Are carbon emissions allowances traded across borders protected investments? According to the Tribunal in Koch Industries, Inc. and Koch Supply & Trading v. Canada,[1] international carbon market investors seeking investment protection should look first to the law of the host state to ensure that carbon credits are a recognized form of property under the domestic regime.  In an Award rendered on 13 March 2024, a NAFTA tribunal dismissed a US$30 million claim by US conglomerate Koch Industries against Canada in respect of its acquisition of carbon credits under Ontario’s cancelled cap-and-trade system, finding that the allowances did not constitute “property” under Ontario law.

An Emissions Trading System (ETS) or, a “cap-and-trade” system, is a climate policy tool which aims to create cost-effective greenhouse gas (GHG) emissions reductions within a given territory. Today, ETS are the principal mechanism used by states to meet their international climate mitigation commitments or “Nationally Determined Contributions” (NDCs) under the Paris Agreement.  The majority of jurisdictions with an ETS in operation have expressed an interest in linking with other systems in order to reap the benefits of an enlarged carbon market.

The linking of carbon markets raises complex questions about the applicable legal framework governing the trade of carbon credits across borders.  This concern is heightened for international participants seeking legal protection from the regulatory risk that may result from the charged political landscape in which domestic climate policy operates.  As recently seen in Ontario, a change in government can lead to the complete reversal of climate policy.  In 2017 the Ontario Liberal government launched an ETS, which it linked with California and Quebec in early 2018.  Shortly thereafter, Ontario held elections which were won by the Progressive Conservative Party.  The newly elected Premier, Doug Ford, swiftly terminated the California-Quebec-Ontario linking agreement, revoked Ontario’s cap-and-trade system, and prohibited the trading of emissions allowances.[2]

In December 2020, Koch Industries (Koch), a US conglomerate and a market participant in Ontario’s cap-and-trade program, initiated arbitration proceedings against Canada under NAFTA.  Koch had purchased USD 30 million worth of emission allowances at Ontario auctions prior to the program’s cancellation, which it planned to move into its California account.  After several of Koch’s requests for compensation were denied, Koch launched arbitration proceedings on the ground that the cancellation and de-linking of the Ontario ETS without compensation amounted to unlawful expropriation and violated NAFTA’s minimum standard of treatment.  Canada objected to the Tribunal’s jurisdiction on the ground, inter alia, that the Claimants did not hold protected investments under NAFTA Articles 1139(g) and 1139(h).  Article 1139(g) defines an investment as “real estate or other property, tangible or intangible, acquired in the expectation or used for the purpose of economic benefit or other business purposes”.  Article 1139(h) requires an investor to hold “interests arising from the commitment of capital or other resources” in Canada.

In an Award dated 13 March 2024, the Tribunal dismissed all claims for want of jurisdiction.  The question of jurisdiction turned primarily on two issues: first, whether carbon emissions allowances constituted “property” under the law of the host state – in this case Ontario; and second, whether the emissions allowances and carbon trading business constituted “interests” arising from the commitment of capital in Ontario.

On the first issue, the analysis proved to be challenging due to the novel nature of the enquiry and the lack of direction from both the Ontario legislature and the Courts on the question of whether emissions allowances are a recognised form of property.  In the absence of direct applicable law, the Tribunal heard evidence on the interpretive approach an Ontario Court would likely take for novel claims of intangible property.

The Tribunal examined the relevant Canadian case law and the purpose of the Act, which gave the government considerable power over the participants’ right to use and control the allowances.  Taking all of these factors into consideration, it determined on balance, that emissions allowances did not constitute “property” under Ontario law because they lacked the requisite element of “exclusive control”.  Of note is the Tribunal’s treatment of foreign case law, including the leading English High Court decision in Armstrong v Winning Networks Ltd where the Court held that EU emissions allowances have proprietary status.[3]  While conceding that a Canadian Court would likely take the Armstrong case into account, the Tribunal distinguished the approach of the Ontario Courts and declined to follow it.

On the second issue, the Tribunal determined that emissions allowances were not covered “interests” under Article 1139(h), because they did not grant the Claimants a legal share in any asset or resource.  Nor, it held, could the US based carbon trading business be construed as a commitment of capital to economic activity in Ontario.  Citing the decision of the Tribunal in Apotex Inc. v. United States of America,[4] the Tribunal determined that the Claimants’ activity was based on cross-border trade between California and Ontario, which several NAFTA tribunals have found not to be protected by Article 1139(h).

The Tribunal, having found that emissions allowances did not meet the definition of property under Article 1139(g), nor did they qualify as “interests” under 1139(h), resolved that it did not have jurisdiction ratione materiae over the Claimants’ purported investment.

As the first decision on the novel issue of whether carbon credits constitute protected investments under international investment law, the Award in Koch has been anticipated for the clarity it would provide to policymakers, investors and practitioners alike.  The Koch Tribunal’s analysis of whether carbon credits constitute protected “investments” under NAFTA provides valuable guidance on the appropriate preliminary analysis that should be undertaken by investors hoping to rely on the investment law regime and Investor-State Dispute Settlement (ISDS) to protect against the regulatory and political risks inherent in cross-border carbon trading.

[1] Koch Industries, Inc. and Koch Supply & Trading v Canada (ICSID Case No. ARB/20/52)

[2] O. Reg. 386/18, s. 2 PROHIBITION AGAINST THE PURCHASE, SALE AND OTHER DEALINGS WITH EMISSION ALLOWANCES AND CREDITS (July 3 2018)

[3] Armstrong DLW GmbH v. Winnington Networks Ltd. [2012] EWHC 10

[4] Apotex Holdings Inc. and Apotex Inc. v. United States of America, ICSID Case No. ARB(AF)/12/1

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Jessica Crow is an independent arbitrator with Arbitra International, an academic in climate and environmental law at the University of Cambridge and a Fellow in climate governance at the World Economic Forum.  Jessica is an expert in the law and governance of the energy transition, climate change and environmental law.