Why This Brazilian Policy Could Shake Up Environmental and Trade Efforts

by: Alexander Ezquerra

A common provision in trade agreements, known as Investor State Dispute Settlement (ISDS), is impeding the international fight for social and climate justice. Despite ISDS provisions becoming central to investment protection and trade agreements over the last 30 years, there has not been sufficient reporting on their impact. Brazil, despite minimal coverage, has a unique position on ISDS arbitration and as the largest economy in Latin America, serves as a possible case study for a reasonable policy alternative. ISDS is an arbitration mechanism which allows investors to sue national governments if they feel that the government has broken conditions that it agreed to uphold. When a foreign investor sues a government under an ISDS clause the case goes to an arbitration tribunal made up of one judge appointed by each party and a third agreed upon by both actors. Often these tribunals cost millions in litigation costs and if the investor wins, the government is forced to pay for all sunk costs as well as possible future profits, leading to payouts which cut into funds that could have been allocated elsewhere. The legal actors involved in ISDS often have financial incentives to rule in favour of investors, as these lawyers and professors who serve as arbitrators are being paid millions in legal fees. ISDS, therefore, is a process which completely skews in favour of investors at the expense of governments and communities.

Since its introduction, ISDS has acted as a barrier to social and environmental reform. Firstly, the case of Vattenfall v. Germany is an important case for everyone seeking to promote environmental regulations.

The case was between a Swedish energy firm and the German government and arose after the government delayed permits for a coal plant after setting energy regulations informed by an international panel on climate change. Rather than follow environmental regulations, the firm launched an ISDS claim against Germany totalling $1.9 billion. To avoid an ISDS arbitration, the government reached a settlement with the company which saw environmental regulations dropped, the firm’s commitment to avoid impacting local water revoked and an undisclosed financial settlement funded by German taxpayers. Social policy is also endangered by ISDS, as the case between Phillip Morris and Australia displays. This case was initiated by Phillip Morris after the Australian government imposed plain packing for all tobacco products to discourage smoking. To initiate the tribunal, Phillip Morris sued under the ISDS clause between Hong Kong and Australia, despite the company being Swiss, they used their Hong Kong branch to launch the claim. The case, luckily, was struck down on these legal grounds, however, this does not mean that the firm did not profit from the event. Due to the case, other countries like Namibia, Togo and New Zealand halted similar anti-smoking regulations in fear of the possible financial costs of a lengthy court case. These 2 cases alone demonstrate how far-reaching and disastrous ISDS clauses can be as governments are influenced by the threat of ISDS while writinglegislation.

Brazil’s rejection of the arbitration mechanism and innovative model for investment agreements in the future presents a viable solution to ISDS and the barriers it imposes on social and environmental reform. The first ISDS treaties were signed in the 1960s primarily between colonial powers and newly independent countries to ensure that investors from the ex-colonial ruler were protected.

ISDS clauses had limited growth, until the 1990s and 2000s when the United States worked to link trade and ISDS by including ISDS chapters in bilateral investment treaties (BITs) and within larger free trade agreements like NAFTA. This link led to ISDS clauses being implemented in over 3000 agreements signed by nearly all countries involved in trade. Governments adopting ISDS thought they simply agreed to a trade protection mechanism that fosters foreign investment and breeds economic growth. Brazil, following the trend of the 1990s and early 2000s, signed BITs with ISDS provisions. However, the government never ratified the agreements because the ISDS chapter was found to be incompatible with Brazil's constitution. Since then, the government has never signed an agreement containing an ISDS clause. The Brazilian case disproves the central defence of ISDS, as despite Brazil being one of the few developing countries to not sign an agreement with an ISDS clause, it has not had difficulty attracting FDI as Brazil was the sixth highest recipient of FDI as recently as 2020.

Despite Brazil’s experience or lack of, with ISDS being important for assessing the viability and rationale of ISDS, it largely has gone ignored. Brazil, as an alternative to ISDS, has established a new model for investment agreements which instead of focusing on investor protection and arbitration, focuses on promoting state-to-state cooperation and shifting public debate about ISDS.

This new model establishes obligations and responsibilities for investors, unlike traditional investment agreements. Brazil’s approach to ISDS could have a global impact. Firstly, developing countries have consistently been limited by ISDS to enact regulations which would benefit their citizens. Notably, the threat of a foreign investor seeking arbitration has halted many policies which promote social change and environmental protection. Scholars call this effect a ‘regulatory chill’, from anti-smoking policy in New Zealand to environmental policy in Mexico, this chilling effects policymakers globally. This combined with the large sums used to pay for arbitration and settlements, which can reach billions of dollars depending on the case, greatly limits the government's capacity to enact necessary reforms. Brazil’s approach has had some limited influence already within other governments critical of ISDS, but the true global impact of Brazil’s model could be realized in the coming years as the arbitration system is hopefully transformed.

The relevance of Brazil’s policy approach to ISDS can be seen within an international context of climate change and sustainable development. The limitations on government action and the unequal power relations which ISDS produces will paralyze the fight against climate change, and Brazil’s policy of scrapping ISDS is necessary for climate justice. Achieving a green economic transition and legislating the climate policy will face major resistance from ISDS. Fossil fuel companies and other investors under ISDS have and will continue to sue governments that enact environmental/social protection. An ambitious commitment against climate change will be thwarted unless countries follow the Brazilian case and terminate investment treaties with ISDS clauses. Brazil is key to the future of international climate policy as it is proof for other developing countries that foreign investment will not disappear if no ISDS clause is signed by the host country.

Despite the uninspiring condition of ISDS debate within the global trade regime currently, Brazil represents an alternative possibility and a starting point for a critical examination of ISDS’s future in trade law. Not only does the peculiar case of Brazil dismantle dominant thinking about ISDS but it provides a path for the international trade community which promotes climate justice rather than corporate power. Brazil's continued economic development over the last 30 years demonstrates that a rejection of ISDS is both economically viable and environmentally necessary.