Investor state dispute settlement mechanisms: implications for the climate transition
Bulletin No. 263, article 1. In order to combat climate change, states must reduce their use of fossil fuels. This may push them to terminate certain contracts already agreed with fossil fuel sector companies. However, some foreign investors may benefit from legal protections, meaning that when a contract is terminated, they can claim compensation before an arbitration tribunal. A financial risk of this kind may hinder the implementation of policies to combat climate change: a phenomenon known as “regulatory chill”. This poses an additional challenge for emerging economies that already need substantial amounts of financing to successfully achieve their energy transition.
Since the 1990s, the number of international investment agreements covering foreign direct investment has increased significantly, with more than 2,600 agreements in force worldwide in 2025. Their purpose is to guarantee multinational corporations (MNCs) a stable economic and legal environment for their foreign direct investment (FDI) and therefore include FDI protection clauses and – almost systematically – investor state dispute settlement (ISDS) mechanisms. If the clauses set out in these agreements are breached, MNCs can claim compensation for financial damages suffered by triggering these ISDS mechanisms to bring the states before ad hoc arbitration tribunals. Over the 1987 2023 period, 1,325 claims were filed worldwide.
Arbitration tribunals’ interpretation of these clauses is complex as there is no international regulatory framework to underpin it. The line between state regulations implemented in good faith and the wilful violation of foreign investment protections can be difficult to discern (Moehlecke, 2020), while the absence, in the majority of cases, of appeal bodies and the heterogeneity of case law may contribute to a form of legal uncertainty for states (Berge and Berger, 2021). The risk of litigation is compounded by the higher financial risk faced by emerging market and developing economies (EMDEs), which, on average, pay greater amounts of compensation than advanced economies.
Given the context, certain states – when exposed to, or risking exposure to, ISDS claims – may reconsider, delay or refrain from implementing some of the regulations that are or may be contested. This phenomenon is referred to as a “regulatory chill” (see definition in the appendix). Efforts currently underway to reform investor state dispute settlement mechanisms and thereby offer greater protection to a state’s “right to regulate” are supported by France and the European Union.
Applied to the challenges associated with the climate transition, the existence of ISDS clauses in agreements on fossil fuel exploration and exploitation may push EMDEs, whose financing needs are particularly severe, to hold back on the implementation of proactive climate policies.
The aim of this bulletin is to (i) explore the regulatory chill phenomenon, (ii) identify the weaknesses specific to EMDEs, particularly in the fossil fuel sector, and (iii) analyse the impact of ISDS mechanisms on financing for the climate transition.
1 The spread of investor state dispute settlement mechanisms carries a risk of “regulatory chill”
ISDS claims are multiplying due to the increase in international investment agreements
Recourse to ISDS mechanisms has risen sharply…
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Updated on the 12th of May 2026