation. Moreover, a groundbreaking research by Pendrill and others established that in the years 2005–2013,

See for instance Cabernard and Pfister (2021), citing key articles in this field. EEA, The European Environment – State and Outlook 2020: Knowledge for Transition to a Sustainable Europe, 2019 (hereinafter The European Environment), p. 32 (emphasis added), available at www.eea.europa.eu/soer/2020 and last accessed 26 March 2022. 5 The European Environment, p. 52 (emphasis added). 3 4

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Europe (excluding Russia) was the largest contributor to global deforestation embodied in imported commodities.6 Furthermore, though between 2005 and 2017 the level of deforestation associated with EU imports has fallen by around 40 percent, in 2017 the EU was still estimated to be responsible for 16 percent of the deforestation embodied in internationally traded commodities.7 Particularly, given that around 27 percent of agricultural commodities was traded that year,8 this implies the EU being responsible for about 4.5 percent of global deforestation.9 Remarkably, in 2018 more than three-quarters of the EU’s global deforestation “footprint” derived from five (agricultural) commodities, namely beef (4.47 percent), coffee (9.05 percent), cocoa (10.14 percent), palm oil (26.14 percent) and soybeans (27 percent).10 As far as wood is concerned, notwithstanding figures for it are not available for 2018, this is estimated to have comprised a 9 percent share of embodied deforestation in 2017, putting it within the top six EU-imported commodities causing global deforestation.11 As to the countries supplying commodities which embodied the EU’s total imported deforestation, taken together Paraguay (12.87 percent), Brazil (20.48 percent) and Indonesia (21.48 percent) provided more than half of such amount in 2018.12 Moreover, it should be taken into account that though China has become the world’s biggest importer of embodied deforestation,13 the (relative) deforestation impact of the EU per unit of import is higher than China for some commodities.14 Finally, while till now consumption of FRCs has provided the main driver of (and the main lens through which to analyse) the EU’s contribution to global

6 Pendrill et al. (2019), p. 20, underscoring that a significant portion of the recent increase registered in net forest cover in Europe has been offset by deforestation occurring elsewhere in order to produce commodities for consumption in Europe. 7 Wedeaux B and Schulmeister-Oldenhove A Stepping up? The Continuing Impact of EU Consumption on Nature Worldwide. WWF, 2021, p. 5 (available at www.wwf.nl/globalassets/pdf/ stepping-up-the-continuing-impact-of-eu-consumption-on-nature-worldwide.pdf accessed 25 March 2022). 8 See Pendrill et al., Deforestation Risk Embodied in Consumption and Production of Agricultural and Forestry Commodities 2005–2018, 2022, available at http://zenodo.org/record/5886600#.Ye1 b7PXP0_U accessed 25 March 2022. 9 Compared to the Commission’s earlier estimate of 10 percent for the period 1990–2008. 10 Pendrill et al., Deforestation Risk Embodied in Consumption and Production of Agricultural and Forestry Commodities 2005–2018. 11 See Wedeaux B and Schulmeister-Oldenhove A Stepping up? The Continuing Impact of EU Consumption on Nature Worldwide. WWF, 2021, p. 7 and 21. 12 See Pendrill et al., Deforestation Risk Embodied in Consumption and Production of Agricultural and Forestry Commodities 2005–2018. 13 24 percent compared to the 16 percent of the EU (Wedeaux B and Schulmeister-Oldenhove A Stepping Up? The Continuing Impact of EU Consumption on Nature Worldwide, p. 5). 14 For example, the EU’s ‘relative deforestation impact’ is twice as high for soy imported Argentina and Brazil, because “the EU’s imports are more often sourced from areas being frontiers of deforestation and conversion such as the Cerrado” (Wedeaux B and Schulmeister-Oldenhove A Stepping Up? The Continuing Impact of EU Consumption on Nature Worldwide, p. 21).

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deforestation, recently attention has (also) turned to the financing of activities causing deforestation. For instance, a research commissioned by Global Witness has recently investigated the financing of six major agribusinesses operating in either the Congo Basin, the Brazilian Amazon or Papua New Guinea,15 revealing “with new starkness the golden sinews that link London, Berlin and New York City to the dwindling rainforests of the Amazon, the Congo Basin and the islands of New Guinea”.16 In relation to these agribusinesses, looking into the credit activities and share/bond holdings of financial institutions, the research finds that several investment firms, banks and pension funds financed them for an amount of 44 billion dollars between 2013 and 2019.17 Remarkably, though Global Witness accepts that it is not possible to establish exactly how much of this financing directly funded deforestation, on the basis of the reconstructed evidence it calls for and urges greater regulation, particularly by the means of due diligence and improved requirements of transparency and disclosure.18

3 International Initiatives on Forests: The Legal Framework Arguments in favour of the relevance and urgency of EU action to regulate trade in FRCs can be better understood if one takes into account the fact that forests’ degradation and destruction has been high on the international agenda since the early 1990; and that a relevant international legal framework has been gradually developed over the last two decades.19 In what follows a brief account of this framework is therefore given, being it prodromal to clarify the legal context where both the current EU action on forests and the recently proposed Regulation on FRC’s trade—illustrated below in Sect. 4—are rooted and legally grounded. Part of the international legal framework on forests takes the form of soft-law instruments which, while being formally non-binding, establish however significant

15 Global Witness, Money to Burn, 2019, available at www.globalwitness.org/en/campains/forests/ money-to-burn-how-iconic-banks-and-investors-fund-the-destruction-of-the-world-largestrainforests/ (accessed 26 March 2022). 16 Global Witness, Money to Burn, p. 3. 17 Financiers with headquarters in France, the Netherlands, Spain, Germany, Cyprus and Italy are among those which made the most significant investments. The research also includes a list of the top countries in terms of the value of credit and investment and a list of the top providers of credit and investments overall. 18 To this respect, the well-known Trase Earth Initiative has recently expanded its initiatives by developing a Trase Finance database seeking to list the financial institutions exposed to deforestation risks. It includes a “watchlist” identifying the “Top 10 Commodity Traders causing the EU’s deforestation risk” (available at http://trase.finance/watchlists/3ebfe1f8-0a62-4c6a-8109-70733 8faf454 accessed 25 March 2022). 19 See Pontecorvo (2011), pp. 143–258 also for further bibliographical references.

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and acceptable rules of behaviour that place equally significant (para-normative) expectations of compliance on the actors concerned by them, including the EU.20 These instruments include, first of all, the so-called Forest Principles (FP)21 adopted in 1992 at the United Nations (UN) Conference on Environment and Development held in Rio de Janeiro. The FP establish key precepts that have since then shaped international discussion on forests; such as, the principle that States have the sovereign right under international law to exploit their forest resources pursuant their own environmental policies,22 linked to responsibility for environmental harm, and the evolving notion of “sustainable forest management”.23 More recently, within the UN 2030 Agenda for Sustainable Development—adopted by the General Assembly (UNGA) in September 2015,24 the international community pledged firstly “[b]y 2020, [to] promote the implementation of sustainable management of all types of forests, halt deforestation, restore degraded forests and sustainably increase afforestation and reforestation globally”(Sustainable Development Goal, SDG, 15.2).25 Moreover, SDG 12.2 commits UN Member States to ensure sustainable patterns of both consumption and production, including through “[achieving] the sustainable management and efficient use of natural resources [by 2030]”.26 Subsequently, in January 2017 the (first-ever) UN Strategic Plan for Forests (2017–2030) was adopted at a special session of the UN Forum on Forests27 and then endorsed (without a vote) by the UNGA in April 2017.28 Such a Strategic Plan provides a global framework for action at various levels to manage forests sustainably and to halt deforestation and forest degradation. This contains a set of six Global Forest Goals and 26 associated targets to be reached by 2030. Of most relevance to our analysis, these targets include “[enhancing] forest law enforcement and governance. . . and [significantly reducing] illegal logging and associated trade worldwide” as part of Goal 5,29 and “building markets and infrastructure to promote

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On this point see generally Boyle (2021), p. 420 f. Non-Legally Binding Authoritative Statement of Principles for a Global Consensus on the Management, Conservation and Sustainable Development of all Types of Forests, adopted at the UN Conference on Environment and Development (Rio de Janeiro 3–14 June 1992), UN Doc. A/CONF.151/26 (Vol. III), hereinafter Rio Forest Principles. 22 Rio Forest Principles, para. 1(a). 23 Rio Forest Principles, para. 2(c). See further Pontecorvo (2011), pp. 204–211, and Savaresi (2012), pp. 150–151. 24 UNGA Res.70/1 (25 September 2015), UN Doc. A/RES/70/1. 25 UNGA Res.70/1, p. 24. 26 UNGA Res.70/1, p. 22. 27 See UN Economic and Social Council Resolution 2017/4 (20 April 2017), in which the Council adopted the United Nations Strategic Plan for Forests 2017–2030 on the recommendation of the United Nations Forum on Forests (UNFF) at its special session held on 20 January 2017. The text of the Strategic Plan for Forest is included in the Report of the UNFF on its Special 2017 Session, UN Doc. E/2017/10 (8 February 2017), Annex I. 28 UNGA Res. 71/285 (1 May 2017), UN Doc. A/RES/71/285. 29 UN Doc. E/2017/10, p. 8. 21

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production and consumption of sustainably managed forest products” as part of Goal 3.30 However, forests have also received increasing attention within the international (but sectorial) legal regimes on climate change and biodiversity conservation. With regards to the former, it is well known that forests are indispensable in the fight against climate change due to their natural capacity to absorb and store carbon from the atmosphere. The rate of contribution of deforestation and forest degradation to global greenhouse gas (GHG) emission varies depending on the assessment; but it has been estimated by the UN to account for about 12–20 percent of global GHG emissions—that is, the second major cause of climate change after the burning of fossil fuels.31 This issue is explicitly acknowledged in Article 5 of the 2016 Paris Agreement, which provides that Parties “should take action to conserve and enhance, as appropriate” carbon sinks, including forests;32 with a particular emphasis being placed on the so-called “REDD+ mechanism”33 introduced in 2005 under the umbrella of the UN Framework Convention on Climate Change (UNFCCC). Of most relevance for the purposes of our study is also the recent Glasgow Leaders’ Declaration on Forest and Land Use, endorsed on 2 November 2021 by 141 UNFCCC Parties (including the EU), which expressly links the collective goal of halting and reversing global forest loss by 2030 with trade regulation. High-ranked representatives of States hosting more than 90 percent of the world’s forests have committed indeed to “facilitate trade and development policies, internationally and domestically, that promote. . . sustainable commodity production and consumption. . . and that do not drive deforestation and land degradation”.34 As to the (relevance of forests within the) biodiversity conservation regime, it is equally known that forests also host most of the Earth’s plant and animal species and cover just over 30 percent of its land area, thus being very crucial for the protection of terrestrial biodiversity.35 The alarming rates of deforestation and forest fragmentation since 1990 have indeed significantly contributed to the on-going loss of ecosystem services and biodiversity that are crucially important to human life and

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UN Doc. E/2017/10, p. 7. See UN, Too Precious to Lose, available at www.un.org/en/observances/forests-and-trees-day, accessed 25 March 2022. 32 Paris Agreement (adopted on 12 December 2015 and entered into force on 4 November 2016), UN Doc. FCCC/CP/2015/L.9/Rev/1, Articles 5(1)-(2). See also UN Framework Convention on Climate Change (adopted on 9 May 1992, entered into force on 21 March 1994), Articles 3(3) and 4(1)(c). 33 The REDD+ acronym stands for “reducing emissions from deforestation and forest degradation in developing countries; plus, the role of conservation, sustainable management of forests and enhancement of forest carbon stocks in developing countries: for further details see Savaresi (2012), pp. 157–167. 34 Glasgow Leaders’ Declaration on Forests and Land Use (adopted on 12 November 2021), text available at https://ukcop26.org/glasgow-leaders-declaration-on-forests-and-land-use/ (accessed 25 March 2022). 35 See UNEP/FAO (2020) The State of the World’s Forests, at xvi and pp. 35–50. 31

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well-being.36 At present the Convention on Biological Diversity (CBD) is the main legally binding instrument applicable to forest ecosystems, establishing a general obligation on Member States on their (biodiversity) conservation and sustainable use. Admittedly, these provisions are framed however in open-ended and qualified terms—leaving thereby considerable discretion to each Contracting Party in terms of implementation.37 Furthermore, in line with the principle of State sovereignty over its natural resources, primary responsibility for ensuring conservation and sustainable use of forests is allocated in the Convention on the basis of national jurisdiction or control.38 This means, in other terms, that the EU—as a CBD Party—is legally responsible under the Convention for preserving forests located within its territory rather than those located in third countries. Notwithstanding, CBD Parties have urged the promotion of sustainable production and consumption of forest products (including the consumption of imported commodities) in achieving the overarching Aichi Biodiversity Targets 2015–2020,39 in particular the goals of halving the rate of loss of natural habitats, including forests, by 2020 and significantly reducing degradation and fragmentation (Target 5), and ensuring sustainable management of areas under agriculture and forestry by 2020 (Target 7).40 Against this regulatory background and the wide consensus on the essential role of forests in addressing both climate change and biodiversity crises, surprisingly the international community failed—so far—in negotiating a comprehensive treaty on forests which would address. in legally binding terms, the interconnected areas of sustainable production and consumption. Nonetheless, in the light of the above illustrated international legal regime on forests, it has to be recognised also that, first of all, the EU (both current and recently proposed) measures on forests—that we will examine in next sections—certainly do not take place in a normative vacuum but they respond, rather, to the urgent need to redress the problem of global deforestation and forest degradation that has been (authoritatively and repeatedly) recognised—including by the UN GA—over the last three decades. Second, the existing international legal framework de facto leaves ample space to each actor with regards to the implementation of multilaterally agreed targets and goals on forest restoration and protection. For, if from an international environmental law

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UNEP/FAO (2020) The State of the World’s Forests, at xvi, pp. 57–59, and p. 76 (pointing to the worrying link between zoonotic diseases on the one hand and deforestation and habitat destruction on the other). 37 Convention on Biological Diversity (adopted on 5 June 1992, entered into force on 29 December 1993), Articles 6–20. See also the Expanded Programme of Work on Forest Biodiversity, adopted on 19 April 2002 by Decision VI/22 (“Forest Biological Diversity”) of the Conference of the Parties (COP) to the CBD. 38 Convention on Biological Diversity, Article 4. 39 COP of the Convention on Biodiversity, Decision XIII/3: Strategic actions to enhance the implementation of the Strategic Plan for Biodiversity 2011–2020 and the achievement of the Aichi Biodiversity Targets (16 December 2016), paras 56 and 56. 40 COP of the Convention on Biodiversity, Decision X/2: Strategic Plan for Biodiversity 2011–2020 (29 October 2010).

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perspective the EU is not strictly required to regulate trade in FRCs, there is however a significant recognition that it should do so. Consequently, it seems difficult to argue that the EU could achieve its international commitments on ending global forest loss and ensuring sustainable consumption patterns without regulating international trade, as its responsibility for global forest destruction arises primarily from its importation of FRCs. In other words, trade regulation seems to be crucial for the EU in order to eliminate (or at least reduce) its (actually significant) contribution to global embodied deforestation. Obviously, such a regulatory path should be taken from a WTO-compatibility perspective, subject to some conditions (as we will better discuss below in Sect. 6).

4 EU Action on Forests Once established the need for the EU to tackle its import-driven contribution to global deforestation by the means of trade regulation, it is now useful to illustrate, in what follows, first of all the EU current regulatory action on forest (Sect. 4.1). Subsequently, the future EU action on forest will be then examined (Sect. 4.2), by discussing the content, aim and scope of the recently proposed Regulation on FRC’s trade and its main differences with the EU Timber Regulation.

4.1

Current EU Action

Current EU action on forest in based, on the one hand, on the Forest Law Enforcement Governance and Trade (FLEGT) Action Plan of 2003 and the 2005 FLEGT Regulation (Sect. 4.1.2); on the other, on the 2010 Timber Regulation (EUTR) (Sect. 4.1.2).

4.1.1

The Forest Law Enforcement, Governance and Trade (FLEGT) Action Plan (2003) and the FLEGT Regulation (2005)

The EU FLEGT Action Plan was adopted in May 200341 with the specific aim to combat illegal logging and associated trade in illegally sourced timber products.42 EU Commission, Forest Law Enforcement, Governance and Trade (FLEGT) – Proposal for an EU Action Plan COM (2003) 251 final. 42 This focused approach in the initial EU action is justified by the complex nature and the severe scale of the problem and by the environmental, socio-economic and cultural costs related to it. In ecological terms, illegal logging is one of the main direct causes of deforestation and forest degradation which, in its turn, is a major driver of biodiversity loss and global warming (see UNEP/FAO (2020) The State of the World’s Forests, p. 83). From an economic perspective, the 41

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The Plan establishes a package of measures to address the supply and demand of products behind illegal logging in the forests and has led to the adoption of two further key pieces of legislation,43 whose main elements will be usefully and briefly outlined. The first of these regulations is the 2005 FLEGT Regulation,44 which introduces a licensing scheme to control the legality of (listed) timber and timber products imported into the EU.45 Such a licensing scheme is to be implemented through the conclusion of Voluntary Partnership Agreements (VPAs) between the EU and timber-producing countries.46 According to the Regulation, shipment of timber products from these partner countries to the EU are prohibited unless they are covered by a FLEGT license, the latter being accepted as proof of legality by the EU.47 Timber products are considered to be “legally produced” if they are harvested “in accordance with the national laws determined by [the] partner country as set out in the [respective VPA]”48—and therefore, as agreed with the EU. Each VPA sets for the establishment of a timber legality assurance system (TLAS) in the third country concerned, which contains the following basic elements: i) a (country specific) definition of “legal” timber,49 ii) sophisticated mechanisms for verifying the compliance throughout the production and supply chain,50 iii) issuance of FLEGT licenses by the competent national authority,51 and iv) independent audits to ensure that the entire system is properly implemented.52 This promotion of legality on the basis of the domestic laws of the timber-exporting country, on the one hand allows VPAs to be tailor-made agreements, whereby the definition of “legality” is developed through a national consultation process of different value of illegal timber trade is estimated to be worth euros 150 billion per year and illegal logging to cost governments in timber-producing countries around dollars 10–15 billion each year in terms of lost revenues. 43 For a broader comment see Pontecorvo (2018), pp. 326–327, and also Marin Durán G and Scott J Reducing the EU’s Global Deforestation Footprint through Trade Regulation, EUI Working Paper n. 14, 2021, available at https://cadmus.eui.eu/bitstream/handle/1814/73189/LAW%20 WP5202021_14.pdf?sequence=1&isAllowed=y (accessed 25 March 2022). 44 Council Regulation 2173/2005 of 20 December 2005 on the Establishment of a FLEGT Licensing Scheme for Imports of Timber into the European Community, OJ 2005 L 347/1 (hereinafter FLEGT Regulation). 45 See FLEGT Regulation, Article 1(1) and Annexes II (listing products covered by all Voluntary Partnership Agreements (VPAs) concluded between the EU and timber producing countries) and III (listing additional products covered by individual VPAs). 46 FLEGT Regulation, Article 1(2) and Annex I. 47 FLEGT Regulation, Article 4(1)-(2). 48 FLEGT Regulation, Article 2(10). 49 See, for instance, the Voluntary Partnership Agreement between the EU and the Republic of Indonesia on Forest Law Enforcement, Governance and Trade in Timber Products into the European Union OJ 2014 L 150/252 (hereinafter VPA EU-Indonesia) Article 2(i) and Annex II. 50 VPA EU-Indonesia, Article 7 and Annex V. 51 VPA EU-Indonesia, Articles 4–6. 52 VPA EU-Indonesia, Article 15.

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stakeholder groups in each partner country and adapted to the specific local needs and priorities.53 On the other hand, it may also be seen as reinforcing the principle of sovereign rights of States to explore natural resources within national jurisdiction.54 At the time of writing, seven VPAS have been concluded by the EU—with countries such as Ghana in November 2009, followed by the Republic of Congo, Cameroon, Indonesia, Liberia and the Central African Republic; and recently also with Vietnam in May 2017.55

4.1.2

The Timber Regulation (EUTR, 2010)

The second trade pillar of its FLEGT Action Plan was established by the EU in October 2010 with the adoption of the Timber Regulation (EUTR, also known as Timber Due Diligence Regulation—TDDR),56 entered into force on 3 March 2013. By this (unilateral) initiative, which strengthened its previous (bilateral) VPAs’ approach,57 the EU prohibits the placing on its internal market of illegally harvested timber, or products derived from such timber,58 irrespective of their domestic or foreign origin.59 Thereby, the EUTR imposes a burden on economic operator (companies) trading such products for the first time,60 which are required to exercise due diligence in ensuring their legal origin.61 With a view to guarantee its proper functioning, the Regulation also provides for regular checks aimed at verifying compliance by operators with the due diligence process62 and for “effective,

See on this respect, for a comment, Bollen A and Ozinga S, Improving Trade Governance – A Comparison of FLEGT VPAs and their Impact, FERN, 2013, p. 17 and Table 2 (available at www. fern.org/fileadmin/uploads/fern/Documents/VPAComparison_internet_0.pdf accessed 22 March 2022). 54 See Savaresi (2012), p. 157. 55 Moreover, VPA negotiations have been recently concluded with Guyana and Honduras; and they are on-going with Gabon, the Democratic Republic of Congo, Côte d’Ivoire, Laos, Thailand and Malaysia (https://ec.europa.eu/environment/forests/flegt.htm accessed 25 March 2022). 56 Council and European Parliament Regulation 995/2010 of 20 October 2010 laying down obligations of operators who place timber and timber products on the market, OJ 2010 L 295/23 (hereinafter EUTR). See for a broad comment Pontecorvo (2018), pp. 328–332, and the bibliographical reference included in it. 57 See Pontecorvo (2018), p. 328. 58 EUTR, Article 2(a) and Annex. 59 EUTR, Article 4(1). 60 EUTR, Article 1. 61 EUTR, Article 6(1)(a)-(c), according to which operators must use a due diligence system based on three key elements: a) procedures and measures to keep track of the legality and origin of timber products; b) risk assessment procedures enabling an evaluation and analysis of the risks of illegally harvested timber products being placed on the EU market; and c) in cases where identified risks are more than “negligible”, risk mitigation measures that are proportionate and adequate to effectively minimise those risks. 62 EUTR, Article 10. 53

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proportionate and dissuasive” penalties in cases of non-compliance.63 Remarkably, the EUTR creates an additional incentive for third countries to enter into VPA negotiations with the EU, by establishing a presumption of compliance with the due diligence requirements for FLEGT-licensed timber originating in partner countries.64 In other words, VPAs actually secure a “green lane” for licensed timber imports into the EU market. Overall, the EU’s FLEGT initiative seems to provide an important and quite costeffective instrument to combat illegal logging and related trade in timber products. It has also been praised—even—as a “novel experimentalist architecture for transnational forest governance”,65 due in particular to the VPA-driven multi-stakeholder participatory process and its reliance on country-specific legality standards and verification systems, while being backed by the Timber Regulation as a penalty default mechanism to sanction non-cooperation by timber exporting countries.66 However, a key shortcoming of the current EU regulatory framework on forests is that—being limited to illegally harvested timber products—it does not tackle another (and even more prevalent) driver of deforestation, namely the expansion of land used for agriculture.67

4.2

Future EU Action

The (causal) link between agricultural expansion and global deforestation, driven in part by international trade in agricultural products, has been well documented.68 As

EUTR, Article 19(2), which establishes that penalties may include fines, seizure of timber and timber products and immediate suspension of the authorisation to trade. 64 EUTR, Article 3. 65 EU Commission, Evaluation of the EU Action Plan for Forest Law Enforcement Governance and Trade (FLEGT) SWD (2016) 275, p. 3 but also 11–12 on difficult progress in establishing timber legality assurance systems in partner countries. See also EU Commission, Report to the European Parliament and to the Council on Regulation EU/995/2010 COM (2016) 74 final, p. 11 on uneven progress in the implementation and enforcement of the Timber Regulation. 66 Overdevest and Zeitlin (2018), pp. 67–69, and also 72–75 on the implementation flaws in VPAs with Indonesia and Ghana. 67 The EU has also addressed deforestation through sustainability criteria for biofuels, but this does not cover uses of commodities (such as palm oil) other than for biofuels: Council and European Parliament Directive 2018/2001 of 11 December 2018 on the Promotion if the Use of Energy from Renewable Sources, OJ 2018 L 328/82. 68 According to the latest UNEP/FAO Report, local subsistence agriculture (driven by domestic demand) caused about 33 percent of global tropical deforestation between 2000 and 2010, while large-scale commercial agriculture (driven instead by international demand) accounted for 40 percent of the problem during the same period of time, though this figure reached almost 70 percent in Latin America. See UNEP/FAO (2020) The State of the World’s Forests, pp. 82–83 (stating that urban expansion accounted for 10 percent, infrastructure development for 10 percent and mining for 7 percent of global deforestation). 63

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already mentioned in Sect. 2, the EU is in fact a major importer of agricultural commodities that contribute very significantly to deforestation, in particular of soy and palm oil.69 EU institutions have consequently recognised the need to undertake a legislative action aimed at reversing the Union’s (consumption-driven) contribution to global deforestation and forest degradation.70 Therefore, in October 2020 the European Parliament adopted a resolution including concrete recommendations on EU mandatory due diligence legislation for forest and ecosystem-risk commodities;71 one year later, on 17 November 2021, the EU Commission presented its own legislative proposal in this respect.72

4.2.1

The (Proposed) Regulation on Forest-Risk Commodities’ Trade: Content, Aim and Scope. . .

The Commission proposes to regulate both the placing on the EU market and the exportation from the Union of certain products and commodities associated with deforestation and forest degradation. The twofold aim of the Commission’s proposal is to minimise the contribution of the EU to global deforestation and forest degradation and to reduce the EU’s contribution to the emissions of greenhouse gas and to the loss of biodiversity worldwide.73 As to its scope, the proposed regulation builds on the existing Timber Regulation (which would be repealed), but with regards to product coverage differs from the latter first of all for being significantly broader. The Commission’s proposal is not limited indeed to timber products (unlike the EUTR), as it also covers five additional forest-risk commodities—such as cocoa, cattle, palm oil, soy and coffee—both of EU and foreign origin. It also extends to the products that either contain these commodities, have been fed with them, or have been made using any of them

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See also COWI and others, Feasibility Study on Options to step up EU Action on Deforestation: Final Report, European Union 2019, pp. 41–81, available at http://ec.europa.eu/environment/ forests/pdf/feasibility_study_deforestation_kh0418199enn_main_report.pdf, accessed 20 March 2022. 70 EU Commission, Stepping up EU Action to Protect and Restore World’s Forests COM (2019) 352 final, p. 1 and 7; endorsed by the EU Council, Conclusions of the Council and of the Governments of the Member States sitting in the Council 15151/19 of 16 December 2019; and European Parliament, Resolution on the European Green Deal, P9_TA(2020)0005 of 15 January 2020, para. 71. 71 European Parliament, Resolution with Recommendations to the Commission on an EU Legal Framework to Halt and Reverse EU-Driven Global Deforestation T9_TA(2020)0285 of 22 October 2020 (hereinafter EP Forest Resolution). 72 EU Commission, Proposal for a Regulation of the European Parliament and of the Council on the making available on the Union market as well as export from the Union of certain commodities and products associated with deforestation and forest degradation and repealing Regulation 995/2010 COM (2021) 706 final (hereinafter Commission Proposal). 73 Commission Proposal, Article 1.

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(so called derived products).74 This list of products appears very reasonable, taking into account that—as mentioned above in Sect. 2—scientific research confirms the selected six commodities representing the largest share of global deforestation embedded in EU imports and, therefore, “policy intervention could bring the highest benefits per unit value of trade”.75 However, in this respect it has been recently (and correctly) also argued that, maize and above all rubber should have been included in this list, being them still the top-ten EU-imported commodities linked to global forest deforestation and degradation.76 Nonetheless, according to the Commission’s proposal, the product scope of the proposed regulation is to be kept under regular review, and may be progressively expanded to other commodities based on their effect on forest destruction worldwide.77 This possibility of an ex post expansion of the Regulation’s scope is clearly very important: not only in relation to the just mentioned criticism concerning the significant role played by maize and rubber in fuelling deforestation, but also in the perspective of addressing shifts in EU consumption over time and mitigating the risk that covered commodities (such as palm oil) are substituted by others (e.g., other vegetable oils) triggering deforestation outside the reach of proposed measures.

4.2.2

. . .and Main Differences from EUTR

The Conditions for Legally Placing Covered Commodities and Derived Products on the EU Market (or for Exporting Them) A second important difference from EUTR (besides that concerning a broader product coverage) is that the proposed regulation equally expands the conditions for legally placing covered commodities (and derived products) on the EU market or for exporting them outside of it. These commodities and products not only have to comply with the legislation of the country of production (i.e., a legality requirement similar to that established by the Timber Regulation),78 but must also be

74

Commission Proposal, Article 1 and Annex I. Commission Proposal, p. 27 (para. 27). 76 WWF, EU Deforestation Law Proposal: Off to a Strong Start, but Loophole Must Be Closed, 2021, available at www.wwf.eu/?5179866/EU-deforestation-law-proposal-Off-to-a-strong-startbut-loopholes-must-be-closed, accessed 20 March 2022. See also: EU Commission, Impact Assessment – Minimising the Risk of Deforestation and Forest Degradation Associated with Products Placed on the EU Market SWD (2021) 326 final (hereinafter Commission Impact Assessment), pp. 32–33; and, very recently, the report by Global Witness, Rubbed Out, 16 June 2022 (available at www.globalwitness.org/en/campaigns/forests/rubbed-out/ accessed 16 June 2022), which provides further evidence on the crucial role played by rubber in relation to deforestation and forest degradation in Africa. 77 Commission Proposal, Article 32(3). 78 Commission Proposal, Article 3(b). 75

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“deforestation-free”.79 This involves that a) operators must carry out the stipulated due diligence process80 with a view to ensure compliance with these legality and deforestation-free requirements and that b) they can only place the relevant commodities and products on the EU market (or export them abroad) if the risk of non-compliance is (no more than) “negligible”.81 Moreover, to confirm that this is the case, such commodities must be accompanied by a “due diligence statement”.82 Particularly, for all six of the covered commodities and derived products, the deforestation-free standard requires that they were not produced on land that has been subjected to deforestation after 31 December 2020.83 Only for wood, it also requires that this has been harvested without inducing forest degradation after the same date.84 Admittedly, this cut-off date of 2020 is anchored in the above mentioned commitments made at international level (such as SDGs 15.2), 85 aligned with the regulation’s objective of minimising the EU’s (both current and future) contribution to deforestation and forest degradation worldwide; and it may arguably also contribute to moderate the immediate costs for operators and third countries that the proposal clearly involves.86 Evidently, the addition under the proposed regulation of a deforestation-free requirement is aimed at avoiding the creation of perverse incentives for third countries exporting the covered commodities to the EU, as they may be tempted to weaken their forest legislative framework to facilitate access of their products to the EU market if only the legality requirement was applicable.87 However, it is important to examine more precisely how exactly such a deforestation-free standard is actually defined by the Commission’s recent proposal. As recognised by the Commission, underlying definitions should provide legal clarity and “be measurable based on quantitative, objective and internationally recognised data”.88 In defining “forests”89 and “deforestation”, the Commission

79

Commission Proposal, Article 3(a). Commission Proposal, Articles 8–11 setting out the due diligence system, which includes information requirements (such as features of relevant commodities and supply-chain geo-location) and detailed procedures for risk assessment and risk mitigation. These obligations also apply to large traders which are not considered “small and medium size enterprises” (Article 6(5)). 81 Commission Proposal, Article 4(5), meaning the compliance assessment “shows no cause for concern” (Article 2(16)). 82 Commission Proposal, Articles 3(c) and 4(2). 83 Commission Proposal, Article 2(8)(a). 84 Commission Proposal, Article 2(8)(b). 85 Choosing a future cut-off date, as per the current 2030 global target, could risk fuelling a “deforestation rush” in third countries and go against the objective of EU intervention: see Commission Impact Assessment, 29. 86 Commission Impact Assessment, pp. 30–31. 87 Commission Proposal, p. 11; and Commission Impact Assessment, p. 26. 88 Commission Proposal, p. 27 (para. 26). 89 Commission Proposal Article 2(2) defines a “forest” by referring to the concept of “land”, as “land spanning more than 0.5 hectares with trees higher than 5 metres and a canopy cover of more 80

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draws closely to the FAO’s definition of these terms. 90 In its proposal, “deforestation” involves indeed “the conversion of forest to agricultural use, whether human induced or not”91—with a wording virtually identical to that used by FAO, with some deviation. Understandably (given the agricultural focus of its proposal of regulation), the Commission’s definition deals exclusively with land that is converted for agricultural use (including livestock grazing),92 and does not include land that is converted for non-agricultural uses (such as mining or urban development).93 In principle, the definition of “deforestation” provided by the Commission seems to contain a sufficiently clear and objective basis for identifying deforested areas through satellite monitoring tools.94 To define “forest degradation” is, admittedly, more complex per se, because it is caused by a variety of human activities and natural factors (such as fire, drought or storms), often interdependent and difficult to quantify. Therefore, there is no internationally agreed definition of this term. Notwithstanding, the Commission’s definition of “forest degradation” included in the proposal of regulation is very close to that provided by recent FAO reports, as it substantially relates to a reduction or loss of the biological or economic productivity and complexity of forest ecosystems.95 However, according to the proposed regulation forest degradation occurs when harvesting operations also are unsustainable. At the moment, the Commission’s notion of “sustainable harvesting operation” (which comprises both procedural and substantive elements) is quite vague and convoluted.96 Neither in the proposal nor in the accompanying impact assessment the Commission explains however the basis for this additional sustainability criterion and how it is to be measured, thereby failing to provide any legal clarity.

than 10 percent, or trees able to to reach those thresholds in situ, excluding agricultural plantations and land that is predominantly under agricultural or urban land use”. 90 FAO, Global Forest Resource Assessment 2020 – Terms and Definitions, 2020, p. 4, (hereinafter FAO, Global Forest Resource Assessment 2020) available at www.fao.org/3/I18661EN/i8661en. pdf, accessed 25 February 2022, explicitly recognising that mangroves situated in a tidal zone that meet the definition of a forest are to count as forests regardless of whether the tidal area is classified as land or not, while the Commission’s proposal is silent on this point. 91 Commission Proposal, Article 2(1). 92 Commission Proposal, Article 24 (para. 13). 93 FAO, Global Forest Resource Assessment 2020, 6. 94 Commission Impact Assessment, p. 26. 95 Commission Proposal, Article 2(6); and FAO/UNEP, The State of the World’s Forests, 2020, p. 19. 96 Commission Proposal, Article 2(7). In procedural terms, harvesting is to be considered as sustainable when it has been carried out “considering maintenance of soil quality and biodiversity with the aim of minimising negative impacts” (emphasis added). Substantively, harvesting must ensure certain outcomes, including minimising large clear-cuts, ensuring locally appropriate thresholds for deadwood extractions and using logging systems that minimise impacts on soil quality and biodiversity.

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The (Three-Tier) Country Benchmarking System The third (and main) innovation of the Commission’s proposal in relation to the 2010 Timber Regulation is the country benchmarking system it introduces. The proposal draws indeed a distinction between countries, or parts of countries, that presents a “high”, “standard” or “low” risk of producing covered commodities or derived products that do not meet the deforestation-free requirement. Such a threetier country classification will apply to both third countries exporting the relevant commodities to the EU and to EU Member States for commodities exported from the EU market. Initially, all countries will be regarded as presenting a standard level of risk and the Commission is empowered to adopt implementing acts to move them into the low or high-risk categories.97 The Commission is required, in doing so, to take into account information provided by the country concerned and to base its decision on six assessment criteria. Of these criteria, the first three pertain to the factual situation in the country concerned, with regards to particularly: i) the rate of deforestation and forest degradation; ii) the rate of expansion of agricultural land for relevant commodities; and iii) the production trend of relevant commodities and derived products.98 The second three criteria pertain instead to aspects of a country’s legal framework in relation to: i) whether emissions from deforestation and forest degradation are accounted towards its mitigation commitments under the Paris Agreement (that is, its nationally determined contribution, (NDC));99 ii) whether agreements or other instruments have been concluded between the EU and the country concerned which address deforestation or forest degradation and which facilitate compliance with the proposed regulation; and iii) whether the country concerned has in place laws and effective enforcement measures to avoid and sanction activities leading to deforestation and forest degradation.100 While at first sight these criteria may appear objective, upon a closer examination it emerges how they are framed in openended terms and also leave main points unclear. For example, it is not self-evident a) whether they should be applied cumulatively, or the Commission can pick and choose among them when deciding on a country’s level of risk; or b) under each of these criteria, what is the level of performance that will be required to justify moving a country into the low or high-risk category. Moreover, the vagueness of these assessment criteria is compounded by the (above mentioned) ambiguous definition of “forest degradation”, and in particular its EU determined notion of “sustainable harvesting operations”. Consequently, the Commission will clearly enjoy a considerable margin of discretion in differentiating between third countries (and between them and the EU Member States) when applying these criteria. This is something

97

Commission Proposal, Article 27(1). Commission Proposal, Article 27(2)(a-c). 99 Paris Agreement, Articles 4.2–4.3. 100 Commission Proposal, Article 27(2)(d-e). 98

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that is likely to create tensions with WTO, as it will be further examined below in Sect. 6. Notwithstanding, under the proposal of regulation under examination here the Commission, before allocating a country to the high or low risk category, is obliged to follow certain procedural requirements.101 First, it must notify a country of its intent to change its risk status, providing reason(s) for the intended change, and invite that country to provide any information that it deems useful. Second, it must allow the country in question adequate time to provide a response, which may include information on measures taken to remedy the situation where the Commission has notified the country of its intent to move it into the high-risk category. Third, the Commission is also required to notify a country of the consequences of it being classified as a low or high-risk country, given that the obligations for operators and Member States competent authorities are differentiated according to the level of risk.102 When a country is identified as low-risk, operators may follow a simplified due diligence procedure (limited to information requirements),103 which excludes the most stringent steps of the standard procedure (risk assessment and risk mitigation). By contrast, where commodities or products are produced in a high-risk country, or where there is a risk that such commodities or products may enter the relevant supply chain, Member States incur an obligation of enhanced scrutiny. In this latter situation, their competent authorities are required to carry out annual checks covering at least 15 percent of operators and 15 percent of the quantity of each of the relevant commodities.104

The Role and Importance of Agreements Between the EU and Third Countries The fourth significant difference between the Timber Regulation and the Commission’s proposal concerns the role and importance of agreements between the EU and third countries. While existing VPAs remain in place, the proposed regulation does not refer to VPAs as such. Instead, it obliges the Commission to engage with affected countries to develop partnerships and cooperation in order to jointly address deforestation and forest degradation. It envisages that cooperation mechanisms may take several forms, including structured dialogues, support programmes and the establishment of new “Forest Partnerships”—enabling third countries to transition to an agricultural production that is compliant with the requirements of the proposed regulation.105

101

Commission Proposal, Article 27(3). Commission Proposal, Article 27(3)(c). 103 Commission Proposal, Articles 9 and 12. 104 Commission Proposal, Article 20, as compared to the standard threshold of 5 percent (Article 14(9)). 105 Commission Proposal, Article 28(1). 102

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Some aspects of the Commission’s proposal are reminiscent of VPAs, including the fact that partnership and cooperation should improve forest governance frameworks in partner countries, allow the full participation of all stakeholders and strengthen the rights of forest-dependent communities, including smallholders, indigenous peoples and local communities.106 However, there seems to be no suggestion that these new forest partnerships will also establish licensing schemes similar to those under VPAs and thereby secure a “green lane” for licensed commodities into the EU market on the basis that they are presumed to present no more than a negligible risk of contributing to deforestation (or forest degradation in the case of wood).107 The proposed regulation merely provides that “such agreements and their effective implementation will be taken into account as part of the [country] benchmarking [system]”.108 It therefore lacks precision both about the content of such agreements and how (precisely) it will influence the process of identifying countries as presenting a non-standard risk. For instance, it remains unclear whether the conclusion of a forest partnership would per se be deemed sufficient for moving towards the low-risk category, or would it rather depend on how ambitious the agreement actually is in terms of enhancing forest governance frameworks and other matters mentioned above. Clearly depending on future practice, this vagueness may however reduce the incentives for third countries to enter into agreements of this kind with the EU.

The Enforcement Requirements A final difference between the Commission’s proposal and the Timber Regulation concerns enforcement. The proposed regulation sets out in substantially greater detail the obligations of Member States’ competent authorities to carry out regular checks on operators to assess their compliance with the due diligence requirements, including specific guidance for conducting such checks,109 a minimum number of inspections,110 and an obligation to carry them out without prior warning except where prior notification is necessary to ensure their effectiveness.111 It further incorporates new features to improve the accountability of operators, including an express obligation for operators to collect geo-location of land plots where

106

Commission Proposal, Article 28(3). See Commission Proposal, Article 10(3) which only provides that FLEGT-licensed wood products are deemed to be compliant with the legality requirements (Article 3(b)). 108 Commission Proposal, Article 28(1) emphasis added. 109 Commission Proposal, Article 14(3)-(4) on a risk-based plan; and Article 15 on additional standards for compliance checks. 110 Commission Proposal, Article 14(9) on annual checks covering at least 5 percent of operators and 5 percent of each of the relevant commodities. 111 Commission Proposal, Article 14(12). 107

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commodities placed on the EU market were produced.112 The proposed regulation is also more prescriptive than EUTR when it comes to the penalties to be applied by the Member States in cases of non-compliance,113 including as a minimum fines proportional to the environmental damage, the confiscation of relevant commodities and of the associated revenues gained by the operator or trader and the temporary exclusion from public procurement processes.114

5 A First Assessment of the Recent Commission’s Proposal of Regulation Coming to an evaluation of the EU action on deforestation and forest degradation, and particularly to a (necessarily only preliminary) assessment of its recent proposal of Regulation on FRCs as to i) its overall legal/economic appropriateness and to ii) its potential effectiveness/limitations, a first general remark on the whole EU action on forest is that, unlike other trade-related environmental measures,115 the FLEGT initiative has not provoked negative reactions from the EU’s trading partners,116 likely because it cannot be considered as “unilateral” in a traditional sense. Indeed, not only does it combine mandatory due diligence with extensive cooperation through VPAs, but it is also well responsive to differences between countries. It is self-evident that by looking to third country law to give content to the underlying legality standard, the EU cannot be accused of having imposed its own rules on other countries.117 Equally, it would have been false and disingenuous for other countries to be dismissive of the importance of securing compliance with domestic forest laws.

112

Commission Proposal, Article 9(1)(d). As mentioned above, Article 19(2) EUTR provides that, in cases of non-compliance, penalties may include fines, seizure of the timber and timber products and immediate suspension of the authorisation to trade. 114 Commission Proposal, Article 23(2). 115 For example, see the on-going WTO disputes concerning the EU’s sustainability criteria for biofuels—introduced, as already mentioned, by Directive 2018/2001 on the promotion of the use of energy from renewable sources: a) the request for the establishment of a Panel by Indonesia (European Union – Certain Measures Concerning Palm Oil and Oil Palm Crop-Based Biofuels) of 24 March 2020, WT/DS593/9, and b) the request for the establishment of a Panel by Malaysia (European Union and Certain Member States – Certain Measures Concerning Palm Oil and Oil Palm Crop-Based Biofuels) of 16 April 2021, WT/DS600/6. 116 See, for example, WTO/CTE, Report of the Meeting held on 30 June 2014, CT/CTE/M/57 for some (merely pro forma) interventions at the WTO Committee on Trade and Environment. 117 Unlike the much stronger reaction of WTO Members to an earlier Dutch proposal concerning the mandatory labelling of wood (see for further detail Marin Durán G, Scott J, Reducing the European Union’s Global Deforestation Footprint Through Trade Regulation, EUI LAW Working Paper n. 14, 2021, pp. 12–13. 113

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Of course, at this stage, it is still too early to say whether the proposed due diligence regulation for FRCs will be adopted and how and, if so, how strong or widespread opposition to it there will be in the WTO.

5.1

Appropriateness and Necessity of EU Action on FRCs’ Trade

For the time being, it seems (more) useful and significant to discuss and evaluate the appropriateness and necessity of the EU recently proposed intervention to reduce its global deforestation “footprint” through trade regulation. To this respect, our argument in favour combines not only pragmatic and moral but also legal aspects to show how all these interact in circumstances of EU shared responsibility for environmental harm. The pragmatic element emerges from the fact that the EU—as already discussed in Sect. 2, because of its continued importation of illegally harvested forest products and hence of commodities causing deforestation worldwide—may be considered to (indirectly but significantly) contribute to global deforestation. As a consequence, the EU bears a (de facto) “responsibility” arising from acts (of trade in FRCs it performed) which could contribute to a (wrongful) activity (of deforestation/forest degradation) materially accomplished by another actor.118 Thereby, the EU seems to have a clear (moral) duty to reduce its global deforestation “footprint”. However, such a (pragmatic) conclusion seems to be also underpinned by relevant legal considerations. First of all, from the above illustration in Sect. 3 it emerges a widespread international recognition that deforestation represents a wrongful activity and that it is essential to stop it. Significantly in this respect, inter alia, 193 States have repeatedly pledged to end deforestation and forest degradation first by 2020 (Sustainable Development Goal 15.2) and then by 2030(UN Strategic Plan for Forests). Secondly, the EU is well aware that deforestation is a wrongful act, as it has endorsed almost all the international instruments mentioned above that recognise the profoundly damaging effects of deforestation. Equally relevant is the fact that the same Commission’s proposal starts by observing that “deforestation and forest degradation are occurring at an alarming rate, aggravating climate change and the loss of biodiversity”.119 Moreover and thirdly, EU action to regulate trade in FRCs has, in fact, a huge potential to reduce global deforestation given the large size and importance of its

118 That is, who illegally harvested forest products in violation of the legislation of the country of origin of these products. 119 Commission Proposal, p. 1.

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market for FRCs.120 However, obviously, to (better) reduce global deforestation EU cooperation with third countries will be particularly important—as correctly pointed out by Raza et al.—where there is a danger of trade diversion or “leakage” creating the risk that “sustainable products currently imported into other States would be diverted to the EU, while non-sustainable products currently imported into the EU would be diverted to other markets”.121 Existing VPAs under the FLEGT initiative have been a promising form of cooperation in this respect.122 The capacity of the future forest partnerships to generate similar spill-over effects—including in relation to the deforestation-free standard, will be a key determinant of their success. Moreover, the EU can certainly play an important role also in generating a “norm cascade”, as experienced with the FLEGT initiative which led to the adoption of timber legality legislation by other major timber importing countries (including Australia, Canada, South Korea and Japan).123 Fourth, the EU knows that regulating trade in FRCs has the potential to reduce global deforestation. The Commission, while acknowledging the weakness inherent in FLEGT,124 concludes that experience shows that the EU “can have an impact and lead the way globally”, despite its decreasing market share.125 It also emphasises that its current proposal builds on and learns from experience under FLEGT.126 Forest partnerships will continue to be a feature of EU policy and the due diligence requirements under the Timber Regulation will be adapted and improved.127 While the main focus in the proposed regulation is on making the EU supply chain more sustainable, the Commission also recognises the key importance of 120 Where the existing supply of sustainably sourced commodities is not sufficient to satisfy increasing demand for such commodities globally, a shift in EU policy in favour of sustainable sourcing can be expected to alter production patterns to increase supply (see Raza W et al., How Can International Trade Contribute to Sustainable Forestry and to the Preservation of the World’s Forests through the Green Deal?, European Union Parliament Think Tank, 19 October 2020, pp. 24–25, available at www.europarl.europa.eu/thinktank/en/document.html?reference=EXPO_ IDA(2020)603513 last accessed 26 March 2022). 121 Raza W et al. How Can International Trade Contribute to Sustainable Forestry and to the Preservation of the World’s Forests through the Green Deal?, p. 24. 122 Because VPAs apply the agreed legality requirements to all exports, including those destined for non-EU countries; and also because, similarly, most have the objective of applying these requirements even to timber products that are consumed domestically within the home market of countries concluding the VPA with the EU. 123 The EU’s efforts at norm diffusion benefited greatly from the fact that on this occasion it combined its market power with that of the USA—which had already adopted timber legality legislation in 2008. It has nonetheless been shown that FLEGT has contributed to the emergence of an “increasingly joined up transnational timber legality regime [that has] developed over the last 15 years” (Zeitlin and Overdevest 2020, p. 701). 124 As highlighted in EU Commission, Illegal Logging: Evaluation of EU Rules (Fitness Check), available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/11630-Illegallogging-evaluation-of-EU-rules-fitness-check-_en, accessed 21 March 2022. 125 Commission Proposal, p. 6. 126 Commission Proposal, pp. 62–63. 127 Commission Proposal, p. 2 (forest partnerships) and p. 7 (due diligence).

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pursuing international cooperation with both producer and consumer partner countries to avoid the leakage which results from deforestation-driving commodities being diverted from the EU to other markets.128

5.2

Shortcomings and Limits (of Ambitions) in the Commission’s Proposal

Before moving on to consider the WTO-compatibility of the Commission’s proposed regulation, it is important to remark the fact that not only it shows some shortcomings but also seems significantly less ambitious than the European Parliament’s earlier recommendations.129 The Commission’s proposal is indeed largely focused on deforestation and much less on forest degradation; and it is limited to forests and does not address the conversion or degradation of other natural ecosystems.130 The Commission’s decision not to include other natural ecosystems alongside forests may entail however the unintended (but significant) consequence of shifting production from forest ecosystems to other valuable high-carbon stock or biodiversity rich ecosystems.131 To this respect, while the Commission observes its intention to work in partnership with countries to improve land tenure,132 and it recognises the issue of “land grabbing” and the forced displacement of local communities,133 there is—in fact—nothing in the proposal to prevent it generating patterns of land use change that fail to respect land tenure rights including customary land tenure rights, of local communities and indigenous people (an important shortcoming, which we will further discuss later).134 Furthermore, by contrast with the European Parliament recommendations the Commission’s proposal does not include novel provisions on civil liability, whereby operators would be jointly and severally liable for environmental harm that is directly linked to their products and business relationships and required to provide

128

Commission Proposal, p. 1 and 65. For a detailed discussion on the point see Marin Durán G, Scott J, Reducing the European Union’s Global Deforestation Footprint Through Trade Regulation, EUI LAW Working Paper n. 14, 2021, pp. 9–12. 130 EP Forest Resolution, p. 24. 131 EP Resolution, p. 12 para. 30. 132 Commission Proposal, recital 21 and Article 28(3). 133 Commission Impact Assessment, p. 13. 134 It is already happening indeed that “from the valleys of Eastern Africa to the Cerrado grasslands of Brazil, some of the biggest land grabs have been for pastures [as opposed to forests]” (Oxfam, International Land Coalition, Rights and Resources Initiative (2016) Common Ground. Securing Land Rights and Safeguarding the Earth, Oxford, p. 21 (available at http://policy-practice.oxfam. org/resources/common-ground-securing-landrights-and-safeguarding-the-earth-600459/ accessed 27 March 2022). 129

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remedies to affected third parties.135 Nor does it propose to place due diligence obligations on financial institutions providing finance, investment and insurance to operators engaged in the supply chain of relevant commodities.136 Perhaps most importantly, the Commission’s proposal is vastly weaker than the European Parliament’s recommendations in relation to the protection of human rights, including land tenure rights.137 Indeed, access to the EU market for FRCs is not made conditional on due diligence, showing that there is no (or only negligible) risk that such products have been produced in, or linked to, violation of human rights, including the customary land tenure rights of forest-dependent communities and of indigenous peoples. In addition, although operators are required to collect adequate and verifiable information that production has been conducted in accordance with relevant legislation of the country of production (including any arrangement conferring the right to use the respective area for the purposes of the production of the relevant commodity),138 there is no obligation to respect international standards on (customary) land tenure rights.139 The Commission is certainly to be commended for its commitment to reviewing the impact of its proposed regulation on indigenous people, local communities and smallholders as well as the need and feasibility of including within its scope other natural ecosystems (than forests).140 Nevertheless, it is unfortunate that the Commission did not follow the recommendations of the European Parliament to adopt a more “people-centred approach” by placing human rights alongside conservation at the core of its legislative proposal. For, in this perspective, while efforts to reduce the off-shoring of demand of forest natural resources to support European consumption marks an important step in the path towards the (environmental) goal of reducing (the EU footprint on) global deforestation and forest degradation, the approach underlying the Commission’s proposal—privileging (for the moment) forest conservation objectives over the rights and interest of indigenous and local community—signals a regrettable (but by no means inescapable) missed opportunity for the EU to adequately balance environmental and human rights dimensions of forest ecosystems’ conservation.

135

EP Forest Resolution, p. 33. EP Forest Resolution, pp. 24–25. 137 EP Forest Resolution, pp. 25 and 27–30. 138 Commission Proposal, Article 9(1)(h). 139 See FAO (2012) Voluntary Guidelines for Responsible Governance of Tenure, available at www.fao.org/3/i2801e.pdf (accessed 21 March 2022). 140 Commission Proposal, Article 32(2)(b). 136

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6 Prima facie Considerations on the WTO-Compatibility of the (Proposed) Regulation The issue of WTO-compatibility is often perceived, from a legal perspective, as a relevant “barrier” to unilateral trade measures addressing environmental problems; and, sometimes, it is used as a convenient “excuse” for not adopting these measures. This perception has been mainly fed by a frequent (mis)belief that WTO law prohibits trade-related environmental measures or regulations (TREMs or also TRERs) that interfere with production activities (so called processes and production methods, PPMs) outside the regulating State, a (mis)belief which has (unfortunately) originated long-standing divisions between the environmental and trade communities of scholars.141 However, the reality is much more articulated and nuanced as evidenced by the fact that measures conditioning market access on environmental PPMs (such as dolphin-safe and turtle-safe methods) have been successfully justified in the WTO compliance proceedings.142 Furthermore, it is worth underscoring that even the EU Timber Regulation—upon which the proposed due diligence regulation for FRCs builds—has been in place for several years and has not (yet) been challenged in the WTO dispute settlement system. Notwithstanding, it should be recognised that the EU measures regulating trade in illegally harvested timber and other FRCs may—at least in principle—be in tension with core WTO rules; therefore, in such a case, they may be in need of justification under WTO exception clauses. In what follows, the potential compatibility issues of the proposed regulation with WTO rules (Sect. 6.1) and possible justifications under GATT Article XX’s general exceptions of the trade measures it introduces on FRCs (Sect. 6.2) will be briefly discussed.

6.1

Possible Tension with Core WTO Disciplines

Particularly, the EU measures regulating trade in illegally harvested timber and other FRCs introduced by the recent Commission’s proposal are likely to be inconsistent—first of all—with the non-discrimination rules of the General Agreement on Tariffs and Trade (GATT);143 that is, i) the most-favoured nation (MFN) 141 See, for instance, Charnovitz (2002), pp. 60–79; and ex multis, recently Sifonios (2018), pp. 9–16 also for further bibliographical references and on the content of the doctrinal debate. 142 Appellate Body Report, United States – Import Prohibition of Certain Shrimp and Shrimp Products, WT/DS58/AB/RW, adopted 21 November 2001 (hereinafter AB, US – Shrimp 2001); Appellate Body Report, United States – Measures Concerning the Importation, Marketing and Sale of Tuna and Tuna Products, WT/DS381/AB/RW2, adopted 11 January 2019 (hereinafter AB, US – Tuna 2019). 143 General Agreement on Tariffs and Trade, LT/UR/A-1A/1/GATT/1, adopted 15 April 1994 and entered into force 1 January 1995 (hereinafter GATT). For sake of space, the WTO Agreement on Technical Barriers on Trade (TBT Agreement, adopted 15 April 1994 and entered into force

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treatment clause144 and ii) the national treatment (NT) obligation.145 As well known, WTO member States are essentially required—respectively—i) not to discriminate between “like” products imported from other countries and ii) not to discriminate between foreign and domestic “like” products. According to well-established case law, discrimination takes place when a trade measure treats less favourably one group of product vis à vis the group of “like” products146 in the sense that it has a “detrimental impact” (e.g., an asymmetric or disparate effect) on their competitive opportunities.147 When applying this to the Commission’s proposed regulation on FRCs and taking wood as an example, it seems clear that it would have a detrimental impact on timber non-compliant with the legality and deforestation-free requirements (which cannot be placed on the EU market) vis à vis legally harvested and deforestation-free timber (which can be placed on the EU market). Consequently, the key question is whether these two sets of timber products can be considered “like”. In WTO jurisprudence, the decisive criterion for assessing likeliness is, as well known, the nature and extent of the competitive relationship between the products concerned, which is determined by several factors but in particular consumers’ tastes and habits.148 In other words, an environmentally sustainable product would be “like” an environmentally unsustainable product for WTO law purposes, if (some) consumers in a given market treat them as substitutable. Thereby, to retake our example, if a subset of EU consumers is willing to substitute legally sourced and deforestation-free timber with timber that has been illegally sourced and caused deforestation—and we may safely assume this is the case—such products would be deemed “like” and there would be a breach of the GATT non-discrimination obligations. Generally speaking, this interpretation of “likeness” increases the chances of finding a breach for trade measures regulating environmental PPMs, as it is quite improbable that all (or most) consumers in a given market would be unwilling to substitute between products (or find them “unlike” in WTO law terms) just because of their embodied deforestation or other environmental impact.149 1 January 1995) will not be considered for the purpose of our analysis, given also that it is currently unclear to which extent it applies to PPM-based measures and regulations. 144 GATT, Article I:1, which applies to internal regulations covered by GATT Article III:4. 145 GATT, Article III:4. Our implicit assumption is that the trade measures established by the Commission’s Proposal are “internal regulations” covered by this GATT provision, as they apply to both EU and foreign products and prohibit the “placing on the market” (and not only the importation) of non-compliant good—thereby qualifying as “law, regulation or requirements affecting the internal sale” of products. See further, on this point, Geraets and Natens (2014), pp. 440–442. 146 Clearly, the comparison is between imported products under the MFN clause and between imported and domestic products under the NT obligation. 147 Appellate Body Report, European Communities – Measures Prohibiting the Importation and Marketing of Seal Products, WT/DS400/DS401/AB/R, adopted 22 May 2014 (hereinafter AB, EU – Seal Products 2014), 5.82, 5.84 and 5.101. 148 Appellate Body Report, European Communities – Measures Affecting Asbestos and AsbestosContaining Products, WT/DS135/AB/R, adopted 5 April 2001, 99. 149 See further Partiti (2020), pp. 40–41; and Marin Durán (2015), p. 114.

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Second, besides the discriminatory treatment between compliant and non-compliant commodities, the proposed regulation on FRCs might also conceivably raise further tensions with the GATT non-discrimination obligations. For example, a possible breach of the NT obligation could arise from the different treatment between imported FRCs that are covered by the proposed measure and subject to its legality and deforestation-free requirements to be placed on the EU market (e.g., imported palm oil) and competing EU agricultural commodities that are not covered by measure (e.g., rapeseed and sunflower oil). In addition, the country benchmarking system may lead to further tension with the GATT non-discrimination obligations because of a violation of the MFN treatment and NT disciplines it is likely to produce. This because such a system is likely to have a detrimental impact on commodities imported from high-risk countries (i.e., beef imported from a country X) which are subject to the standard due diligence requirements for operators and the enhanced scrutiny obligation for Member States, vis-à-vis competing commodities originating from countries in the low-risk category (e.g., beef imported from country Y or of EU origin), which are only subject to a much-simplified due diligence procedure.

6.2

Possible Justification Under WTO Exception Clauses (Article XX GATT)

The fundamental issue is however whether the proposed due diligence regulation for FRCs can still be justified under Article XX GATT. As well known, this provision establishes a conditional exception for a measure that is prima facie inconsistent with core GATT obligations, provided that: i) it is provisionally justified under one of the policy grounds listed in sections (a) to (j); and ii) it meets the requirements of the chapeau (or introductory clause) of that provision. In our opinion, as we will discuss below, the proposed regulation seems in need to be better designed to meet the chapeau conditions. However, this should not be just seen as an obstacle to ensure its WTO-compatibility but as an opportunity to review its soundness also from an environmental policy standpoint. As to the first step required under Article XX GATT, there are three policy grounds that appear relevant to the proposed regulation at first glance; however, Article XX letter (g) seems to be the most promising one among them.150 This provision requires that: a) the measure at issue be related to the conservation of exhaustible natural resources; and b) are made effective in conjunction with restrictions on domestic production and consumption. With regard to the latter

The other grounds are: Article XX letter (a) on measures “necessary to protect public morals” and Article XX letter (b) on measures “necessary to protect human, animal or plant life and health”, but both are subject to a stricter necessity test. For further elaboration in this respect see Partiti (2020), pp. 45–47 and 49–51.

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requirement, the proposed regulation is likely indeed to meet this even-handedness condition151 because, in principle, it imposes the same restrictions on domestically produced and imported FRCs. As to the first requirement, it is clear that the proposed regulation is “closely related to”152 the conservation of natural forests, since it requires covered commodities to be legally sourced and deforestation-free in order to be marketable in the EU and thereby (as illustrated above in Sect. 2) minimises its consumption-driven contribution to global deforestation. There is also little doubt that forests constitute “exhaustible natural resources” within the meaning of Article XX letter (g), taking into account the (quite expansive and flexible) interpretation given of this term in WTO jurisprudence. Notably, in the landmark US – Shrimp case the Appellate Body (AB) emphasised the importance of interpreting the concept in an evolutionary manner, “in the light of the contemporary concerns of the community of nations about the protection and conservation of the environment” with reference to relevant international instruments.153 To this respect, as previously discussed in Sect. 3, several multilateral instruments have consistently urged action to protect and restore the world’s forests since 1992; while the latest UNEP/FAO report154 warns that the rates of deforestation and forest degradation “continue to take place at alarming rates”.155 Turning to the second step required under Article XX, that is the evaluation of the measures established by the proposed regulation in the light of the requirements its 151 Appellate Body Report, United States – Import Prohibition of Certain Shrimps and Shrimp Product, WT/DS58/AB/R, adopted 6 November 1998 (hereinafter AB, US – Shrimp 1998), 143–144. 152 AB, US – Shrimp 1998, 136. 153 AB, US – Shrimp 1998, 129–132. 154 UNEP/FAO (2020) The State of the World’s Forests, p. xvi. 155 Incidentally, an objection that may be raised here is that the proposed regulation (partly) seeks to protect forests outside the EU’s territory insofar as imported FRCs are concerned and that Article XX letter g) GATT cannot justify environmental measures with such “extraterritorial” effects. However, we do not agree with such objections. Firstly, because there is no explicit jurisdictional limitation in the text of Article XX; secondly, the Appellate Body has avoided ruling on whether such a jurisdictional limitation could be implied while accepting the invocation of Article XX GATT as a defence for measures of a similar extraterritorial nature (AB, US – Shrimp (1998), 133, concerning sea turtles; AB, EC – Seal Products (2014) concerning seals partly outside the territory of the regulating State). For the sake of space, we cannot engage here with scholarly debate on the appropriateness of this jurisprudential approach (but see for a recent contribution in this respect, Dobson (2018), pp. 78–88). In any event, it could be argued that a “sufficient nexus” (AB, US – Shrimp 1998, 133) exist between the forest being protected and the EU, given the abovementioned transnational consequences of deforestation and forest degradation in terms of climate change and biodiversity loss that also have a negative impact on its own territory. In other words, the severe environmental effects of forest destruction are not limited to the country (or countries) where the forests are located, but affect other countries through global warming and biodiversity loss as a matter of “common concern (on this point see further Brunnée (2008), pp. 564–568; and Cooreman (2021), p. 213). This is explicitly acknowledged in the dual objectives of the proposed regulation (see Commission Proposal, p. 9, where it is expected that the proposed measure would lead to a reduction of at least 31.9 million metric tons of carbon emissions to the atmosphere every year due to EU consumption and production of the relevant commodities; and Article 1).

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chapeau, this provision essentially requires that the measure at issue does not result in “arbitrary” or “unjustifiable” discrimination between countries (and their products) where the same conditions prevail. Several factors have been considered in WTO case law to determine when discrimination is “arbitrary” or “unjustifiable”, with the most prominent one being the rational connection standard. This standard looks in particular at the rationale for the discrimination put forward by the WTO regulating Member State; and the key question is whether it can be reconciled with (or rationally connected to) the objective pursued by the measure.156 In our case, can the EU genuinely justify the instances of discrimination between countries/products we identified above in light of the goal of reducing its consumption-driven contribution to global deforestation? The discrimination between compliant commodities (permitted in the EU market) and non-compliant commodities (prohibited in the EU market) is most likely justifiable and thus WTO-compatible, as far as the latter are found through the due diligence process to be illegally sourced and/or to have caused deforestation which clearly goes against the objective of the proposed measure. To put it differently, the point is whether the EU can objectively demonstrate that these two sets of products create varying degrees of risk to forests. This is true to the extent that the legality and deforestation-free requirements under the proposed regulation are based on objective criteria—e.g., the domestic laws of the producing country and internationally accepted FAO definitions, respectively—and these are properly applied by operators when exercising due diligence.157 A further (and more complicated) question is whether the discrimination between low-risk and standard/high-risk countries arising from the benchmarking system can be rationally explained by the measure’s environmental objectives and therefore justifiable under WTO law. In broad terms, the Commission argues that this system seeks to incentivise countries to protect their forests (as adopting stronger forest protection and governance standards would bring them within the low risk category and secure easier access for their products to the EU market).158 But this country classification also pursues other objectives (such as, reduced compliance costs for operators and calibrated enforcement efforts by competent authorities),159 which are unrelated to the goal of curbing EU-driven global deforestation. In any case, the key challenge for the EU is to show that commodities from countries classified at low

Appellate Body Report, Brazil – Measures Affecting Imports of Retreaded Tyres, WT/DS332/ AB/R, adopted 17 December 2007, 226–227; and AB, EC – Seal Products (2014), 5.318. 157 However, as already discussed earlier in Sect. 4.2 above, we have some doubts about the Commission’s definition of “forest degradation” (though only relevant to timber products) and the aspect it adds to existing FAO criteria (i.e., the notion of “sustainable harvesting operations”). Therefore, without clearer guidance from the EU legislator on this point, operators risk being left to rely on the ill-defined criteria in the current proposal for evaluating the risk of emergence of a vague outcome (forest degradation); and, clearly, this may lead in some cases to arbitrary discrimination between timber products. 158 Commission Impact Assessment, p. 41. 159 Commission Impact Assessment, p. 42; and Commission Proposal, p. 19. 156

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risk actually pose a reduced risk of causing deforestation, thus identifying a simplified due diligence procedure.160 However, in our opinion this cannot be objectively established for two main reasons. First, as already illustrated above, the criteria for allocating countries among the different risk categories are stipulated in very loose terms, particularly without clear thresholds as to when a country may be deemed a low-risk one.161 This vagueness risks opening the door for potentially biased determinations by the Commission, particularly when assessing performance by third countries against that of the EU Member States. Secondly, it is unclear how these criteria are directly linked to the objective of keeping illegally sourced and deforestation-causing commodities out of the EU market. For instance, the mere fact that the nationally determined contribution (NDC) of a given country under the Paris Agreement “covers emissions from deforestation and forest degradation”162 is not a guarantee that all commodities from that country are deforestation-free.163 The same applies if a given country concludes an agreement with the EU to “facilitate compliance of the relevant commodities”164 with the proposed regulation, unless such an agreement establishes a licensing scheme to ensure that only legally sourced and deforestation-free commodities are shipped to the EU—which is not the intention of the Commission’s proposal.165 However, if the given country is nonetheless considered to be low-risk by the Commission, operators supplying FRCs from that country would only be required to collect information and data, including any information that is important to evaluate compliance by relevant commodities with the legality and deforestation-free requirements. Yet, crucially, these operators are not obliged to carry out a risk assessment based on that information to ascertain that such commodities are, in fact, legally sourced and deforestation-free. As such, the low-risk category could open a loophole for commodities associated with global deforestation and forest degradation to find their way into the EU market. Therefore, the safest option—from both a WTO law and an environmental law perspective— would be to apply the standard due diligence procedure to all FRCs placed on the EU

See, by analogy, AB, US – Tuna 2019, 6.278–6.291 (where regulatory distinctions drawn under the dolphin-safe labelling scheme had to be “calibrated to, or explained by, differences in the relative risks of harm to dolphin from different shifting methods in different areas of the ocean” in order to be justified under the Article XX’s chapeau. 161 By analogy, see AB, US – Shrimp (1998), 178–184 (where the lack of transparency and predictability in the certification process of the measures proved problematic under the chapeau); and EC – Seal Products (2014), 5.322–5.328 (where the ambiguous criteria and broad discretion in the application of the Inuit exception were found inconsistent with the chapeau). 162 Commission Proposal, Article 27(2)(d). 163 It is also not clear how this assessment criterion will be applied in practice, given that NDCs are formulated in a variety of ways: for an overview see UNFCCC, Nationally Determined Contributions under the Paris Agreement – Synthesis Report by the Secretariat, UN Doc/FCCC/PA/CMA/ 2021/8 of 17 December 2021. 164 Commission Proposal, Article 27(2)(e). 165 Unlike, as mentioned above in Sect. 4.1, the timber legality assurance system under VPAs. 160

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market irrespective of their origin, so as to verify their legal and deforestation-free status on a transaction (rather than a country) basis. Another important issue to be considered under the chapeau of Article XX GATT concerns international cooperation; and, more specifically, whether the regulating WTO Member State is required to engage in good faith negotiations with affected countries before resorting to unilateral measures to protect the global environment. Scholarly opinions differ as to whether the chapeau imposes such a self-standing duty of prior negotiations before any unilateral action,166 or its cooperative requirements are rather confined to the particular circumstances of the US – Shrimp case.167 From subsequent case law what seems clear is that, “as far as possible”, a multilateral cooperative approach to address global environmental problems is “strongly preferred”168 under WTO law, just as it is under international environmental law.169 In addition, comparable negotiating efforts should be made with all affected countries (whether before or after the adoption of unilateral measures),170 even if they do not need to lead to the conclusion of an international agreement, nor identical results between different negotiating groups.171 Given this strong preference for international cooperation in WTO law, the forest partnerships foreseen under the proposed regulation should be—in our opinion—an integral element of the EU efforts to tackle global deforestation and should build on VPAs. There are indeed important arguments for not abandoning the VPA approach, not least the achievements in terms of improved forest governance frameworks in partner countries which the Commission itself recognises and of enhanced stakeholders participation.172 In addition, these agreements can also be useful to temper criticism of unilateral EU action in this domain.173 Furthermore, by giving voice to local communities negatively impacted by deforestation, these partnerships can play the role of “inclusive incubators” for defining sustainability in context, as well as for establishing an 166 Among those challenging this reading, see Howse (2002), pp. 507–509. Endorsing this prior negotiation as a pre-condition for WTO-compatible unilateral environmental action, see Gascoigne (2021), pp. 23–25. 167 AB, US – Shrimp (1998), 172; and AB, US – Shrimp (2001), 119 and 228. 168 AB, US – Shrimp (2001), 124. 169 See e.g., Principle 12 of the Rio Declaration on Environment and Development (UN Conference on Environment and Development, Rio de Janeiro 3–14 June 1992, UN Doc/A/CONF.151/26 (Vol. I). 170 AB, EC – Seal Products (2014), 5.337. 171 AB, US – Shrimp (2001), 122–123. 172 See in this respect: FERN, Voluntary Partnership Agreements 2.0: A Response to the European Commission FLEGT Fitness Check, and Options for the Future, 2021, available at www.fern.org/ publications-insights/flegt-voluntary-partnership-agreements-2-0-2444/ accessed 24 March 2022; and Commission Impact Assessment, p. 20. 173 The Commission, on its side, contends that one of the main problems with VPAs is that key EU trading partners have shown little interest in engaging in the VPA process (see Commission Proposal, p. 7). However, in our opinion, this is not the point. Even where third countries do not take the opportunity to enter negotiations, the EU can still argue that it favours a cooperative over a unilateral approach to addressing the global challenge of deforestation.

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institutional framework for the provision of EU technical and financial assistance to address the supply-side drivers of deforestation and forest degradation.

7 Concluding Remarks The EU is a relevant importer of FRCs, actually the second major consumer of agricultural and timber products embodying global deforestation. Since the early ‘90s the international community member States, and the EU among them, committed themselves to end global deforestation loss by establishing an international legal framework on forest conservation. Remarkably, at the recent UN climate summit in Glasgow the EU joined (again) other world leaders in reiterating pledges to end global deforestation loss and to ensure sustainable consumption patterns by 2030. It is precisely to meet these commitments that the EU needs to act with a view to (better) regulate trade in FRCs, in a more holistic manner going beyond its existing FLEGT initiative—limited to regulate trade in illegally harvested timber products. Under such a perspective, it is in fact not by chance that just a few days after the UN Glasgow Summit the EU Commission submitted an important and courageous proposal of regulation aimed at adopting a mandatory due diligence legislation for (several) FRCs. As this article demonstrates, the ambitious Commission’s proposal is very appropriate, as it (practically) aims at preventing the EU from (further) contributing to the destruction and degradation of forests worldwide by its large import of (agricultural and timber) FRCs. It is also well justified, being (legally) rooted in the broad international consensus to halt deforestation as expressed in multiple (soft and hard) international legal instruments. Finally, the proposed regulation (factually) seems to have the potential to contribute significantly to reducing global destruction and degradation of forests, given the (well documented) relevant scale of the EU deforestation “footprint”. Nevertheless, the article recognises that the Commission’s proposal (as currently formulated) also presents i) some shortcomings, such as its limited focus on “deforestation” and “forests” and, especially, its inadequate consideration of the rights— including customary land tenure rights—of indigenous people and forest-dependent communities; and ii) some limits (of ambition) when compared to the European Parliament’s earlier recommendations. In addition, it also shows some potential tension with WTO’s core rules, notably with regards its (inadequate) cooperation with affected exporting countries and its (three-tier) country benchmarking system of classification to assess deforestation (not grounded on objective environmental indicators). Therefore, the article suggests that proposed regulation needs to be better designed to be compatible with the WTO law, particularly to meet the requirements of GATT Article XX’s exceptions. To this extent the EU needs, at the very least, to provide clarity and predictability as to why assessment criteria underlying the country benchmarking system have been chosen and how exactly, possibly by well-grounding this in objective

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environmental indicators. Otherwise, the safest option, from both a WTO and an environmental perspective, would be to leave aside the country classification system and assess deforestation risks on a transaction (rather than on a country) basis—by applying the standard due diligence procedure to commodities from all countries. Moreover, while not strictly required from a WTO law perspective, the article suggests that the new forest partnerships the Commission’s proposal foresees should draw on the VPAs experience and continue to play an important role as “incubators” for negotiated solutions to the global problems of deforestation and forest degradation. The above-mentioned shortcomings and limits that the proposal of regulation currently shows might (and should) be addressed in the legislative process it is undergoing, with a view to make it even more courageous, unprecedented and, above all, effective under an (holistic) environmental, human rights and WTO perspective.

References Boyle A (2021) Soft law. In: Rajamani L, Peel J (eds) The Oxford handbook of international environmental law. Oxford University Press, Oxford, pp 420–436 Brunnée J (2008) Common areas, common heritage and common concern. In: Bodansky D, Brunnée J, Hey E (eds) The Oxford handbook of international environmental law. Oxford University Press, Oxford, pp 550–573 Cabernard L, Pfister S (2021) A highly resolved MRIO database for analysing environmental footprints and green economy progress. Sci Total Environ 775(1):1–14 Charnovitz S (2002) The law of environmental PPMs in the WTO: debunking the myth of illegality. Yale J Int Law 27:59–110 Cooreman B (2021) Article XX, MEAs and extraterritoriality. In: Delimatsis P, Reins L (eds) Trade and environmental law. Elgar, Cheltenham, pp 210–219 Dobson N (2018) The EU’s conditioning of the “extraterritorial” carbon footprint: a call for an integrated approach in the trade law discourse. Rev Int Community Int Environ Law 27(1):75–89 Gascoigne C (2021) ‘Seeing the wood for the trees’: revisiting the consistency of Australia’s illegal logging act with the law of the World Trade Organisation. J Environ Law 33(2):395–442 Geraets D, Natens B (2014) The WTO consistency of the European Union Timber Regulation. J World Trade 48(2):433–455 Howse R (2002) The appellate body rulings in the shrimp/turtle case: a new legal baseline for trade and environment debate. Columbia J Environ Law 27:491–633 Marin Durán G (2015) NTBs and the WTO agreement on technical barriers to trade: the case of PPMs-based measures following US-Tuna II and EC seal products. In: Hermann C, Krajewski M, Terhechte J (eds) European yearbook of international economic law, vol 6. Springer, Heidelberg, pp 87–136 Overdevest C, Zeitlin J (2018) Experimentalism in transnational forest governance: implementing European Union Forest Law Enforcement, Governance and Trade (FLEGT) voluntary partnerships in Indonesia and Ghana. Regul Gov 12(1):64–87 Partiti E (2020) Regulating trade in forest-risk commodities. J World Trade 54(1):31–58 Pearce F (2021) A million trees. Granta Books, London Pendrill F et al (2019) Deforestation displaced: trade in forest-risk commodities and the prospect for a global forest transition. Environ Res Lett 14(5):14–29

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Pontecorvo C (2011) Il ‘regime’ internazionale per la protezione delle foreste. Satura editrice, Napoli Pontecorvo C (2018) The EU legal framework on trade in timber and timber products: recent developments in the implementation and enforcement of the timber regulation. In: Hermann C, Krajewski M, Terhechte J (eds) European yearbook of international economic law, vol 9. Springer, Heidelberg, pp 323–347 Savaresi A (2012) EU external action on forests: FLEGT and the development of international law. In: Morgera E (ed) The external environmental policy of the European Union. EU and international law perspectives. Cambridge University Press, Cambridge, pp 149–173 Sifonios D (2018) Environmental Processes and Production Methods (PPMs) in international law. Springer, Heidelberg Zeitlin J, Overdevest C (2020) Experimentalist interactions: joining up the transnational timber legality regime. Regul Gov 15(3):686–708 Concetta Maria Pontecorvo is Full Professor of International Law at the University “Federico II” of Naples, Italy, where she teaches International Law, EU Law and International Economic Law. Concetta Maria obtained a Ph.D in International Economic Law from the Bocconi University of Milan, Italy. She has been several times visiting scholar to the Max-Planck-Institute for Comparative Public Law and International Law of Heidelberg, Germany. Her research interests focus, inter alia, on the relationship between international environmental law and international economic law. She is author of, among others, a book (in Italian) on The International Regime on Forest Governance, a topic on which she also published articles and other works. Concetta Maria is a member of the Italian Society of International Law and of the European Society of International Law.

Part II

Current Challenges, Development and Events in European and International Economic Law

Seven Years Inside the Trade Defence Machinery Room: How Political Is the European Commission? Frank Hoffmeister

Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Anti-Dumping Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1 The Initiation of Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2 The New Methodology for Establishing Dumping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3 The Injury Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 The Causality Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5 The Union Interest Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.6 The Timing of Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.7 Interim Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Anti-Subsidy Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Export Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Investment Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Financial Support to Entities Outside the Jurisdiction of the Granting Authority: Cross-Border Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 R & D Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Calculating the Benefit of Preferential Lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.6 The Timing of Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.7 Interim Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Safeguard Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Special and Differential Treatment of Developing Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Internal Decision Making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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The author was Head of Unit at DG Trade’s Directorate for Trade Defence Instrument from 2004–2011, Unit H3/G3 and is now Director of the Legal Department of the European External Action service. The views expressed are personal and do not bind the European Commission or the EEAS. The author wishes to thank Wolfgang Müller, Laurens Elsen, Mihail Milev, Lilia Petrova, Mariusz Hubski, Hélène Juramy from DG Trade, Tim Maxian-Rusche and Gustavo Luengo from the Commission’s Legal Service, and Nicolaj Kuplewatzky, Legal secretary at the European Court of Justice, for helpful comments on the draft. F. Hoffmeister (*) European External Action Service, Brussels, Belgium e-mail: [email protected] © The Author(s), under exclusive license to Springer Nature Switzerland AG 2022 J. Bäumler et al. (eds.), European Yearbook of International Economic Law 2022, European Yearbook of International Economic Law (2023) 13: 543–582, https://doi.org/10.1007/8165_2022_87, Published online: 30 September 2022

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Abstract The article reviews the practice of the European Commission in the area of trade defence as of 2014, when the Brussels executive became competent to adopt trade defence regulations instead of the Council of the European Union. The author provides a detailed analysis how the Commission exercised its political discretion in the field of anti-dumping measures, countervailing duties and safeguards. In the area of anti-dumping he looks at the timing of measures, the dumping and injury analysis and the application of the Union interest test. In the anti-subsidy practice, new cases on export restrictions, investment subsidies and cross-border subsidies are presented. Hoffmeister also reviews the safeguard practice and the way how special and differential treatment of developing countries plays out in the European Union’s (EU) trade defence instrument (TDI) practice. He concludes that there was a progressive development of Commission practice (mostly seen in the anti-dumping practice) based on a dynamic interpretation of the law (mostly seen in the antisubsidy practice) in the last 7 years.

1 Introduction Prior to the adoption of the Lisbon Treaty in 2009, the decision on definitive trade defence measures in the EU was in the hands of the Council. As this is a political body, where Member States represent different interests, it is not surprising that some EU decisions in the field were the outcome of a political compromise. For example, when the Council had to decide in 2006 whether to impose anti-dumping duties on shoes from China and Vietnam, a hard political bargain produced a majority in favour of imposition, provided that sports and children shoes are exempted and that the measure would only be applicable for 2 years (instead of the usual 5 years).1 After an expiry review initiated in October 2008, similar discussions in the Council led to a further prolongation of the measures for 15 months only in December 2009.2 Hence, relevant analysis of the EU politics in the area of Trade Defence Instruments (TDI) rightly primarily focused on the role of the Council in that decade.3 However, since then the political landscape changed significantly. Under the new comitology rules,4 a committee composed of representative of Member States controls the Commission’s newly obtained implementing powers. Those rules

Council Regulation (EC) 1472/2006 (footwear from China and Vietnam – definitive measures), OJ L 275/1 (2006). 2 Council Regulation (EU) 1294/2009 (footwear from China and Vietnam – expiry review), OJ L 352/1) (2009). 3 Evenett and Vermulst (2005). 4 Regulation 182/2011 of the European Parliament and the Council, OJ L 55/11 (2011). 1

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became fully applicable to the world of TDI as of 2014.5 Since then, the Commission adopts itself both provisional and definitive TDI measures subject to varying levels of control by the committee in charge (the Trade Defence Committee, and, in the area of safeguards, the Safeguards Committee). At provisional stage, the Commission consults the Trade Defence Committee under the advisory procedure, which gives the Commission the decisive say. At definitive stage, the Member States vote on the draft-implementing act (DIA) from the Commission in the Trade Defence Committee. Three scenarios may arise. If the TDC supports the DIA, the Commission must adopt it. If the TDC does not reach an opinion, the Commission may adopt it. If the TDC votes against the DIA, the Chair of the Committee must refer the matter to the Appeals Committee, where a qualified majority of Member States is needed to prevent the Commission from adopting the original DIA or a revised DIA. In practice, the Member States rarely reach the simple majority for a negative opinion to trigger such an appeal.6 Moreover, they have never reached the qualified majority in the Appeal Committee to overturn the Commission upon appeal. In other words, all Commission draft implementing acts pass the TDC either at first stage or (in the original form or slightly revised) on appeal. Hence, the Commission has exercised considerable powers in the TDI field for roughly 7 years now. Has this made the Commission also more “political” in its TDI decision-making process? At first sight, the directions from the very top of the Brussels executive seems to provide an affirmative answer. President Juncker (2014–2019) promised to lead a “political Commission”. His successor, President von der Leyen (since 2019) wanted the Commission to become a “geopolitical actor”. However, at second sight, the orientation provided by their respective Trade Commissioners has been less fulminant in the policy documents adopted by the College of Commissioners upon their respective initiatives. When Trade Commissioner Cecilia Malmström (Juncker Commission 2014–2019) argued for a “more responsible trade and investment policy” in her Communication “Trade for All”, she observed in the section on implementation and enforcement:7 The EU also needs to stand firm against unfair trade practices through anti-dumping and antisubsidy measures. This is necessary to uphold the EU’s commitment to open markets. The EU is one of the main users of trade defence instruments globally. It ensures that procedures are followed rigorously and takes all the Union’s interests into account.

5

Regulation (EU) No 37/2014 of the European Parliament and of the Council of 15 January 2014 amending certain regulations relating to the common commercial policy as regards the procedures for the adoption of certain measures, OJ L 18/1 (2014). 6 Between 2009 and 2021, there were only three appeals, namely on the expiry of the Solar Panel measures in 2017 (Commission Implementing Regulation (EU) 2017/367 (Solar Panels from China—expiry review), Recitals 379–380, OJ L 56, 131) (2017), on the imposition of HRF measures against five countries in 2017 (Commission Implementing Regulation (EU) 2017/1795 (HRF steel from five countries—definitive measures), Recitals 625–671, OJ L 258, 24) (2017), on the imposition of measures on polyvinyl alcohol (PVA) (Commission implementing Regulation (EU) 2020/1336, OJ L 315, 1 (2020), Recitals 672–673. 7 European Commission, Trade for All, Communication of October 2015, https://trade.ec.europa. eu/doclib/docs/2015/october/tradoc_153846.pdf (last accessed: 17 May 2022), p. 16.

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As one headline action, she promised that the Commission will evaluate “the efficiency and effectiveness” of its own trade defence practice. Compared to the many other headline actions in the 30-pages long document, this could be seen as the bare minimum of political attention for TDI. When the von der Leyen Commission assumed office in November 2019, the political interest for visible EU enforcement action rose a bit. In her commitments to the European Parliament, the new President promised to establish the office of a “Chief Trade Enforcement Officer” (CTEO). The College appointed the Frenchman Denis Redonnet, an experienced senior trade official, to the post as Deputy DirectorGeneral in DG Trade in the following year. Among his tasks is not only tackling market access barriers and overseeing that trade partners deliver on their commitments arising under bilateral or multilateral trade agreements, but also overseeing the EU’s trade defence work.8 After the resignation of EU Trade Commissioner Phil Hogan in summer 2020, his successor Valdis Dombrovskis, laid down his political program in the “Trade Policy Review”. For the Executive Vice-President (EVP), EU Trade policy should be “open, sustainable and assertive”. On TDI, he stated in the chapter on implementation and enforcement:9 The Commission will continue to use Trade Defence Instruments in a firm manner so that European industry is not exposed to unfair trade. This also includes tracking new forms of subsidisation by third countries, for instance, in the area of investment financing, and adequately addressing them with countervailing measures.

In Headline Action 14, the EVP asked the CTEO to concentrate on other priorities, though. In particular, he should “maximise benefits of negotiated outcomes for companies, in particular small and medium sized enterprises (SME) and farmers, and eliminate hurdles that impair on the potential of the agreements to deliver, including on sustainable development”.10 It appears that TDI should remain business as usual also under the authority of the new CTEO. Against that background, one could well gain the impression that European trade defence is running its steady course, irrespective of higher politics. Indeed, one of the “buzz words” often used in Brussels is to identify the EU TDI process as “quasi-judicial”. This expression wishes to convince the public that EU investigators make technical determinations (“as quasi-judges”) and do not exercise much political discretion (“not as politicians”).11 At the same time, it is clear that EU trade defence officials work under the instruction of their respective Trade Commissioner, and that TDI measures are political acts adopted by the College of Commissioners.

8

See the description of the tasks of the EU Chief Trade Enforcement Officer, https://ec.europa.eu/ trade/trade-policy-and-you/contacts/chief-trade-enforcement-officer/ (last accessed: 17 May 2022). 9 European Commission, Trade Policy Review – An open, sustainable and assertive trade policy; 18.2.2021; COM (2021) 66, p. 20. 10 European Commission, Trade Policy Review – An open, sustainable and assertive trade policy; 18.2.2021; COM (2021) 66, p. 21. 11 For an early discussion of this aspect see Eymann and Schuknecht (1996).

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In the present contribution, I wish to look at this dichotomy (political v. technical) through the lens of an EU TDI practitioner. Is there room for innovation below the threshold of a full “policy initiative” mandated from the Commissioner? In order to reply to this question, I will refer to a number of Commission TDI decisions taken in the last 7 years. The selection should provide the reader with the main trends in the last 7 years of the EU’s TDI practice from the machine room thereof.12

2 Anti-Dumping Practice 2.1

The Initiation of Cases

The initiation of cases is prepared in the EU’s Complaints Office, which is a specialised section in the horizontal unit G1. The Complaints Office scrutinizes drafts from the EU industry, and rejects them when the necessary evidence is not sufficient under Article 5 (2) of the basic Regulation.13 At the same time, it will also give time and advice to complainants how to improve shortcomings in their drafts. In that exercise, a certain discretion plays a role. In the assessment of the Complaints Office, it will normally play a role whether an (unexperienced) SME or a wellestablished industry association, represented by specialised lawyers, brings forward the complaint. However, the “gateway” to DG Trade remains the same: Based on the professional proposal from the Head of the Complaints Office and the CTEO the Commission decides on the acceptance of a complaint after consultation of the associated services. Under Article 5(6) of the basic Regulation, the Commission can also initiate a case on its own motion “in special circumstances”. In May 2013, the Commission took a “decision in principle” to start a case on mobile telecommunications network against China in May 2013. However, the College also decided not to activate the case to allow for negotiations towards an amicable solution with the Chinese authorities.14 The case was dropped towards the end of Commissioner De Gucht’s mandate when a deal was reached in the EU-China Joint Committee on 18 October 2014 to guarantee equal access of European companies towards the relevant Chinese standard setting bodies and the equal treatment in the Chinese 4G procurement market.15 Clearly, this was high politics with the personal involvement of the EU Trade Commissioner and the Chinese Minister for Commerce.

12

Mizushima et al. (2017), p. 544 et seq. Regulation 2016/1036, OJ 2016, L 176, 1, with subsequent modifications. 14 Statement of EU Trade Commissioner Karel De Gucht of 15 May 2013, https://ec.europa.eu/ commission/presscorner/detail/en/MEMO_13_439 (last accessed: 17 May 2022). 15 Statement of EU Trade Commissioner Karel De Gucht of 20 October 2014; https://ec.europa.eu/ commission/presscorner/detail/en/IP_14_1182 (last accessed: 17 May 2022). 13

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However, the promised “monitoring” of the EU’s and China’s telecoms network markets “by an independent body” never materialized as China did not agree on the financing of that activity. Moreover, De Gucht’s successors did not venture into similar territory. His idea to strengthen the ex-officio powers of the Commission by adding a provision into the basic Regulation that EU companies would be obliged to cooperate in such cases in order to better fight retaliation put forward as part of the modernisation proposal of April 2013,16 was firmly opposed by some EU Member States. Hence, the final modernisation regulation of 201817 simply recorded the legislature’s understanding: In order to ensure that measures to fight against retaliation are effective, Union producers should be able to rely on the Regulations without fear of retaliation by third countries. Existing provisions, under special circumstances, provide for the initiation of an investigation without having received a complaint, where sufficient evidence exists of dumping or countervailable subsidies, and of injury and causal link. Such special circumstances should include the threat of retaliation by third countries.

This recital may serve as a tool for the interpretation of Article 5(6) of the basic Regulation on the ex-officio powers of the Commission, but falls short of constituting an invitation to do more on this front. The absence of any “high-profile” ex-officio cases after 2014 does not mean that the Commission stayed completely passive on this territory, though. Rather, in line with the general expectation of stronger enforcement of the rules, the TDI Directorate became more active in the area of anti-circumvention. During an expiry review on ceramic tableware from China (completed in July 2019) it detected anomalies in the export performance of certain exporting producers: the latter either increased their export volumes over 150% in a short period of time or exported well above their stated capacity. Faced with such sufficient evidence, the Commission, on its own initiative, launched in March 2019 the biggest anti-circumvention case in EU TDI history against 50 suspect companies. 20 TDI investigators, managed in crossunit teams carried out verification visits in all cooperating companies in China.18 Very importantly, the Commission concluded the investigation in December that year successfully, as over 30 companies of the 50 suspect ones could not put forward sufficient explanations for their stated exports.19 It thus concluded that large-scale intra-company channelling practices were ongoing, probably also involving some related or unrelated traders. In order to close this loophole for the future, the Commission also created an obligation for additional documentation: importers

16

Commission proposal on the modernisation of trade defence instruments of 13 April 2013; Communication COM (2013)191 final, Section 2.2.1, pp. 5–6. 17 Regulation 2018/825, OJ 2018, L 143/1, Article 1 (6) and Annex II. 18 Commission news of 12 December 2019; https://trade.ec.europa.eu/doclib/press/index.cfm? id=2092&title=Commission-sanctions-Chinese-tableware-exporters-evading-EU-anti-dumpingduties (last accessed: 17 May 2022). 19 One Chinese exporting producer challenged its findings. In its judgment of 8 June 2022 in case T-144/20, the General Court confirmed the Commission’s findings and dismissed the action.

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must henceforth also produce a “manufacturer certificate” to EU customs.20 Moreover, the operation of this case brought about cooperation between the Commission with the relevant Chinese Chamber of Commerce in order to exchange data about relevant export flows. Shortly after this “mega-operation” the Commission triggered another ex-officio case against circumvention practices relating to peroxosulfate exports from China. The sole exporter not subject to duties had continued to use its 0% rate although his factory had been closed in the meantime.21 Other circumvention cases followed, also involving other countries such as Turkey.22 It follows that the ex-officio initiation of such cases may serve as indicator that the fight against circumvention practices has become one of the priorities of the Directorate-General over time.

2.2

The New Methodology for Establishing Dumping

A major innovation between 2014 and 2021 was the adoption of the new methodology for establishing dumping by the co-legislature in December 2017.23 Starting from the assumption that the reliance on domestic prices and cost is not helpful to determine a product’s normal value when an overwhelming presence of the State in certain exporting countries leads to significant distortions, the Commission nowadays applies a separate set of rules with respect to those countries. While the new methodology applies in principle to all countries with such features, it is currently only used with respect to China. The Commission services have prepared in December 2017 an extensive report that examines the existence of significant distortions in China. It is placed on file in all investigations with regard to that country.24 The second report on Russia from October 2020 is also critical,25 but not to the extent that an application of the new methodology would be generally warranted in Russian cases. Against that background, the question has arisen whether the new methodology does not constitute a “political move” against China, so that the Commission, in fact, would “always” find dumping from Chinese

20

Commission Implementing Regulation (EU) 2019/2013 of 29 November 2019 (Tableware from China – Anti-Circumvention), OJ 2019, L 321, 139. 21 Commission Implementing Regulation (EU) 2020/477, (Peroxosulfates from China – AntiCircumvention), OJ 2020, L 100, 25. 22 Commission Implementing Regulation (EU) 2021/2230 (Glass Fibre Fabrics from China and Egypt –Circumvention via Turkey - initiation), OJ 2021, L 448, 58. 23 Regulation (EU) 2017/2321 of the Parliament and the Council, OJ 2017, L 338, 1. 24 Commission staff working paper of December 2017 on significant distortions in the economy of the People’s Republic of China for the purpose of trade defence investigations on China. SWD (2017) 483/2 final. 25 Commission staff working paper of October 2020 on significant distortions in the economy of the Russian Federation for the purpose of trade defence investigations, SWD/(2020)242 final.

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exporting producers. Does the China report make a dumping finding already foregone conclusion? While the legislative background of the new methodology has been described in detail elsewhere,26 four points of its subsequent application merit some attention in order to reply to the allegation of inherent political bias. First, it is true that the Commission does not spend much space in its decisions to discuss the World Trade Organisation’s (WTO) compatibility of the new rules, questioned in literature.27 The case Aluminium Flat Rolled Products from China is a typical example how the Commission addresses WTO arguments from the Chinese government and exporting producers:28 (271) The Commission considers that the provisions of Article 2(6a) are consistent with the European Union’s WTO obligations. It is the Commission’s view that, in line with the Appellate Body’s clarifications in DS473 EU-Biodiesel (Argentina), the provisions of the basic Regulation that apply generally with respect to all WTO Members, in particular Article 2(5), second sub-paragraph, permit the use of data from a third country, duly adjusted when such adjustment is necessary and substantiated. Therefore, the Commission rejected this claim.

Given that China has withdrawn its WTO case against the old “analogue country” methodology in which also Section 15 of its Accession Protocol had been raised,29 a more detailed analysis of this point does not seem to be warranted. Second, the Commission spends considerable detail on the findings that all six indicators for significant distortions are met in each individual case. It is not sufficient to rely on the China report as such to discard domestic Chinese prices. Rather, the distortions need to be present also in the sector under investigation. The Brussels executive formulated this position in the Aluminium Hot Rolled Foil Case from China very clearly as follows:30 The Commission examined whether it was appropriate or not to use domestic prices and costs in the PRC, due to the existence of significant distortions within the meaning of point (b) of Article 2(6a) of the basic Regulation. The Commission did so on the basis of the evidence available on the file, including the evidence contained in the Report, which relies on publicly available sources. That analysis covered the examination of the substantial government interventions in the PRC’s economy in general, but also the specific market situation in the relevant sector including the product concerned. The Commission further supplemented these evidentiary elements with its own research on the various criteria relevant to confirm the existence of significant distortions in the PRC.

26

Müller (2017); Vermulst and Sud (2018). Tietje and Sacher (2018). 28 Commission Implementing Regulation (EU) 2021/1784 of 8 October 2021 (Aluminium Flat Rolled Products from China – definitive measures), OJ 2021, L 359/6, Recital 271. 29 On that case see Zhou and Peng (2018); As China did not agree to the circulation of the report after having seen the interim report, the authority of the Panel lapsed after a year of non-action under Article 12.12 DSU. 30 Commission Implementing Regulation (EU) 2021/582 of 12 April 2021 (Aluminium Hot Rolled Flat Products from China – provisional measures), OJ 2021, L 124/40, Recital 124. The detailed analysis is then presented in Recitals 125–188. 27

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Third, Article 2(6a) of the basic Regulation leaves room for relying on domestic prices and costs if it is “positively established” that they are not distorted. Accordingly, even if sector-specific significant distortions are confirmed, it is still possible for an exporting producer to make the claim that his domestic costs should be used for some items. While this remained a sole theoretical possibility in the first 3 years,31 the Commission accepted for the first time that such a company specific defence was valid for certain raw materials sourced from abroad in the abovementioned aluminium case. In that specific situation it found:32 that Xiamen Xiashun did not provide evidence positively establishing that its costs regarding domestically sourced inputs were not affected by the substantial government intervention according to the findings made in Sections 3.3.1.2 to 3.3.1.9. The investigation established distortions in the entire chain of the aluminium flat-rolled products sector. Those distortions also concern the suppliers of raw materials, who are subject to all types of distortions found in the PRC, including the cost of electricity, labour, access to finance etc. In contrast, in the case of Xiamen Xiashun’s purchases overseas, on the basis of the evidence submitted and subsequently remotely cross-checked, including the questionnaire reply, the relevant contracts, a price analysis of these purchases (showing prices similar to the ones used from the representative country), and absent any evidence of distortions for this input in the United Kingdom, it was positively established that the purchase price of Titanium Boron Aluminium Rod from the United Kingdom (which represents a small part of the overall costs of raw materials of this company) is non-distorted and does not have to be replaced with data from a representative country.

Fourth, the new methodology can also lead to a negative finding on dumping in China-related cases. In the recent expiry on grain-oriented electrical steel from China (GOES), the Commission compared the export price of high-end GOES from China with an international benchmark and found no dumping practices of the Chinese exporting producer.33 All in all, these examples demonstrate that the new methodology has been applied with caution and flexibility, not giving rise to political engineering of the EU’s TDI practice in this regard.

2.3

The Injury Analysis

The injury analysis under Article 3(7) of the basic Regulation is the second corner stone of every anti-dumping case. In this field, the Commission possess a large amount of discretion when assessing the many injury factors “in a holistic” manner. The whole analysis is very fact-intensive. In some cases market shares, employment For the proposition that a “company-specific defense” is possible under the new methodology see Hoffmeister (2020b), p. 216. 32 Commission Implementing Regulation (EU) 2021/582 of 12 April 2021 (Aluminium Hot Rolled Flat Products from China – provisional measures), OJ 2021, L 124/40, Recital 204. 33 Commission Implementing Regulation (EU) 2022/52 (GOES from five countries – Expiry Review), OJ 2022, L 10, 17, Recitals 207–208. 31

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and investment decisions are considered important, whereas in other cases the development of profitability in a tight market is a key indicator for injury. While a full overview of this complicated issue is for specialised literature, two interesting trends are noteworthy in the last 7 years. First, the Commission applied the concept of a “threat of injury” in Article 3 (9) of the basic Regulation despite a rather bad experience from the past. Back in 2009, the Council had concluded in the seamless tubes and pipes case that the EU injury was in a “fragile situation” and not yet injured. However, for the Council, there had been signs of a “threat of injury” which it read from the import trends of the product concerned, the existing Chinese production capacity and a likelihood of further price depression justifying the imposition of measures.34 Alas, following a legal action in Luxemburg, the General Court of the European Union annulled the regulation, insofar as it imposed an anti-dumping duty on products manufactured by Hubei.35 The appeals brought against that judgment were dismissed by the judgment of the Court of Justice in 2016.36 Moreover, upon a preliminary reference, the Court declared the regulation fully invalid in 2021 as none of the relevant facts had supported the threat analysis. For the judges in Luxemburg, there was neither a likelihood of increased imports after the end of the investigation period, nor did free capacity in China support the indication of a threat, nor was there a good ground to assume a further price depression.37 Clearly, this litigation presented a warning to the Commission not to apply Article 3(9) of the basic Regulation too easily. The litmus test came in the Hot-rolled flat (HRF) steel case from China. When she initiated it in February 2016 (together with an investigation on heavy plates and seamless pipes), the then Trade Commission Malmström told the press:38 The steel sector currently faces a range of challenges. EU trade defence instruments cannot on their own solve all those problems, but the European Commission is acting and applying the instruments at its disposal to support and ensure a level-playing field. We cannot allow unfair competition from artificially cheap imports to threaten our industry. I am determined to use all means possible to ensure that our trading partners play by the rules. We have so far put in place trade defence measures for more than 30 different types of steel products, and we will continue to effectively address legitimate concerns of our industry.

A careful reading reveals that, already at initiation stage, she used two catchwords, namely the concept of “threats” and the option to take “all means possible”. And indeed, when the Commission adopted provisional and definitive measures on HRF 34

Council Regulation(EC) No 926/2009 of 24 September 2009, OJ 2009, L 262, 19. General Court judgment of 29 January 2014, Hubei Xinyegang Steel v Council, T-528/09, EU: T:2014:35. 36 ECJ judgment of 7 April 2016, ArcelorMittal Tubular Products Ostrava and Others v Hubei Xinyegang Steel, C-186/15 P and C-193/14 P, EU:C.2016:209. 37 ECJ judgment of 4 February 2021 in case C-324/19, ECLI:EU:C:2021:94, Recitals 59–73. 38 Commission launches new anti-dumping investigations into several steel products, 12 February 2016, https://ec.europa.eu/commission/presscorner/detail/ro/IP_16_287 (last accessed: 17 May 2022). 35

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products from China in October 2016 and April 2017, respectively, it based itself on Article 3(9) of the basic Regulation. In contrast to the seamless pipes case, it carried out a very detailed analysis of all the four factors mentioned there (import increase, free capacity, price depression, stocks), in light of developments that took place in 2016, i.e. after the end of the investigation period (the year 2015).39 Importantly, it divided the IP into four quarters, finding that the last two quarters showed very negative developments for the industry. Moreover, it added a novel section on profitability and order intakes as an “other element”.40 That criterion is not enumerated in the basic Regulation, but flows from the case law of the Court. In the abovementioned Hubei case, it had accepted that the situation of the EU industry’s position, analysed in the context of assessing the existence of material injury, is also relevant for the “threat” analysis.41 The Commission also added a section on the foreseeability and imminence of the changed circumstances,42 and concluded that a threat of injury actually existed at the end of the IP.43 Not challenged before the General Court, the solid analysis in this case represents the leading precedent in the area to-date. In 2019, the Commission carried out the first threat of injury case also in an anti-subsidy case.44 Another major step occurred in the tyres case from China. In that case, the industrial challenge was the competition of Chinese imports at the “low end” of the market, putting pressure also on the “high end” where the EU industry was making (still) considerable profits. The Commission decided to split the market into three segments. It meticulously analysed the competitive specificities of the three segments and the interaction between them, arguing that there was a “reverse cascade effect”. On the basis of this segmented approach, it imposed provisional measures.45 In October 2018, at definitive stage, the Commission further refined its analysis. Accepting comments from some interested parties, it also individualised the target profits for each segment.46 This, it seems, was another innovative feature in the attempt to grasp in a faithful way the specificities of that particular market. In

39

Commission Implementing Regulation (EU) 2017/649 (Hot-Rolled Flat Steel Products from China, Definitive Measures), Recitals 56–98, OJ 2017, L 92, 68. 40 Commission Implementing Regulation (EU) 2017/649 (Hot-Rolled Flat Steel Products from China, Definitive Measures), Recitals 56–98, OJ 2017, L 92, 68, Recitals 99–102. 41 ECJ judgment of 7 April 2016, ArcelorMittal Tubular Products Ostrava and Others v Hubei Xinyegang Steel, C-186/15 P and C-193/14 P, EU:C.2016:209, Recital 31. 42 Commission Implementing Regulation (EU) 2017/649 (Hot-Rolled Flat Steel Products from China, Definitive Measures), Recitals 103–105. 43 Commission Implementing Regulation (EU) 2017/649 (Hot-Rolled Flat Steel Products from China, Definitive Measures), Recitals 108–111. 44 Commission Implementing Regulation (EU) 2019/244 (Countervailing Duties on biodiesel from Argentina), Recitals 418–440, OJ 2019, L 40, 1. 45 Commission Implementing Regulation (EU) 2018/683 (Tyres from China, Provisional Measures), Recitals 54–67, OJ 2018, L 116, 8. 46 Commission Implementing Regulation (EU) 2018/1579, (Tyres from China, Definitive Measures), Recitals 301–325, OJ 2018, L 263, 3.

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May 2022, the General Court annulled the regulation for other reasons relating to the dumping calculation.47

2.4

The Causality Analysis

Another open door for political considerations may be the causality analysis. While it is common sense that injury must be “caused” by the dumping practices, the precise test under Article 3(6) of the basic Regulation is not very clear. In that very domain case handlers usually start from the assumption that there is sufficient evidence for a correlation between dumping and injury, similar to the one found by the Complaints Office for the period analysed in the complaint. But what happens if the investigation reveals that the correlation is not so clear cut, or that there are other factors that may have also contributed to the injury? In many cases the analysis leads the result that they are not “sufficiently important” to put the causation finding into question. Nevertheless, practice in the period under consideration also shows some exceptions where the investigating team actually did not agree with the causation analysis put forward by the industry at complaints stage. For example, in the large seamless pipes case, the Commission assessed the export performance of the EU industry as another factor in its causality analysis at provisional stage and invited interested parties to provide further information in order to assess whether the Union industry has performed in line with the world market, or worse than the world market.48 At definitive stage, the suspicion that the Union’s export performance was worse than the overall world-wide trend, was confirmed. The Commission concluded49 that the decrease of export sales had a negative impact on the financial situation of the Union industry and contributed to the injury. The decrease in sales volumes led to lower capacity utilisation and thus increased the weight of the overheads on all sales, also on the Union sales. The weak export performance was thus a factor contributing to the injury suffered by the Union industry by increasing the costs of the Union sales. Due to the adjustments to the costs of the Union producers explained in recitals (81) and (84), the impact of this cause was largely removed from the calculation of the injury margin. To the extent that the effect would not have been fully removed by the adjustments, any remaining impact on the level of the injury margin would have been only marginal.

Accordingly, the Commission excluded the extra-ordinary write-offs due to the weak export earnings in the calculation of the injury. Consequently, the duties ranging between 45 and 81% at provisional stage were substantially decreased to 29–54% at definitive stage from the calculation of the injury margin. This is a rare, 47

T-30/19 CRIA and CCCMC v Commission, judgment of 4 May 2022. ECLI:EU:T:2022:266. Commission Implementing Regulation (EU) 2016/1977 (Large seamless pipes and tubes from China – provisional measures), OJ 2016, L 305, 1, Recital 98. 49 Commission Implementing Regulation (EU) 2017/804 (Large seamless pipes and tubes from China – definitive measures), OJ 2017, L 121, 3, Recital 116. 48

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but important example that the non-attribution analysis in the causality section can actually be quantified in the injury margin calculation where the elements of the case permit it. In 2019, the Court of Justice vindicated that approach in the Canadian Solar-cases. On appeal, it emphasized that the level of an anti-dumping duty should not be higher than what is necessary to protect the EU industry. In that context, it categorically held: In order to ensure that the amount of the anti-dumping duty imposed in accordance with Article 9(4) of the basic regulation does not exceed that which is necessary to counter the injurious effects of the dumped imports, that amount should not take into account injurious effects caused by factors other than those imports.50

In other cases, the causality analysis may even lead to the termination of the case altogether. A good example is the Silico-Manganese case relating to imports from India. There, the volume of imports from India had increased in 2012 compared to 2011, but decreased afterwards whereas the two cooperating Union producers had incurred the highest losses in 2011 (when the volume of imports from India was the lowest) and the lowest losses in 2012 (when the volume of imports from India was the highest). In its termination decision of March 2016, the Commission concluded:51 (134) (. . .) that there was no coincidence in time between the trend of the difficult economic situation of the two cooperating Union producers and the increase of volume of dumped imports from India. The investigation established the existence of counter-trends between the increase in volume of the dumped imports and the injury suffered by the two cooperating Union producers. In addition, the market share of the dumped imports increased in the period considered, but only from [18 %/24 %] to [23 %/30 %]. The market share did not show a continuously increasing trend, and prices did not, or hardly, undercut the prices of the Union industry. (135) In view of the lack of coincidence in time between the deterioration in the economic situation of the cooperating Union producers and the trends of volume and market share of the dumped imports of silico-manganese from India, the Commission concluded that the impact of the dumped imports on the situation of the Union industry cannot be classified as material in the sense of Article 3(6) of the basic Regulation. In these circumstances, it was not demonstrated that the volume and/or price levels of the Indian dumped imports were responsible for the injurious situation of the two cooperating producers.

While this finding did not go down well with the industry and the then Hearing Officer, the Commission showed a similar sense of impartiality in the subsequent case of pins and staples from China. When the complainant withdrew the case, the Commission came up with a novelty. In its termination decision it expressed its readiness for quick action if a massive diversion of imports from the (recently closed) US market to Europe should create injury. Based on Article 56(2) of the

50

ECJ, Case C-236/17 P (Canadian Solar v. Commission), ECLI:EU:C:2019:258, Recitals 163–172, at Recital 169. 51 Commission Implementing Decision (EU) 2016/299 (Silico-Manganese from India – termination), OJ 2016, L 57, 8, Recitals 134–135.

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EU customs code,52 it agreed in August 2020 to monitor the market for 2 more years by maintaining the Integrated Tariff of the European Union (TARIC) codes for the product concerned.53 This has the advantage to provide a more precise analysis of the market when compared to the broader Combined Nomenclatur (CN) codes, where the statistics also cover other similar products than the product concerned.

2.5

The Union Interest Test

One of the most controversial aspects in the EU’s TDI practice is the Union interest test under Article 21 of the basic Regulation—probably because it is very apt to incorporate political considerations. In the past, the Directorate-General adopted a rather conservative approach. In the traditional reading, the Union institutions may only exceptionally not impose measures, namely when the imposition of measures would lead to clearly disproportionate negative economic effects for other sectors. In this model of binary choice, the main question is whether the economic interests of the upstream or downstream industry clearly outweigh the legitimate interest of the producers to receive protection against unfair trade. Not surprisingly, this approach has produced very little output. The cases, in which the Commission did not impose measures on Union interest grounds, can be counted on one hand. Against that background, Commissioner Malmström buried her predecessor’s proposal of 2013 to adopt guidelines on Union interest for a more pro-active use thereof when some Member States and the European Parliament opposed the initiative. Nevertheless, in the period under consideration, some important developments took place even without the existence of such guidelines, bringing some more flexibility into the rigid structures.

2.5.1

Policy Interests Are Interests Under Article 21 of the Basic Regulation

First, there was a steady broadening of the interests that can be taken into account under Article 21 of the basic Regulation. Famously, already the Solar Panels Regulation of 2013 contained a section “other interests”, in which the question was asked whether imposition on measures would not undermine the EU’s environmental objectives in promoting the transition to renewable energy sources.54 The Commission deepened the analysis in 2017 with a detailed section on the question

52

Regulation 952/2013 (EU) of the European Parliament and the Council, OJ 2013, 269, 1. Commission Implementing Decision (EU) 2020/2012 (Pins and Staples from China – termination), OJ 2020, L 269, 40, Recital 7 and Article 2. 54 Commission Regulation (EU) 513/2013 (Solar Panels from China – provisional measures) OJ 2013, L 152, 5, Recitals 257–259. 53

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whether the maintenance of the measures would put the Union’s climate goals in jeopardy.55 In the case on grain-oriented electrical steel (GOES), the Commission argued that there is a public interest in meeting the efficiency requirements of the ECO-design directive, which speaks in favour of ensuring the sufficient supply of high-performing GOES with minimum core loss.56 While these aspects could have spoken against the imposition of measures, the optic may also change into the other direction. For example, in the tyres case, the Commission argued in favour of measures by referring to the EU’s policy objectives in the area of recycling. The point was that the Chinese dumping not only put EU producers at risk, but also the business of retreading tyres in the EU which is important for a circular economy.57

2.5.2

Modulation of the Form Measures Because of Union Interest Considerations

Second, the Commission used in the 7 years period the Union interest more often to modulate the form of the measures, in line with previous practice. Traditionally, it adopts an ad valorem duty in TDI cases. Hence, importers must pay an increasing border tariff when the declared value is also rising. This flexibility may not be fully adequate in certain circumstances, in particular when the interest of the users are not strong enough to prevent a measure altogether, but militate in favour of a more moderate measure. In the GOES case, the Commission solved the dilemma with the imposition of a three-tier Minimum Import Price. The EU industry faced stiff competition from some low quality GOES from Russia, but also from high quality GOES from Japan, Korea and the USA. The users, companies manufacturing transformers, were interested to keep the supply chain intact for the high quality GOES, in particular because the EU industry itself was not providing that product in sufficient quantities.58 After an in-depth investigation, the Commission decided in 2015 to make a distinction. The AD duties were imposed in the form of minimum import prices (MIPs) of three different product categories of GOES, ranging from 1 536 EUR/tonne to 2 043 EUR/tonne. If the export price is equal to or above the relevant MIP, no duty is payable.59 If the export price is below the MIP, the importer must pay the difference, up to a maximum ranging between 21.5% and 39% of the export price. In practice, in particular third-tier GOES did not reach the requested level, making such imports subject to duties. This system stabilised the market and 55

Commission Implementing Regulation (EU) 2017/367, Recitals 314–318, OJ 2017, L 56, 131. Commission Implementing Regulation (EU) 2015/953 (GOES from five countries- Definitive Measures), Recitals 140–143, OJ L 284, 109. 57 Commission Implementing Regulation (EU) 2018/1579, (Tyres from China, Definitive Measures), Recitals 243–249, OJ 2018, L 263, 3. 58 Commission Implementing Regulation (EU) 2015/953 (GOES from five countries- Definitive Measures), Recitals 119–139, OJ 2005, L 284, 109. 59 Commission Implementing Regulation (EU) 2015/953 (GOES from five countries- Definitive Measures), Recitals 167–204, OJ 2005, L 284, 109. 56

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satisfied the main participants in such a way that the Commission could roll it over for another 5 years early 2022.60 Another variation of this exercise is to replace ad valorem duties with fixed duties. Here, importers will have to pay the imposed duty, but can be sure that the duties stay at the same level even when the import prices will rise again after the imposition of measures. This more moderate form of the measures was chosen in the HRF steel case with respect to five countries (upon appeal61) and in the tyres case.62 The modulation of measures is hence a very important instrument to better take account the interest of users.63 Third, the Commission decided to shorten the duration of measures in the Solar Panels case because of Union interest considerations. Instead of the normal 5 years, it opted in 2013 for 2 years because of the volatile market situation, in which the needs of the downstream industry were not predictable with sufficient certainty.64 In parallel, it accepted the largest undertaking in the history of TDI with more than 200 Chinese exporters cooperating to receive a minimum import price (MIP undertaking).65 Normally, the Commission would not accept such offers as the monitoring thereof poses a number of practical challenges. Moreover, accepting the undertaking also entailed a certain risk of litigation, as the EU industry unsuccessfully challenged the adjustment mechanism under the MIP as not eliminating the injury suffered.66 Much more important was the political imperative to avoid a potential trade war with China, though. The political dimension of the Solar Panels case became again obvious when the prolongation of measures were at stake. After its expiry review investigation (when the measures continued) the Commission proposed another 2 years, but a majority of Member States forced it to shorten the duration even further. The Appeals Committee reached an agreement in March 2017 to continue the measures for 18 months only, coupled with an interim review to gradually bring down the minimum import price.67 For that purpose, the Commission cancelled the MIP undertaking and replaced it by a gradually decreasing duty MIP for all Chinese exporters. The final touch arrived in summer 2018, when the Commission decided not to open a second

Commission Implementing Regulation (EU) 2022/52 (GOES from five countries – Expiry Review), OJ 2022, L 10, 17. 61 Commission Implementing Regulation (EU) 2017/1795 (HRF steel from five countries – definitive measures), Recitals 625–671, OJ 2017, L 258, 24). 62 Commission Implementing Regulation (EU) 2017/649 (Hot-Rolled Flat Steel Products from China, Definitive Measures), Recitals 335–343, OJ 2017, L 92, 3. 63 Cf Juramy (2018), p. 511. 64 Council Regulation (EU) 1238/2013 (Solar Panels from China – definitive measures), Recitals 421–423, OJ 2013, L 325, 1. 65 Commission Implementing Decision (EU) 2013/707, OJ 2013, L 325, 214. 66 General Court, Case T-783/14, Solarworld v. Commission, ECLI:T:2017:88. 67 Commission Implementing Regulation (EU) 2017/367 (Solar Panels from China – expiry review), Recitals 373 and 378, OJ 2017, L 56, 131. 60

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review with the effect that the measure expired in September 2018.68 The reason for this move could be found in the detailed Union interest analysis of March 2017, where the Commission had already opined that the measure would lose its raison d’être when grid parity is reached in Europe.69 This position can be further backed by the Court’s jurisprudence, which found that Union interest considerations are a cross-cutting concept which have its legitimate place in an expiry review,70 even though Article 21 of the basic Regulation is not mentioned in Article 11 (2) of the basic Regulation.

2.6

The Timing of Measures

A final observation relates to the timing of measures. In the past 7 years, there have been a number of important developments relating to provisional measures, retroactivity, suspension and prolongation of measures.

2.6.1

Provisional Measures

After initiation of the China HRF steel case in mid-February 2016, the Commission announced in its political communication of March that year that it “will immediately use the available margins to further accelerate the adoption of provisional measures”.71 Having this political direction in mind, the Directorate-General made its best efforts to hand down provisional measures already in early October that year,72 i.e. after only seven months instead of the usual nine months. However, the political top level has not repeated such highly unusual sector specific demands to EU TDI investigators.

68

Commission Implementing Decision rejecting requests for the initiation of expiry reviews with regard to the definitive antidumping and countervailing duties imposed on imports of photovoltaic (PV) cells and modules originating in or consigned from the People’s Republic of China by Commission Implementing Regulations (EU) 2017/366 and 2017/367; C(2018)5635/1; see Commission Notice of 3 September 2018, OJ 2018, C 310, 6. 69 Commission Implementing Regulation (EU) 2017/367, Recitals 335 and 746, OJ 2017, L 56, 131. 70 General Court, Case T-132/01, Euroalliages et al., [2003] ECR II-2359, paras. 40, 56–58; Case T-369/08 EWRIA v Commission, ECLI:EU:T:2010:549, paras 105–110; case T-432/12 VTZ v Council, ECLI:EU:T:2015:248, at paras 135–144. 71 European Commission, Communication on steel: Preserving jobs and growth in Europe, COM (2016) 155 final of 16 March 2016, p. 4. 72 European Commission Implementing Regulation (EU) 2016/1778 (HRF from China – provisional measures), OJ 2016, L 272, 33.

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Instead, in the modernisation package of 2018,73 the legislature expressed the political will towards the Commission that it should investigate generally faster. Hence, it shorted the statutory timeline for provisional measures from nine to seven months (maximum eight months) and for definitive measures from 15 to 13 months. However, it is impossible to implement such a change without additional human resources, which the legislature did not approve in the next multi-annual framework. Moreover, with the new methodology on top and the obligation to provide pre-disclosure for provisional measures, the amount of analytical work and additional steps increased even further. Consequently, provisional measures hardly meet the seven months target today.

2.6.2

Retroactive Imposition of Measures

Another additional tool mobilised during the steel crisis of 2016–2017 was the retroactive imposition of measures. Under the basic regulation, that is only possible if imports are registered as of the sixth month of the investigation (Article 14(5) and 10(4) of the basic Regulation). In the cold-rolled flat steel case from Russia and China, the Commission activated this possibility in a cautious manner. It adopted the main regulation imposing measures,74 and added a second regulation providing for the retroactive application thereof.75 That split followed some pre-litigation logic. If an importer were to attack the retroactive application as a matter of principle, a possible success in Luxemburg would not invalidate the prospective application of the measure. And indeed, the case was immediately brought to the attention of the General Court, which confirmed the legality thereof.76 It provided in particular clarity that a notice of initiation in the Official Journal of the European Union is sufficient for an importer to be aware potential ongoing dumping practices under Article 14 (5) (c) of the Basic Regulation and that actual awareness of the importer does not have to be demonstrated.77 Furthermore, the General Court found that the condition under Article 14 (5) (d) of a “further substantial rise of imports” was met in a situation when over 1 million of products entered the EU market in the registration period, when compared to 165 thousand before.78 Finally, the General Court clarified the condition in Article 14 (5) (d) that additional imports must pose a serious risk of undermining the effectiveness of the measure and supported the

73

Regulation (EU) 2018/825 of the European Parliament and the Council, OJ 2018, L 143, 1: For a good overview see Cornelis (2018). 74 Commission Implementing Regulation (EU) 2016/1328 (Cold Rolle Flat Steel from Russian and China – definitive measures), OJ 2016, L 210, 1. 75 Commission Implementing Regulation (EU) 2016/1329 (Cold Rolled Flat Steel from Russia and China – retroactive application), OJ 2016 L 210, 27. 76 GC, Case T-749/16, Stemcor, ECLI:EU:T:2019:310. 77 GC, Case T-749/16, Stemcor, ECLI:EU:T:2019:310, paras. 23–67. 78 GC, Case T-749/16, Stemcor, ECLI:EU:T:2019:310, paras. 68–79.

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Commission’s approach that volume, timing and other circumstances should be looked at.79 Since then, the Commission has increased its recourse to registration as a tool to deter further imports. In a generous manner, it interprets that any rise in imports above 15%, when compared to the IP, is sufficient to register imports. However, there is no automaticity between registration and retroactive application of definitive duties.

2.6.3

Retroactive Implementation of Court Judgments

Connected to the question of retroactivity is also the recent practice of implementation of Court judgments. Where an action for an annulment of a measure by the Court is successful, the Court will usually declare it void. The judgment thus has effect ex tunc—that is, as if the measure has never existed in the European legal order. At the same time, the Court has allowed the Commission to remedy the shortcomings and re-start the investigation at the time where the illegality occurred.80 In practice, this meant that the Commission cured the procedural or substantial mistake and re-enacted the adjusted measure ex nunc, unless the found illegality was so grave that a subsequent healing appears impossible. In such cases, the Commission may not re-open a case or terminate a re-opened investigation.81 The Commission changed this long-standing practice recently in the light of the Brosman and Puma & Clarks jurisprudence. In that string of cases relating to the controversial measures on import of shoes from China and Vietnam,82 the Court had faulted the Commission in 2012 and 2016 for not having carried out the test whether certain exporting producers operate under market economy conditions (“market economy treatment) or should receive individual treatment under the old methodology (“individual treatment”).83 After the annulment of the original measure with respect to these importers, the Commission reopened the cases for those who asked for MET by instructing the national customs authorities to forward to it all pending reimbursement claims.84 Going through many individual requests, it found after a verification that market economy treatment was not warranted. The Commission hence re-enacted the measures ex tunc with the argument that the procedural vice had

79

GC, Case T-749/16, Stemcor, ECLI:EU:T:2019:310, paras. 80–108. By way of example, see judgment of 20 September 2019, Case T-650/17, Jinan Meide Casting v Commision, EU:T:2019:644, paras. 339 to 341. 81 See for example the Commission Implementing Decision (EU) 2018/928 (Seamless Pipes and Tubes from China – Termination of re-opening after the Court judgments in C-184/14 P and C-193/ 14 P (Hubei), OJ 2018, L 164, 51. 82 See Council Regulation (EU) 1294/2009 (footwear from China and Vietnam – expiry review), OJ L 352/1) (2009); Evenett and Vermulst (2005). 83 ECJ, Judgments of 2 February 2012 in cases C-249/10 P Brosmann Footwear (HK) and Others v Council and of 15 November 2012 in cases C-247/10P Zhejiang Aokang Shoes v Council; ECJ, Judgment of 4 February 2016, Cases C-659/13 and C-34/14 (Puma and Clarks). 84 Commission Implementing Regulation (EU) 2016/223, OJ 2016, L 43, 3. 80

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been immaterial. Upon application by the importers Deichmann and Clark, the Court confirmed that this course of action was lawful.85 Inspired by these findings, the Commission then transposed the logic also to other scenarios. In Jindal, the General Court told the Commission in February 201986 that it had committed a mistake in the undercutting calculations for its anti-dumping and countervailing measures on imports of ductile pipes from 2016.87 The Commission reopened the case by virtue of a notice in June 2019,88 and registered the imports as of July 2019. In that regulation, it brought forward the new argument that the resumption of the administrative procedure and the eventual re-imposition of duties cannot be seen as contrary to the rule of non-retro-activity, according to the rulings of the Court in Deichman and Clark.89 In the final decisions of April 2020, the Commission then enacted the measures with a reduced level to correct the undercutting mistake, but also decided to provide for a retroactive application of the new duty as of 2016.90 Seen from the perspective of the importers, this new practice tilts the balance of powers between the Commission and the Courts too much in favour of the administration. In their view,91 the effect of such practice is to reduce the effect of the initial judgment to zero: Even if the Commission loses a case, it can repair the illegality with no additional sanction whatsoever, while the importers need to continue paying the duties as if they had never won the case in the first place. In their view, this would set the wrong incentive, as the Commission could neglect its due process duties during an investigation cost-free, while the importers would bear the burden and cost to force the Commission to correct its mistakes by Court cases. The importers have thus decided in July 2020 to bring a follow-up case to the Court, where the sole bone of contention is the new retroactivity and not the recalculated duty as such.92

85

Case C-256/16, ECJ judgment of the Court of 15 March 2018, Deichmann SE v Hauptzollamt Duisburg, para. 79 and Case C-612/16, ECJ judgment of 19 June 2019, C & J Clark International Ltd v Commissioners for Her Majesty's Revenue & Customs, ECLI:EU:C:2019:508, para. 58. 86 Cases T-300/16 and T-301/16, General Court, judgements of 10 April 2019 in ECLI:EU:T:2019, paras. 325 and 324. 87 Commission Implementing Regulation (EU) 2016/1369 (Ductile Pipes from India – definitive measures), OJ 2016, L 73, 53. 88 OJ 2019, C 209, 35. 89 Commission Implementing Regulation (EU) 2019/1250 (Ductile Pipes from India – registration), Recitals 11–22, OJ 2019, L 195, 13. 90 Commission Implementing Regulation (EU) 2020/526 (Ductile Pipes from India – reimposition of countervailing duties), Recital 75 and Article 1, OJ 2020, L 118, 1. Commission Implementing Regulation (EU) 2020/527 (Ductile Pipes from India – reimposition of anti-dumping measures) Recital 71 and Article 1, OJ 2020, L 118, 14. 91 See the intervention of Jindal’s Counsel, Renato Antonini, in the TDI Yearly Conference 2021, at the Brussels School of Governance, 16 November 2021, at the panel on EU TDI jurisprudence. 92 Case T-440/20, pending before the General Court – see OJ 2021, C 297, 44 for a summary of the pleas.

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Temporary Suspension of Measures

Under Article 14(4) of the basic Regulation the Commission can decide to suspend measures in the interest of the Union when injury temporarily does not exist because of a change in the market conditions and suspension will not create a likelihood that injury comes back. The Commission use this provision in only rare circumstances in the past. However, a more recent application is the Aluminium Flat Rolled Products Case in 2021. In that case, the investigation showed Chinese dumping causing injury during the investigation period, but after the imposition of provisional measures in April 2021, the EU industry recovered quickly with strong order books and limitations in their capacity to fulfil the needs of the EU user industry. All this was fuelled by a strong comeback of the industry in a post COVID-19 situation. Upon information from two users and some importers militating for suspension of future definitive measures, the Commission decided ex officio at the end of July to gather further information on offer and demand and on the alleged temporary shortages on the market in the post-investigation period. Confirming the main allegations, it then decided to complete the investigation in parallel with suspending the future measures. Thus, it presented to the Member States two acts: a draft implementing regulation, imposing measures on aluminium imports from China for 5 years, and a draft implementing decision, suspending such measures for 9 months in view of the temporary distortions in the market.93 This package allowed a swift sailing through the Trade Defence Committee, as some Member States with user interests saw that the Commission had allowed the users to gain some additional time to prepare for a change in the value chains, with rather long delays due to the need for individual testing of the quality of the products from new suppliers. The EU industry, though, vehemently opposed this step as a political digression,94 and the industry association AEGIS warned against a new and unwarranted policy trend of general suspension.95 The Commission, though, rebutted this point by stating that suspension requests will be decided on a case-by-case basis, based on the merits of

93

Commission Implementing Regulation (EU) 2021/1784 (Aluminium Fla Rolled products from China – definitive measures), OJ 2021, L 359, 1. Commission Implementing Decision (EU) 2021/ 1788 (Aluminium Flat Rolled products from China – suspension), OJ 2021, L 359, 105. 94 Press release of the European Aluminium industry of 10 September 2021, entitled “Intended Suspension of Anti-Dumping Duties keeps floodgates for unfair and high-carbon Chinese imports open”. https://www.european-aluminium.eu/media/3223/2021-09-10-european-aluminium_pressrelease_suspension-of-anti-dumping-duties-keeps-floodgates-for-unfair-and-high-carbon-chineseimports-open.pdf (last accessed 2 June 2022); As indicated by the counsel for the European Aluminium Industry, Bernard O’Conner on the panel about recent Commission TDI practice in the TDI Yearly, Brussels School of Governance, 16 November 2021, the industry has challenge the finding before the Court, as well as the decision not to collect provisional duties (Cases T-781/21 and T-782/21). 95 AEGIS Press release of 20 December 2021: “AEGIS Europe calls for greater certainty and clarity for the suspension of trade defence measures”; https://static1.squarespace.com/static/5537b2fbe4b0 e49a1e30c01c/t/61c0393e794219144fb8c3f2/1639987518997/2021-12-20_AEGIS+Europe_Press +Release+suspension_draft+final.pdf (last accessed 2 June 2022).

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each request. And indeed, in the next case, where suspension was at issue, namely on birch plywood from Russia, the Commission imposed definitive measures in November 2021,96 but refrained from suspending the measures in a decision of December that year as the EU industry had not yet recovered from injury in the postinvestigation period.97

2.6.5

Prolongation of Measures

When a TDI measures comes to its end, the EU industry may ask for a prolongation. If the Commission accepts the request for an expiry review, it will investigate under Article 11(2) of the Basic Regulation whether there is continued dumping and injury or at least the likelihood thereof if measures were to lapse. Like the causality test, the likelihood test is somewhat vague. As nobody can predict the future, the investigator has to rely on reasonable assumptions. In that respect, an easy assumption is that the repeal of measures will create an incentive for resumed dumping, causing new injury, as the Commission had enacted them before precisely in order to restore fair competition against a growing trend of imports. However, such a self-fulfilling prophecy is not good enough and questions the impartiality of the investigators, who are bound to look also at other elements, which could speak against such likelihood. In that respect, some more recent cases have introduced a “simulation test”.98 Under that test, the Commission takes the data from the original investigation and simulates what would happen if the exports would resume at the same volume with comparable low prices. Would the EU industry be injured, if it kept its prices and ceded market share or if it lowered prices to maintain its market share? Where such simulations are carried out the likelihood analysis has become much more solid— and has since then not been questioned in Court anymore.

96

Commission Implementing Regulation (EU) 2021/1930 (Birch Plywood from Russia, definitive measures), OJ 2021, L 394, 7. 97 Commission Implementing Decision (EU) 2021/2145 (Birch Plywood from Russia – no suspension), Recitals 9–21, OJ 2021, L 433, 19. 98 Commission Implementing Regulation 2017/2179 (Ceramic Tiles from China), Recitals 173–197, OJ 2017, L 307, 25; Commission Implementing Regulation 2020/39 (Peroxosulphates from China), Recitals 141–145, OJ 2020, L 13, 18; Commission Implementing Regulation 2020/ 1080 (Solar Glass from China, Anti-Dumping), Recitals 186–195, OJ 2020, L 238, 1; Commission Implementing Regulation 2020/1081, Recitals 185–194; (Solar Glass from China, Subsidy), OJ 2020, L 238, 43; Commission Implementing Regulation 2021/1266 (Biodiesel from United States, Anti-Dumping), Recitals 123–128, OJ 2021, L 277, 34; Commission Implementing Regulation 2021/1267 (Biodiesel from the United States, Subsidy), Recitals 202–207, OJ 2021, L 277, 267; Commission Implementing Regulation 2021/1805 (Wire Rod from China, Anti-Dumping), Recitals 158–165, OJ 2021, L 364/14.

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Review of Measures

Finally, the duration of a measure may be affected by an interim review under Article 11(3) of the Basic Regulation. Here, either the EU industry or an exporting producer may request the Commission to review the dumping or injury analysis, arguing that changed circumstances of a lasting nature had intervened after the adoption of the measures. These exercises are most of the time purely technical, as they will deal with the company-specific facts affecting the calculations of the duties. Exceptionally, though, even such cases from “deep down” the machinery room may bring with them a political dimension for the Commission “higher up”. For example, in 2017, the Russian exporting producer Acron and the several farmers associations in Europe both brought interim reviews against the long-standing EU measures on ammonium nitrate from Russia. In the former case, limited to dumping aspects, Acron asked to lower its dumping duty as there had been allegedly significant changes in the Russian dual pricing system for gas as a consequence of Russia’s WTO accession in 2012. They claimed that this had brought domestic gas prices considerably up, which in turn should reduce the adjustment made for the dumping calculation, as the gap between domestic and international prices was shrinking. The Commission rejected this point as follows:99 The Commission cannot qualify changes in domestic raw material prices as lasting because such changes are normally the result of volatile market forces. In any case, the Commission found that gas prices in Russia were regulated by the State via federal laws and did not reflect normal market conditions, where prices are principally set by production costs and profit expectations. Gas prices set by the State are directly applicable to state-owned companies, such as Gazprom. Gazprom is the biggest gas provider in the country with a market share above 50 %, and therefore it acts as a price-setter. On this basis, this situation is similar to the one that prevailed in previous investigations. Therefore, the Commission considers that the circumstances regarding the gas market in Russia have not changed and, as a result, that a modification of the measures pursuant to Article 11(3) of the basic Regulation is not warranted on that basis.

The delicate issue about this finding was that a press report from summer that year alleged that this change only came about upon insistence of the Polish Internal Market Commissioner, Bienkówska, at a meeting at the level of Heads of Cabinet before general disclosure occurred at the end of August 2018. This insinuated that the Commission did not base the rejection decision of November 2018 on the results of the investigation, but more on the political stance to oppose the Russian gas distortions with all possible means. In any case, such insinuation did not impress the General Court. In its judgment of May 2021, the Luxemburg judges confirmed the Commission’s assessment that the gas prices in Russian remain regulated. This kept the prices paid by Russian producers distorted, making Acron’s plea that the Commission should have affirmed lasting circumstances unfounded.100

99 Commission Implementing Regulation 2018/1703 (Ammonium Nitrate from Russia – interim review limited to dumping), OJ 2018, L 285, 97. 100 Case T-45/19, General Court, Judgment of 5 May 2021, ECLI:EU:T:238, paras. 53–68.

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Notwithstanding this victory in Luxemburg, this issue is not yet finally resolved. The Russian Federation has won a case against the EU in Geneva that the “dual pricing” methodology was not in line with the EU’s WTO commitments, and the EU has decided to appeal the Panel report from 25 July 2020.101 As the Appellate Body is not functioning anymore since December 2019, such appeal is currently pending “in the void”. In the second interim review on the same product, limited to injury aspects, a group of European farmers associations took issue with the level of the measure. Pointing to concentration in the European market on the producer side on global market changes, they argued that the measures overprotected the European fertilizer industry. They hence asked for a termination or at least a suspension of the measures, perhaps also counting on the political support of the Irish Agriculture Commissioner under the Juncker Commission, Phil Hogan. In November 2018, the Commission agreed with applicants half-way. While it affirmed a lasting change of circumstances that had led to efficiency gains in the EU fertilisers industry, it did not find that the there was a sufficient likelihood that injury would not recur after termination. It hence decided to lower the level of the measures by roughly a half.102 Formally speaking, the Commission explained this decision in two sections entitled “Level of the measures” and “Definitive Anti-Dumping measures”, where the Commission discussed the user’s arguments for termination.103 On substance, though, this was nothing else than carrying out a new Union interest test in an interim review limited to injury. As the new weighing and balancing of the competing interests between the fertiliser industry (producers) and the farmers (users) lead to a lowering of measures rather than termination this case is another indication that the dogmatic position about the “binary choice” under Article 21 of the basic Regulation is not convincing anymore.

2.7

Interim Conclusion

The Commission’s anti-dumping practice developed in a number of important areas after Lisbon. There are more ex-officio cases to fight circumvention cases. The new anti-dumping methodology is applied to counter significant distortions in all Chinarelated cases with due respect for the specificities of each case. A solid “threat of injury” case opened the door for more preventive action. The causality analysis is taken seriously. The Union interest test has become more actionable, as it motivated more often the change in the form of measures, in the duration and even decided the

Panel Report of 25 July 2020, WT/DS 494 (EU- Cost Adjustment Methodologies II – Russia). Commission Implementing Regulation 2018/1722 (Ammonium Nitrate from Russia – interim review limited to injury), Recital 20, OJ 2018, L 287, 3. 103 Commission Implementing Regulation 2018/1722 (Ammonium Nitrate from Russia – interim review limited to injury), Sections 7 and 8, Recitals 168–180. 101 102

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outcome of an interim review and the question of opening another expiry review (in exceptional circumstances). Moreover, the Commission’s action has become faster on provisional measures and more daring by enacting certain measures retroactively. Most recently, the Commission made use of the possibility to suspend measures. At the same time, the Commission solidified its likelihood analysis in some expiry review cases and stood firm in fighting structural distortions in third countries, such as dual pricing in Russia. None of these steps constitutes a bold political move. Rather, the Commission mainly implemented the political directions set by the EU legislator, when it introduced the new anti-dumping methodology and the shorter time-line for provisional measures in 2018. At the same time, the Commission started applying existing provisions in the basic Regulation, which were rarely used in the past, such as retroactive enactment of duties (Article 10 (4)), threat of injury analysis (Article 3 (9)) or suspension of duties (Article 14 (4)). While interested parties sometimes see in the “activation” of a sleeping provision a “political move”, such discretionary action falls more into the realm of progressive development of EU practice within the confines of the existing law.

3 Anti-Subsidy Practice Leaving aside the anti-dumping field, the EU’s anti-subsidy practice has probably made an even bigger jump ahead in terms of political significance in the last 7 years. Traditionally, EU industry was not very interested in that instrument as it involved a lot of preparatory work to build a complaint and yielded rather low margins in successful cases. However, that assessment slowly changed over time. First, it is much easier to muster support in Member States when the Commission has found in a case that another country resorts to countervailable subsidization. Second, in the modernisation package the legislator abandoned the lesser-duty rules in subsidy cases,104 sending a political signal to step up the fight against foreign subsidies. Third, the practice of the Commission has also become more forthcoming when addressing certain salient issues. While the wide arrays of the EU’s countervailing practice up to 2015 has been aptly summarised elsewhere,105 some newer trends from the last 7 years are worth mentioning.

104 Regulation 2018/825 of the European Parliament and the Council, Article 2, Point 4 on provisional duties changing Article 12 of the Basic Anti-Subsidy Regulation 2016/1037: “The amount of the provisional countervailing duty shall be the total amount of countervailable subsidies as provisional established” and Article 2 Point 7 on definitive duties changing Article 15 thereof: “The amount of the countervailing duty shall not exceed the amount of countervailable subsidies established”. OJ 2018, L 143, 1. 105 See Sud and Vermulst (2016).

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Export Restrictions

Under Article 1.1 of the SCM Agreement, the Commission can take countervailing action if a third State grants a financial contribution to a company, which confers a benefit and is specific. A financial contribution also exists if a government entrusts or directs a private body to carry out a function, which would normally be vested in the government, and the practice, in no real sense, differs from practices normally followed by governments (Article 1.1 (a) (iv) SCM Agreement). In the case concerning ductile pipes from India, the Commission used this concept for the first time to tackle export restrictions on iron ore in the form of an export tax and a dual freight policy for inland transport of iron ore. The question was whether such restrictions would not make iron ore cheaper for domestic Indian mining companies, which would then render a quasi-governmental service to the ductile pipes producers. After having reviewed the Appellate Body’s guidance from the DRAMS case (Korea),106 the Commission set out the relevant legal construction as follows:107 In line with the WTO’s five-step test, the Commission has therefore reviewed very carefully the nature of the government’s intervention (Does it involve entrustment or direction of iron ore mining companies?); the nature of the entrusted bodies (Are the mining companies private bodies within the meaning of Article 3(1)(a) (iv) of the basic Regulation?); and the action of the entrusted or directed bodies (Did the entrusted or directed iron ore mining companies provide iron ore to the ductile pipes industry for less than adequate remuneration and hence act as a proxy for the government?). Moreover, the Commission has verified whether the function carried out would normally be vested in the government (Is the provision of iron ore at less than adequate remuneration to producing companies in India a normal government activity?); and whether such function does not, in real sense, differ from the practices normally followed by governments (Does the actual provision of iron ore by mining companies, in real sense, differ from what the government would have done itself?). Reviewing relevant governmental documents, it affirmed all five questions and countervailed the Indian export restrictions on iron ore. Importantly, upon application of one Indian exporting producer, the General Court sided with the Commission, explicitly backing the five-step test and the appreciation of the underlying evidence.108 Moreover, it rejected the applicant’s arguments about the WTO

Appellate Body Report of 21 February 2005, DS296 United States — Countervailing duty investigation on Dynamic Random Access Memory (DRAMS) from Korea, paragraphs 110–118. 107 Commission Implementing Regulation (EU) 2016/387 (Ductile Pipes from India – Definitive countervailing duties), Recital 142, OJ 2016, L 73, 1. 108 Case T-300/16, General Court, Judgment of 10 April 2019, ECLI:EU:T:2019:235, paras. 110–120. 106

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dimension of the Commission’s approach, confirming a wide reading of the “entrustment and direction” standard as an anti-circumvention provision.109 With such frank backing from Luxemburg, the ductile pipes approach became the new standard in subsequent similar cases. This was particularly evident in the biodiesel cases from Argentina and Indonesia. Back in 2012, the Commission had started parallel anti-dumping and anti-subsidy cases against the import of biodiesel from these countries. After a withdrawal of the anti-subsidy complaints by the EU biodiesel industry, the Council then imposed anti-dumping measures only in November 2013, using Article 2(5) of the basic Regulation as a basis for a controversial adjustment on input costs for the biodiesel producers.110 However, in October 2016, the WTO Appellate Body confirmed an adverse Panel report brought about by Argentina. It declared the adjustments carried out to catch the economic effects of the export restrictions in these countries to infringe the EU’s WTO obligations.111 Based on the WTO enabling Regulation 2015/476,112 the Commission then faithfully implemented the WTO ruling on Argentina in October 2017113 against the tough resistance of the EU biodiesel industry and revised the antidumping margins downwards. Having taken out Indonesia from the first exercise,114 the Commission also implemented the subsequent panel report on Indonesia from February 2018 (not appealed by either side) in a second exercise. An important factor therein was the fact that the General Court had declared the original measures null and void with respect to a number of Indonesian exporting producers in several judgments of 15 September 2016.115 The Council had appealed them, but after withdrawal of the appeal, they became final on 5 March 2018. The Commission then recalculated the margins for Indonesia without the adjustment and decided to terminate the case in October 2018, as they fell below the de-minimis threshold.116 However, in the meantime, the EU industry already prepared anti-subsidy complaint based on the ductile-pipes precedent. Investigations against Argentina and Indonesia were concluded in February and November 2019. Repeating the five-step-test, the Commission found that both countries had provided subsidies to their biodiesel exporters by operating several export restraints on the respective raw materials,

109

Case T-300/16, General Court, Judgment of 10 April 2019, ECLI:EU:T:2019:235, paras. 107 and 121–155. 110 Council Implementing Regulation 2013/1194, OJ 2013, L 315, 2. 111 Panel and Appellate Body Report in DS 473 (EU-Biodiesel from Argentina); Panel and Appellate Body in DS 480 (EU-Biodiesel from Indonesia). 112 Regulation (EU) 2015/476 of the European Parliament and the Council, OJ 2015, L 83, 6. 113 Commission Implementing Regulation 2017/1578 (Biodiesel from Argentina – Implementation of WTO rulings), OJ 2017, L 239, 9. 114 Commission Implementing Regulation 2017/1578 (Biodiesel from Argentina – Implementation of WTO rulings), Recitals 13–33, OJ 2017, L 239, 9. 115 General Court, Judgments of 15 September 2016, Cases T-T-80/14, T-111/14 to T-121/14 (Musim Mas and others) and T-139/14 (Wilmar), ECLI:EU:T. 116 Commission Implementing Regulation (EU) 2018/1570 (Biodiesel from Indonesia – Implementation of WTO rulings), Recitals 29–63, OJ 2018, L 262, 40.

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which had caused an imminent threat of injury to the EU industry. It hence imposed countervailing duties on Argentina between 25 and 34%,117 and on Indonesia between 8 and 18 %.118 The bitter pill was somewhat swallowed for the Argentinian exporters whose offer for an undertaking was accepted,119 whereas the Commission rejected the offer of one Indonesian company as being impossible to monitor.120

3.2

Investment Subsidies

Another major step occurred in the tyres case of 2018. During the on-spot verification of subsidy programs for Chinese producers of tyres, the case handlers detected a major financial injection from the “Silk Road Funds”. Together with four other financial transactions from State-owned banks, this inter-agency fund had paid 533 million in equity participation, so that the national rubber company (China National Tire & Rubber Co Lt.—CNRC) could acquire 65% shares in the Pirelli Group, a consortium worth 7.1 billion USD at the time of the purchase. The Commission decided to include this “newly discovered” subsidy, which had not been mentioned in the complaint, into the investigation, as a complement to the other four covered financial interventions in the acquisition of the Pirelli Group.121 Importantly, it then decided to countervail the equity injection as an “export subsidy”. Under Article 3 (1) (a) SCM Agreement it has to be shown that the granting of the subsidy is tied to increase the export activity of the company. After a meticulous study of the facts and legally weighing its defensive interests, the Commission reasoned that the investment was part of a “going out” strategy of the Chinese government under the “One Road One Belt” initiative. The government’s expectation to foster export sales was subsequently confirmed: after having acquired the Pirelli shares, CNRC did indeed reinforce its export sales to the EU significantly benefiting from the new know-how, sales structures and reputation of Pirelli in Europe.122

Commission Implementing Regulation (EU) 2019/244 (Biodiesel from Argentina – Definitive countervailing duties, OJ 2019, L 40, 1. 118 Commission Implementing Regulation (EU) 2019/292 (Biodiesel from Indonesia – Definitive countervailing duties), Recitals 102–161, OJ 2019, L 317, 42. 119 Commission Implementing Decision (EU) 2019/245 (Biodiesel from Argentina – Undertaking), OJ 2019, L40, 71. 120 Commission Implementing Regulation (EU) 2019/292 (Biodiesel from Indonesia – Definitive countervailing duties), Recitals 490–500, OJ 2019, L 317, 42. 121 Commission Implementing Regulation 2018/1690 (Tyres from China – Definitive countervailing duties), Recitals 329–330; OJ 2018, 283, 1. 122 Commission Implementing Regulation 2018/1690 (Tyres from China – Definitive countervailing duties), Recitals 379–416. 117

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571

Financial Support to Entities Outside the Jurisdiction of the Granting Authority: Cross-Border Subsidies

The next noteworthy evolution also relates to Chinese overseas financing. In the glass fibre fabrics case, the Commission dealt with preferential financing for Chinese entities operating in a special economic zone in Egypt. In a Cooperation Agreement signed by both Presidents, Egypt and China promised to fully support the Chinese manufacturing on Egyptian soil with available means, including overseas financing from China. Would such financial support trigger the responsibility of China, Egypt or both when such subsidized products enter the European market? Based on the specific facts at issue, the Commission opined that the notion of “government” under the SCM Agreement does not only entail the situation where a national government hands out subsidies to its own companies within its territorial jurisdiction. Rather, in line with Article 11 of the ILC Articles on State Responsibility, it was also possible that a national government (here: Egypt) can be the channel of financial support of another government (here: China) when the first government “acknowledges and adopts” such conduct as its own.123 On that basis, the Commission attributed the overseas financing by the Government of China to the government of Egypt.124 This is probably also the first time that a resolution of the UN General Assembly and a judgment of the International Court of Justice made it into a TDI Regulation.125 In any case, the legality of importing of general international principles into the SCM Agreement has sparked a lot of academic debate since then.126 Nevertheless, one should be cautious in generalising the findings, as the test of “acknowledging and adoption as one’s own” under Article 11 of the ILC Articles is demanding. For example, a general investment framework between two countries would not meet this test. A case on SSHR from China and Indonesia was probably less clear-cut as the industry decided to withdraw it in November 2020.127 Another investigation on Indonesia and India has then been started in February 2021,128 where the question is at stake in how far Chinese investments in an industrial park in Commission Implementing Regulation 2020/776 (GFF from Egypt and China – Definitive countervailing duties, Recitals 685–689, OJ 2020, 189, 1. 124 Commission Implementing Regulation 2020/776 (GFF from Egypt and China – Definitive countervailing duties, Recitals 690–699. 125 Commission Implementing Regulation 2020/776 (GFF from Egypt and China – Definitive countervailing duties, Recitals 714 (UNGA Resolution 3314 of 1974 on the definition of aggression) and Recital 721 on the ICJ’s judgment in the Genocide case (Bosnia and Hercegovina v. Serbia and Montenegro) of 2007. 126 See for example the intervention of Juhi Dion Sud in the TDI Yearly 2020, Brussels School of Governance, November 2020, and several blog entries worldwide. See e.g. one comment from an Indian researcher (http://regulatingforglobalization.com/2020/10/20/subsidies-in-free-trade-zonesextension-of-territorial-limits-and-state-responsibility/ (last accessed 2 June 2022)). 127 Commission Implementing Regulation 2020/1653 (SSHR from China and Indonesia – Termination), OJ 2002, 357, 50. 128 Notice of initiation, OJ 2021, C 57, 16. 123

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Indonesia can be countervailed as cross-border subsidies. Hence, the jury on the scope and limits of that concept is still out.

3.4

R & D Contracts

In the Optical Fibre Cables case, the Commission confronted yet another challenge. Providing the Chinese “Silicon Valley” companies with varying support measures, the Chinese State also created a new category of R&D subsidies next to the traditional grants and preferential financing from banks. In that scenario, an investment company, holding a big part of the shares of the producing company, provides financing to the producer in the form of R&D fees for research purposes. According to their contract, the investment company (itself held by SASAC) and the producing company share the patents arising out of such research. For the Commission, such “reward” for the financing was rather theoretical as the investment company could by its own admission not make any good use of such patents and the benefits of the research were shared with the producing company. Hence, the Commission treated such “R&D contracts” as a subsidy in form of a grant from the Chinese state to the producing company.129 That may also contain an important precedent for dealing with similar R&D constructions in China, which seem to become more widespread in certain high-tech sectors there.

3.5

Calculating the Benefit of Preferential Lending

Turning to the analysis of the benefit of a financial contribution handed out by the State to a company, the Commission regularly applies the WTO “market investor test”. Under this concept, the benefit is the difference between the State’s actual behaviour and the hypothetical behaviour of a market investor. If, for example, a private bank would have given a 1-year loan with an interest rate of 5%, whereas the State only demanded 3% for a similar loan, the benefit for the company is the non-payment of 2% of interest rates of that year. In market economies, it is not so difficult to find appropriate benchmarks as the private banks may orientate themselves from relevant publicly available data, which are also accessible to the Commission. However, when dealing with Chinese financing it is more demanding to carry out such benchmarking. Traditionally, the Commission gave all Chinese companies a “hypothetical rating” (namely BB) and then put a figure on the difference between BB and the actual rating received from Chinese policy banks.

129

Commission Implementing Regulation (EU) 2022/72 of 18 January 2022 (definitive countervailing duties on imports of optical fibre cables from China), OJ 2022, L 12, 34, Recitals 176–180.

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This methodology had two drawbacks, though. First, it ignored differences between the individual financial situations of different Chinese exporting producers: one exporting producer may be a very solid, internationally active SOE, whereas another exporting producer may just survive because letting it go bankrupt would have too high social costs for a regional government. Second, it assumed that the differences in ratings from a free-market logic would properly reflect the actual benefit received under conditions of the Chinese economic system. That, however, was a debatable assumption since access to cheaper State money in a regulated economy may bring much bigger advantages in terms of financial stability of the recipient. In the HRF steel subsidy case from China, the Commission changed this methodology.130 Faced with the issue of so-called “zombie companies” in the steel sector, which only survived through recurring loans which no private bank would grant, it carried out an individual assessment of each sampled company. That made it possible to qualify certain loans of one sampled company as grants.131 Moreover, and even more fundamentally, it introduced the benchmarking of a “relative spread” instead of the previous “absolute spread”. An example can explain the difference: A Chinese bank treats a company as AA in the Chinese system (and thus provides a 1-year loan with 3% interest). The Commission considers that “BB” is appropriate (and the company would receive a 1-year-loan with 5% in the Chinese system). In that situation the benefit was not the simple “absolute” difference between the two interest rates (= 2%) anymore. Rather, the mark-up was determined by calculating the relative spread between the indices of US AA rated corporate bonds to US BB rated corporate bonds based on Bloomberg data for industrial segments (which could be much higher). The relative spread thus calculated was then added to the benchmark interest rates as published by the PBOC at the date when the loan was granted, and for the same duration as the loan in question. By now, this approach has become standard practice, as the Commission applied in tyres,132 GFF133 and all further subsidy cases. Consequently, the amount of subsidization found in cases involving preferential financing have generally come up.

3.6

The Timing of Measures

Given the complexity of the subsidy investigations, the legislator refrained from reducing the available investigation periods for subsidy cases. Hence, under the 130

Commission Implementing Regulation 2017/969, Recitals 152–244, (HRF from China, Definitive countervailing duties), OJ 2017, L 146, 17. 131 Commission Implementing Regulation 2017/969, Recitals 210–228, (HRF from China, Definitive countervailing duties), OJ 2017, L 146, 17. 132 Commission Implementing Regulation (EU) 2018/1690 (Tyres from China), Recital 236, OJ 2018, L 283, 1. 133 Commission Implementing Regulation (EU) 2020/776 (GFF from Egypt and China – Definitive countervailing duties, Recitals 300–344, OJ 2020, 189, 1.

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modernisation package, the duration for provisional measures remained 9 months, whereas definitive countervailing need to be imposed within 13 months as before. A particular timing issue in subsidy cases arises when the third State changes its subsidy practice. Under the basic Regulation, the raison d’être of the countervailing measures would then have to be reviewed, as warranted by Article 15 (1) 2nd subparagraph of Regulation 2016/1037: No measures shall be imposed if the subsidy or subsidies are withdrawn or it has been demonstrated that the subsidies no longer confer any benefit on the exporters involved. In the Commission’s recent practice, this rule played an important role in two interesting scenarios. In an expiry review on measures relating to the imports of biodiesel from the United States of 2009, the different subsidy schemes at federal and state level were continued over the period under investigation (mid-2013 to mid-2014). However, the main federal scheme had expired by the end of 2014. When the Commission had to decide on the prolongation in September 2015, a formal reading could have thus suggested that the US subsidy had been “withdrawn” within the meaning of Article 15 (1) of the basic Regulation. However, the Commission showed that there was a pattern of retroactive enactment of the scheme, which had occurred three times earlier already. Against that background, the Commission affirmed a strong likelihood of recurrence of the scheme and prolonged the EU countervailing measures.134 In the most recent expiry review, the US subsidy schemes were indeed still in place (without the retroactive feature), triggering another prolongation.135 In the second scenario, Turkey abolished a couple of subsidies for the producers for rainbow trout, which the Commission had countervailed in 2015.136 However, rather than exposing the trout producers to market forces, Turkey enacted other schemes for the fisheries sector. Here, the question was how to factor in such compensatory measures in an interim review brought by Turkish exporting producers. The Commission opted for a differentiated approach. As the economic benefits of the compensatory measures were rather close to the original measures, it rejected the request to terminate the countervailing duties at a countrywide level.137 At the same time, it could not exclude that individual exporters would not be eligible anymore under the new schemes or would not apply for new subsidies.138 Hence, the Commission entertained individual interim review requests from

134

Commission Implementing Regulation (EU) 2016/675, Recitals 106–131, OJ 2016, L 116, 27. Commission Implementing Regulation (EU) 2021/1267 (Biodiesel from the US – second expiry review), Recitals 41–95, OJ 2021, L 277, 62. 136 Commission Implementing Regulation (EU) 2015/309 (Countervailing Duties on Turkish Trout), OJ 2015, L 56, 12. 137 Commission Implementing Regulation (EU) 2018/823 (Interim Review on Turkish Trout), OJ 2018, L 139, 14. 138 Commission Implementing Regulation (EU) 2018/823 (Interim Review on Turkish Trout), Recital 49, OJ 2018, L 139, 14. 135

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individual companies who would show that their individual situation is different from normal sector-wide subsidy level.139

3.7

Interim Conclusion

The Commission’s anti-subsidy practice evolved significantly in the last 7 years. When Executive Vice-President Dombrovskis expressed in his Trade Strategy of February 2021 the priority to tackle “new form of subsidies, for example in the area of investment financing”,140 he probably had the two showcases involving Chinese (overseas) investment in mind, namely the 2018 case on tyres and the 2020 case on GFF. Indeed, it its latest annual report covering 2020, the Commission praised these two cases as its main achievements in the area.141 At the same time, it built on a steady practice to countervail export restrictions. A new momentum may also arise with respect to countervailing R&D subsidies. Below the radar of high politics, the Directorate-General also introduced a tougher methodology in order to identify a proper benchmark for preferential Chinese financing and showed political sensitivity when dealing with difficult expiry issues in the area of subsidies. All these examples are heading towards the political goal to make the anti-subsidy tool a stronger instrument. Against this background, the Commission also defended an expensive reading of the definition of a subsidy under Article 1.1 SCM Agreement, as witnessed in the cases on export restraints and transnational subsidies. This strand of activities could be characterised as a dynamic approach addressing new forms of subsidisation to the interpretation and application of the relevant WTO rules.

4 Safeguard Practice Under Article XIX of the General Agreement on Tariffs and Trade (GATT), WTO members may also adopt safeguards as an exceptional measure. This trade defence instrument is particularly open for political considerations, as it does not fight clearly defined “unfair trade”, but dangers for the domestic industry arising from an increase in imports. The measures are enacted “erga omnes” (applicable to all trading partners). In the EU’s domestic system, there are particular political safeguards to fetter the Commission’s discretion. As mentioned before, the Member States can

139

Commission Implementing Regulation 2020/658 (Interim Review on Turkish Trout), Recitals 30–71, OJ 2020, L 155, 3. 140 European Commission, Trade Policy Review – An open, sustainable and assertive trade policy; 18.2.2021; COM (2021) 66, p. 20. 141 39th Annual Report on EU TDI practice, COM (2021) 496 final of 30.8.2021, pp. 13–14.

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only stop the Commission in the area of anti-dumping and countervailing duties, when a simple majority against the measure refers the case to the Appeals Committee. Upon appeal, Member States can adopt a negative vote against the (revised) Draft Implementing Act only by qualified majority in the Appeals Committee (Article 6 (3) Comitology Regulation).142 However, when it comes to safeguards, already the absence of a positive vote in the Appeals Committee has the consequence that the Commission cannot adopt the intended safeguard. This exception was included into Article 6(4) of the Comitology Regulation upon insistence of the German government in 2011, which wanted to receive reassurances that the EU’s safeguard policy would not take a protectionist twist when laid into the hands of the Commission. In the seminal steel-safeguards case, the modulated balance of powers came into application in the last 3 years. When the Trump administration enacted in March 2018 an (WTO inconsistent) safeguard measure on steel and aluminium based on Section 232 of the 1962 Trade Expansion Act, the EU did not only attack this move by bringing a WTO case in Geneva with several other trading partners. It also took retaliatory measures and initiated its own safeguards investigation.143 The idea behind was, however, not to copy the faulty US practice, but to protect the EU market against possible diversion effects. Supported by a strong positive opinion of the Member State in the Safeguards Committee, the Commission enacted a cleverly designed safeguard measure to maintain non-injurious, traditional trade flows whilst avoiding the potential trade diversion derived from the US measures, which could seriously harm the Union industry. It introduced Tariff-Rate Quotas (TRQs) for all countries, reflecting its (legitimate) trade volume over the last 3 years. However, when a quota is exhausted, an additional tariff of 25% on those products would apply. The Commission justified this predominantly preventive concept with an overall increase of steel imports between 2013 and 2017 and several factors constituting a threat of serious injury. Remarkably, it found that the fragile situation of the EU industry could be threatened by further imports following the US Section 232 decision. This thinly veiled consideration of reciprocity allowed it to impose both a provisional safeguard in July 2018144 as well as a definitive safeguard in January 2019.145 Importantly, the Commission also carried out regular reviews on the operation of the measure. After a first review in October 2019, the Commission implemented a country-specific Tariff Rate Quotas in product category 1 (hot-rolled steel) as it was in the Union interest to allow further imports of this product after a quick exhaustion

142

Regulation (EU) of the Parliament and the Council 182/2011, OJ 2011, L 55, 13. For more detail on the EU reaction see Hoffmeister (2020a), p. 84. 144 Commission Implementing Regulation 2018/1013 (provisional safeguards on steel), Recitals 58–68, in particular recital 60, OJ 2018, L 181, 39. 145 Commission Implementing Regulation 2019/159 (definitive safeguards on steel); Recitals 90–93, OJ 2019, L 31, 27. 143

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of the quotas by the five biggest exporting nations.146 Also the second review of July 2020 led to an important adjustment. In view of the disruptions emanating from the COVID-19 pandemic, the Commission introduced a quarterly administration of all TRQ, and a designed a new regime for accessing the residual TRQ in the last quarter of a period.147 On 30 October 2020, the Commission initiated another review to adapt the volume of quotas, in view of the UK’s departure from the Union. These changes came into effect on 1 January 2021.148 Upon request of 12 Member States in February 2021, it initiated a fourth review and it extended the measure for another 3 years in June that year, to run from 1 July 2021 to 1 July 2024.149 During the necessary WTO consultations in mid-June, several third countries objected that move and demanded compensation. Turkey also brought a WTO challenge, and the Panel was composed in September 2020. In its report of 29 April 2022, the Panel rejected a number of Turkish claims. However, it also found that the increase of imports into the EU were not “the result” of unforeseen developments (as required by Article XIX:1(a) GATT), and that the finding of a serious threat of injury for the EU industry was not based “on facts”, contravening Article 4.1(b) of the Safeguards Agreement.150 It hence asked the Union to bring its measure into conformity with its WTO obligations.

5 Special and Differential Treatment of Developing Countries From a horizontal perspective, a brief mention should be made about the Commission’s application of the WTO concept of special and differential treatment of developing countries in its TDI practice. In general, two approaches are available. One could either accept the “self-designation” practice of States in the WTO. In that optic, all States who claim developing status in Geneva, are treated as such by the EU as well. Or, in the alternative, the EU defines for itself which are developing countries from a more objective starting point, taking into account the economic classification of a country in the UN and OECD. Curiously, the Commission has adopted both approaches in TDI cases.

146 Commission Implementing Regulation 2019/1590 (definitive safeguards on steel – first review), Recitals 17–28, OJ 2019, L 248, 48. 147 Commission Implementing Regulation 2020/894 (definitive safeguards on steel – second review), Recitals 10–27, OJ 2020, L 206, 27. 148 Commission Implementing Regulation 2020/2039 (definitive safeguards on steel – third review), Recitals 69–29, OJ 2020, L 416, 32. 149 Commission Implementing Regulation 2021/1029 (Safeguard measures on steel—fourth review), OJ 2021, L 225, 1. 150 Report of the Panel of 29 April 2022, EU—Safeguards on Certain Steal Safeguards, WT/DS 595/R.

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Article 18 of Regulation 2015/478151 mandates the Commission to exclude developing countries from safeguard measures if their export share is below 3% and developing country members of the WTO share collectively not more than 9% of the market shares in the Union market. The Commission applied this concept inter alia to Brazil, Ukraine, Egypt, India, Turkey and China in the steel safeguards from 2018.152 The opposite happened in anti-subsidy cases, where Article 14 (5) of the basic Anti-Subsidy Regulation increases the general de-minimis level of 1% to 2% for developing countries. In an interim review from one exporting producer on trout from Turkey, the revised margins were set at 1.55%. When Turkey claimed that the case should be terminated because of its development status, the Commission quoted a precedent from 2014153 and replied:154 (61) (. . .) The Commission recalled that the de minimis threshold is 1% but for developing countries, it is 2%. It further recalled that for the application of Article 14(5), a country is considered as a developing country if it is listed in Annex II of Regulation (EU) No 978/2012 of the European Parliament and of the Council of 25 October 2012 applying a scheme of generalised tariff preferences and repealing Council Regulation (EC) No 732/2008 (OJ L 303, 31.10.2012, p. 1) (16). As Turkey is not included in the list of eligible countries under that Regulation the Commission rejected the claim.

The Commission’s different treatment of Turkey under the safeguards and the antisubsidy instrument seems to follow a political logic derived from the different purposes of the instrument. In the operation of the safeguards instrument, the generous application of the developing countries exception serves the implied Union interest not to disrupt the Union market with imports of higher-middle income countries, integrated in the global steel value chain. In the anti-subsidy instrument, the main consideration is to protect the Union producing industry against unfair competition derived from specific state support. When a third country government can afford to hand out subsidies to its own industry whose exports distort competition in the Union, there is no need to apply special and differentiated treatment in the same way as in a situation where third country engages in legitimate trade, which causes temporary disruption in the Union’s market because of sheer volume effects.

151 Regulation (EU) 2015/478 of the European Parliament and of the Council of 11 March 2015 on common rules for imports, OJ L 83, 27.3.2015, p. 16. 152 Commission Implementing Regulation 2019/159 (definitive safeguards on steel); Recitals 119–124, OJ 2019, L 31, 27. 153 Commission Implementing Decision 2014/918/EU of 16 December 2014 terminating the antisubsidy proceeding concerning the imports of polyester staple fibres originating in the People’s Republic of China, India and Vietnam (OJ L 360, 17.12.2014, p. 65), Recital 76, fn. 3. 154 Commission Implementing Regulation 2020/658 (Interim Review on Turkish Trout), Recital 61, OJ 2020, L 155, 3.

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6 Internal Decision Making Finally, some words about the internal decision-making of the Commission in TDI. Given the enormous power vested in the institution vis-à-vis the Member States, there is a natural tendency for interested parties to direct their lobbying activities more towards Brussels than to the national capitals. More and more actors have realised in the last years that the “dice are cast” already at the stage when draft implementing act arrives in the Trade Defence Committee for a vote in the last month before adoption of the measure. In this respect, it is important to understand the normal course of action of typical TDI investigation inside the Commission. The Directorate-General for Trade prepares every formal TDI Commission decision. Upon admission in the Complaint’s Office, the Director for Trade Defence attributes the investigation to a case manager. This Head of Unit or Deputy Head of Unit in the Directorate-General assembles the teams on dumping, subsidy and injury, normally lead by Head of Sector from his/her own unit. Sometimes, cross-unit composition occurs, when specific expertise is needed, or when one unit does not have sufficient human resources to take a full case. Throughout the investigation, the case manager is supposed to take the interim decisions to advance the case and to present the overall outcome to the Director. The latter receives advice from the policy and legal section of the horizontal Unit G1, whose main preoccupation is to ensure consistency between the approaches from the different units. The policy section is also in charge of running the interpretation of the new methodology. In case of disagreement between the case manager and the policy unit, the Director for Trade Defence decides. Afterwards, the consolidated case is brought to the attention of the CTEO, who will bring in his perspective. He has a standing authority from the Director-General to seize the Cabinet with his drafts. At Cabinet level, the respective member of Cabinet, sometimes with the express agreement of the Head of Cabinet, would then seize the agreement of the Trade Commissioner to launch the respective inter-service consultations. All these steps are neither communicated nor intended to reach the public, the internal-decision making inside DG Trade presents a good case for technically driven exercise. As College of Commissioners takes TDI decisions usually in written procedure, DG Trade then engages an inter-service consultation with all relevant services. These are the Directorate-Generals for Industry (DG GROW), for taxation and customs (DG TAXUD), the Secretariat-General (SecGEN), the External Action Service (EEAS) and the Legal Service (LS). If a case touches specific other sectors, specialised DGs on agriculture, environment or climate may also be involved. In case of a disagreement between the DG’s, their respective Cabinets have to find a solution. Such “arbitrage” is, however, exceptional. Moreover, given the fact that the dossiers are fact-intensive and legally complex, the “political” Cabinets cannot opt for solutions, not supported by the facts or the law. Accordingly, the probability of a change in the draft decision emanating from the investigation at Cabinet level is very low—which also makes lobbying activity at political level a rather futile exercise.

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The situation is different when it comes to input from the Commission’s Legal Service.155 As only the College can overturn the Legal Service’s advice, the investigators would have to escalate any disagreement to the highest level. In view of the tight deadlines and political costs involved, such an approach would be generally unwise. Hence, the position of the Legal Service carries an enormous weight, and modifications in the drafts can sometimes be significant. At the same time, the Legal Service is a particular sensitive to safeguard its independence. Hence, any lobbying exercise in that direction is doomed to fail from the very beginning, unless a party considers that political intervention with the Commission’s President would trickle down via the Director-General of the Legal Service to the Legal Advisors in question. However, in my experience, that has not happened in a single case. Rather, the Legal Service has constantly revised drafts from a neutral and professional standpoint, having as its primary aim to increase the solidity of the act in view of potential challenges in Luxemburg or Geneva.

7 Conclusion In conclusion, the material reviewed from the last 7 years seems to provide a nuanced reply to the opening question how political the Commission has become in Trade Defence cases since the increase of its powers in 2014 by the new comitology rules. The institution does not engage regularly into “high politics”, but its decisions are often also more than a mere “technical application” of the rules. Under the general control of the College of the Commission, the Commissioner for Trade and his Directorate-General for Trade is responsible for a progressive development of Commission practice (mostly seen in the anti-dumping practice) based on a dynamic interpretation of the law (mostly seen in the anti-subsidy practice). In the latest annual report on the EU’s TDI practice in 2020 the Commission itself called this phenomenon a “robust and innovative way” of using trade defence instruments, which had shown “the EU’s continued commitment to rules based open trade”.156 Having worked in the TDI machine-room for 7 years together with an enormous pool of talented and committed colleagues, reading the word “innovation” in an EU annual TDI report is itself quite innovative! After all, the EU saying of the quasijudicial application of the rules in the area of trade defence has turned out to be true when it comes to the independence and impartiality of the investigations. At the same time, the Commission’s exercise of discretion is frequently less technical than sometimes suggested, when reviewing the progressive outcome of its TDI cases between 2014 and 2021.

155 On the role of the Commission’s Legal Service in general see the relevant chapter in LeinoSandberg (2021) and Agerbeek (2018). 156 39th Annual Report on EU TDI practice, COM (2021) 496 final of 30.8.2021, pp. 13–14.

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Frank Hoffmeister is Director at the European External Action Service and heads the Legal Department. He also teaches international economic law as a professor at the Free University of Brussels. He is a German lawyer and holds a PhD from the University of Heidelberg (summa cum laude). He has published numerous articles on international and European law and co-authored of the Law of EU External Relations (OUP, 3rd edition, 2020) with Jan Wouters, Geert De Baere and Thomas Ramopoulos.