Authored By: Soliyana Yirgalem Abera
Lebawi International Academy
Introduction
Foreign investment is an essential component of economic development. It provides capital, employment opportunities, and technological growth for host states, as well as profitability for foreign investors. International investment agreements have, therefore, developed mechanisms to protect foreign investors against unfair treatment by host nations and to encourage cross-border investment.[1] Investor-State Dispute Settlement (ISDS) is among the mechanisms that allow foreign investors to bring claims against governments through international arbitration.[2]
However, ISDS has faced criticism regarding its impact on a state’s ability to regulate in the public interest. Broad investment protections may discourage governments from adopting legitimate measures relating to public health, environmental protection, and social welfare.[3] This issue has placed the principle of the “right to regulate” at the centre of investment law debates.[4]
By advocating reforms to traditional ISDS mechanisms, including the creation of the Investment Court System (ICS) in agreements such as the Comprehensive Economic and Trade Agreement (CETA), the European Union has responded to these concerns.[5] This article argues that, although EU ISDS reforms have strengthened state regulatory autonomy through greater transparency and institutional improvements, further clarification of investment protection standards remains necessary to ensure that investor protection does not restrict legitimate government regulation. The article examines the right to regulate in investment law, analyses EU ISDS reforms, and evaluates whether these reforms have achieved balance between investor rights and state sovereignty.
The Right to Regulate in International Investment Law
The right to regulate is the ability of states to create and enforce laws necessary to protect public interests. It is a principle that reflects a fundamental aspect of state sovereignty: governments must retain the authority to respond to changing social and economic conditions.[6]
Investment law, however, creates obligations that restrict certain government actions affecting foreign investors. International investment agreements commonly provide protections such as fair and equitable treatment (FET), protection against unlawful expropriation, and non-discrimination. These protections aim to prevent arbitrary or unfair government conduct that could harm foreign investment.[7]
The challenge arises when legitimate regulation affects foreign investors’ economic interests. A government measure adopted for public welfare may reduce an investor’s expected profits, creating a potential conflict between regulatory authority and investment protection.[8]
Traditional ISDS mechanisms allowed investors to challenge state measures before international arbitration tribunals. While this system was designed to provide investors with neutral protection against state abuse, critics argued that certain interpretations of investment standards could give tribunals excessive influence over domestic policy decisions.[9]
This concern is often described as “regulatory chill.” Regulatory chill occurs when governments hesitate to enact public-interest regulations because they fear costly investor claims. Although the existence and extent of regulatory chill remain debated, the concern has influenced international efforts to reform investment dispute settlement.[10]
The European Union has therefore attempted to redesign investment protection mechanisms to ensure that investors receive legal protection while governments maintain sufficient regulatory freedom.[11]
EU ISDS Reform and Protection of Regulatory Autonomy
The European Union has been one of the strongest advocates for reforming traditional ISDS. Critics of the traditional arbitration model highlighted several concerns, including limited transparency, inconsistent interpretations by arbitral tribunals, and questions regarding the independence of arbitrators.[12]
In response, the European Union introduced the Investment Court System (ICS), first included in agreements such as the EU-Canada Comprehensive Economic and Trade Agreement (CETA). Unlike traditional ISDS, which relies on ad hoc arbitration tribunals, the ICS establishes a more permanent structure with appointed tribunal members, greater transparency requirements, and an appeal mechanism.[13]
These reforms aim to improve the legitimacy and predictability of investment dispute settlement. By creating a more judicial model, the EU sought to reduce concerns that private tribunals could interfere with states’ ability to regulate. The EU’s approach also explicitly recognises the right of governments to pursue legitimate public policy objectives.[14]
The relationship between investment arbitration and EU regulatory autonomy has also been examined by the Court of Justice of the European Union. In Achmea BV v Slovakia, the Court held that arbitration clauses in intra-EU bilateral investment treaties were incompatible with the autonomy of EU law.[15] The judgment reflected concerns that external dispute settlement mechanisms could undermine the EU legal order by allowing tribunals outside the EU judicial system to interpret EU law.[16]
The decision demonstrated the EU’s broader objective of ensuring that investment protection mechanisms remain compatible with its own constitutional principles. By restricting certain forms of intra-EU arbitration, the EU prioritised the authority of its legal system and its ability to regulate within its own framework.[17]
However, while EU reforms have addressed many criticisms of traditional ISDS, questions remain regarding whether they have completely resolved the tension between investor protection and regulatory autonomy. Investment protection standards, particularly fair and equitable treatment, continue to provide investors with opportunities to challenge state actions.[18] The interpretation of these standards will therefore remain central to determining the future relationship between investment protection and state regulation.
Has EU ISDS Reform Achieved the Necessary Balance?
EU ISDS reform represents a significant attempt to correct the weaknesses of traditional investor-state arbitration. Increased transparency, permanent decision-makers, and clearer procedures strengthen the legitimacy of the dispute settlement process.[19] These reforms reduce concerns that investment tribunals operate without sufficient accountability.
Furthermore, recognising the right to regulate within investment agreements provides greater assurance that governments can adopt measures for legitimate public purposes. This is particularly important in areas such as climate regulation, environmental protection, and public health, where governments must respond to evolving challenges.[20]
Nevertheless, reform has not eliminated the underlying tension between investor protection and state autonomy. The existence of investment protection standards means that disputes over government measures will continue to arise. If these standards are interpreted too broadly, investors may still challenge regulatory decisions that are adopted in good faith.[21]
Therefore, future development of EU investment law should focus on maintaining a clearer distinction between unfair government conduct and legitimate public regulation. Investment agreements should provide more precise definitions of investor protections while expressly confirming the authority of states to regulate in the public interest.[22]
The objective should not be to remove investor protection entirely. Foreign investors require legal certainty to encourage international economic cooperation. Instead, the goal should be a balanced system where investors are protected from arbitrary state action without preventing governments from fulfilling their responsibilities to society.[23]
Conclusion
Investor-State Dispute Settlement reform reflects the need to provide effective protection for foreign investors while preserving states’ ability to regulate in pursuit of legitimate public objectives. Investment protection remains essential for maintaining investor confidence and encouraging cross-border economic cooperation; however, such protection cannot operate in a way that prevents governments from responding to social, economic, and environmental challenges.
The European Union’s approach to ISDS reform shows a significant shift towards a more balanced investment framework. By improving transparency, institutional structure, and accountability, the EU has attempted to address concerns associated with traditional investor-state arbitration. These reforms represent an important recognition that investment law must not only protect economic interests but also respect states’ regulatory responsibilities.
Nevertheless, reform alone cannot eliminate the tension between investor rights and state authority. The effectiveness of the new framework will depend on how investment protection standards are interpreted and applied in practice. A system that protects investors from unfair treatment while allowing governments to adopt necessary public-interest measures is essential for the future legitimacy of international investment law.
Ultimately, the goal of investment law should not be to prioritise either investors or states, but to create a fair relationship between them. The right to regulate should be understood not as a limitation on investment protection, but as a necessary principle that ensures investment agreements serve broader societal interests. The EU’s reforms mark meaningful progress towards this balance, but continued efforts are required to develop an investment system that is both economically reliable and respectful of state sovereignty.
Reference(S):
[1] United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2024: Investment Facilitation and Digital Government (United Nations 2024).
[2] Convention on the Settlement of Investment Disputes between States and Nationals of Other States (opened for signature 18 March 1965, entered into force 14 October 1966) 575 UNTS 159, art 25.
[3] UNCTAD, Reforming Investment Dispute Settlement: A Stocktaking (United Nations 2019).
[4] OECD, International Investment Law: Understanding Concepts and Tracking Innovations (OECD Publishing 2008).
[5] European Commission, ‘Investment Protection and Investor-to-State Dispute Settlement in EU
[6] UNCTAD, Investment Policy Framework for Sustainable Development (United Nations 2015).
[7] Rudolf Dolzer, Christoph Schreuer and Ursula Kriebaum, Principles of International Investment Law (3rd edn, Oxford University Press 2022).
[8] Dolzer, Schreuer and Kriebaum (n 7).
[9] Gus Van Harten, Investment Treaty Arbitration and Public Law (Oxford University Press 2007).
[10] UNCTAD, Reforming Investment Dispute Settlement: A Stocktaking (United Nations 2019).
[11] European Commission, ‘Investment Protection and Investor-to-State Dispute Settlement in EU Agreements’.
[12] European Parliament Research Service, Investor-State Dispute Settlement (ISDS): State of Play and Prospects for Reform (European Parliament 2017).
[13] Comprehensive Economic and Trade Agreement between Canada and the European Union and its Member States (CETA), ch 8, s F.
[14] CETA, art 8.9.
[15] Slovak Republic v Achmea BV (Case C-284/16) EU:C:2018:158.
[16] ibid.
[17] ibid.
18 Dolzer, Schreuer and Kriebaum (n 7).
[19] CETA, arts 8.27–8.28.
[20] CETA, art 8.9.
[21] UNCTAD, Reforming Investment Dispute Settlement: A Stocktaking (United Nations 2019).
[22] UNCITRAL Working Group III, ‘Investor-State Dispute Settlement Reform’ (United Nations Commission on International Trade Law).
[23] Dolzer, Schreuer and Kriebaum (n 7).
