At last week’s United Nations climate negotiations in Sharm el-Sheik, Egypt, finance questions were at the top of the agenda. At stake was how countries—particularly in the developing world—can afford much-needed investments that reduce carbon emissions, and adapt their infrastructure to a rapidly changing climate.
While governments spar over the resources needed to address climate change, they overlook the fact that law—in particular, international legal protections of foreign investments—can fundamentally alter the calculations of potential foreign investors.
A new international treaty that provides special legal protections for climate-positive private foreign investments should be part of the broader strategy to close the climate funding gap.
Growing Need for Climate Investment
The gap between the resources needed and those available to address climate change is growing. The UN estimates that climate adaptation may require as much as $340 billion annually by 2030 and developing countries alone may need up to $1 trillion a year to meet their current pledges to reduce carbon emissions.
The only way to meet developing countries’ climate finance needs is to maximize the private money flowing to the developing world in conjunction with robust multilateral climate finance. Even as debates continue over who should pay for climate change, countries can use the tools of international law to incentivize private businesses to make foreign investments that advance climate mitigation and adaptation.
For better or worse, private finance is fundamentally driven by profit. Investments across borders are made when investors believe the returns on an investment will be greater than the risks.
Given the imperative of making climate funding available to the developing world at the lowest possible cost, we must reduce the risks to private financial flows to the developing world. John Kerry, former US Senator and US Special Presidential Envoy for Climate Change, recently noted the urgent need to “take the risk out of the deal” so that private capital, which is typically risk-averse, will make meaningful contributions to climate finance.
Existing Energy Charter Treaty
Fifty-three countries recognized the power of law as a tool to mobilize private investment in 1994 when they launched the Energy Charter Treaty—an international agreement that promotes and protects foreign investments in energy infrastructure. It has successfully increased the flows of energy-related foreign direct investment in participating states by reducing investment risk. It protects more than $350 billion of energy investments in the EU and UK alone.
The Energy Charter Treaty, like other investment protection agreements, is a binding commitment from governments not to nationalize foreign investments, to treat such investments fairly, and to accord them due process of law. So too, the treaty gives investors a direct right to compensation if a host government harms the investment. As a result, foreign investors can have confidence their investments will be safe and the risk premiums for covered investments decline.
Today, the Energy Charter Treaty is rightly criticized for locking countries into existing fossil fuel energy infrastructure. If participating countries change their laws and regulations to meet climate, they may be required to compensate energy companies for resulting economic losses.
Under the Energy Charter Treaty, investors have won more than $1 billion from countries that have harmed their energy investments. France, Germany, Italy, the Netherlands, Poland, Slovenia, and Spain, among others, have withdrawn or announced they will withdraw from the Energy Charter Treaty to avoid such liability.
Tentative agreement has been reached to modernize the Energy Charter Treaty to phase out protections of fossil fuel investments and preserve states’ abilities to advance their climate goals. This is a step in the right direction. But a more ambitious vision is needed to promote climate-positive investment in the developing world.
New Agreement Needed
Rather than merely modernize the Energy Charter Treaty, states should consider a new investment protection agreement that is truly climate-friendly—call it the Investment Agreement for Climate Adaptation and Mitigation.
Such a treaty must attract countries in the developing world that have the greatest needs for green investment, most of which have not joined the Energy Charter Treaty. Through the treaty these countries would agree to protect and treat fairly investments that that are climate-positive, rather than climate-negative.
Critically, this new treaty would only protect investments that meet ambitious climate adaptation and mitigation goals consistent with countries’ pledges under the Paris Agreement and national climate adaptation plans. In so doing, the treaty would reduce risks for green investments only, thereby increasing climate-friendly investment flows to the developing world that align with states’ own climate commitments.
Admittedly, such a treaty could still expose member states to financial liability if they nationalize or otherwise harm protected green foreign investments. To encourage developing-world countries to join this agreement, developed states could promise to pay some forms of liability that might arise if developing countries suffering the most severe impacts from climate change are successfully sued under the treaty.
Such an indemnification could help developed states meet the substantial climate finance commitments they have made, but largely failed to achieve. So too, it would ensure that the risks to climate positive foreign investment flows to the developing world are reduced without subjecting at-risk developing states to potential new financial liability.
It’s time to start discussions on the sidelines of the UN climate negotiations and at the UN Conference on Trade and Development about how a new green investment protection treaty could help close the finance gap.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
William Burke-White is a professor of law at the University of Pennsylvania Carey Law School. From 2009-2011, Burke-White served on Secretary Hillary Clinton’s Policy Planning Staff at the US Department of State.