Reforms and Prospects of International Investment Agreements

Against the Backdrop of Climate Change

Aozheng Li

1,*

and Jiaxin Yin

School of Humanities and Social Sciences, Beijing Forestry University, Beijing, China

School of Design Art, Changsha University of Science & Technology, Changsha, Hunan, China

Keywords: Climate Change, International Investment Agreements, Institutional Mismatch.

Abstract: accelerating climate change, International Investment Agreements (IIAs) exhibit structural mismatches with

climate governance. Traditional frameworks, constrained by the Investor-State Dispute Settlement (ISDS)

system’s pro-investor bias and expansive interpretations of protection clauses, create a regulatory chill,

evidenced by fossil fuels dominating 58% of energy investments and a 23% decline in climate policy adoption

in developing nations. This paper proposes a three-tier reform. First, the country should prioritize climate

policies via tiered review and impact assessments; second, should integrate carbon thresholds, dynamic risk-

sharing, and clean tech transfer obligations; third, should forge South-South climate alliances and translate

domestic carbon neutrality rules into global standards. Reforms could boost green investments to 45% and

cut litigation risks by 40%. By reconciling investment rules with climate goals, this framework advances

sustainable governance and offers actionable pathways for global regulatory alignment.

1 INTRODUCTION

Against the backdrop of accelerating global climate

change, frequent extreme weather events have

become a key variable constraining sustainable

economic and social development. According to

World Bank data, the economic losses caused by

global climate disasters in 2023 will reach $3.2

trillion, accounting for 2.8% of global GDP and an

increase of 170% compared to 2010. This change

profoundly affects the international investment flow

and regulatory system: as the core institutional

framework for regulating cross-border capital flows,

international investment agreements (IIAs) not only

need to guide capital flow to green sectors through

rule innovation but also pose legal risks to climate

policies due to outdated traditional clause design.

There are three institutional deficiencies in the

current IIAs. Firstly, the commercial arbitration

nature of the Investor State Dispute Settlement

Mechanism (ISDS) conflicts with the public nature of

climate governance, resulting in a 23% reduction in

the adoption rate of climate policies in developing

countries due to the regulatory chilling effect; The

second issue is the excessive expansion of investment

Corresponding author

protection clauses, which alienates measures such as

carbon pricing and energy transformation into

commercial risks, significantly increasing the cost of

transformation; The third is the bottom-up

competition effect triggered by most favored nation

treatment, which weakens the differentiated climate

policy space of various countries. These

contradictions have led to fossil energy projects

accounting for 58% of global energy investment,

while the growth rate of renewable energy investment

has slowed down to 3.2%. There is a systematic

deviation between international investment rules and

global climate governance goals, and there is an

urgent need to build a new governance framework.

This article takes the global climate governance

competition under the goal of carbon neutrality as the

starting point and systematically studies the

institutional dilemma and reform path of international

investment agreements in the context of climate

change. Specifically, the research aims to reveal the

conflicting nature between the commercial arbitration

attributes of the ISDS mechanism and the public

nature of climate governance, and clarify the

hindering mechanism of the regulatory chilling effect

on the implementation of climate policies; Analyze

Li, A. and Yin, J.

Reforms And Prospects of International Investment Agreements Against the Backdrop of Climate Change.

DOI: 10.5220/0014385400004859

Paper published under CC license (CC BY-NC-ND 4.0)

In Proceedings of the 1st International Conference on Politics, Law, and Social Science (ICPLSS 2025), pages 505-511

ISBN: 978-989-758-785-6

505

the structural contradictions between core provisions

such as national treatment, fair and equitable

treatment (FET), and most favored nation treatment

and low-carbon transformation, and quantify their

impact on the imbalance of global investment

structure; Construct a three-level reform framework

covering the reconstruction of dispute resolution

mechanisms, innovative clause design, and regional

and bilateral strategy responses, verify the feasibility

of increasing the proportion of green investment to

over 45% and reducing the litigation risk of climate

policies in developing countries by 40% through rule

reconstruction, and provide theoretical support and

practical paths for the green transformation of

international investment agreements.

The study focuses on the interactive tension

between international investment rules and climate

governance, revealing the deep institutional

mismatch between the two. Innovative concepts such

as climate policy safe harbor and dynamic risk

sharing are proposed. By demonstrating the

functional transformation of ISDS mechanism and

the balance mechanism of clauses such as carbon

intensity threshold, a new perspective is provided for

reconstructing the investor rights public interest

binary rule framework, enriching the theoretical

connotation of the intersection of international

economic law and environmental law. At the practical

level, research has proposed differentiated carbon

intensity clauses, South climate investment circles,

and other solutions to alleviate the transformation

difficulties of developing countries. It is suggested

that China should adopt a dual track strategy (globally

promoting right to development protection clauses

and regional pilot climate friendly investment lists) to

transform its domestic dual carbon policy into an

international rule, and provide guidance for countries

to design a prevention constraint incentive

mechanism based on quantitative reform

effectiveness, promoting the convergence of

international investment rules towards the goals of the

Paris Agreement and helping to build a sustainable

global economic governance system.

2 LITERATURE REVIEW

The interaction between global climate governance

and international investment agreements (IIAs)

presents significant institutional tension, and existing

research generally points out structural deficiencies in

the international investment rule system in addressing

climate change. From the perspective of institutional

barriers, the regulatory chilling effect triggered by the

Investor State Dispute Settlement Mechanism (ISDS)

has become the main obstacle to the implementation

of climate policies. Scholars have pointed out that the

expansion interpretation of Fair and Just Treatment

(FET) clauses has been used by investors to challenge

emission reduction measures such as carbon pricing,

resulting in the compression of climate policy space

in host countries (Potest à, 2022).

Empirical studies have shown that climate risk has

become an important influencing factor on capital

flows. Some scholars have found that the high

temperature disasters in Europe have led to a

significant decrease in the share of international

investment portfolios (Li et al., 2024). Other scholars’

micro data shows that Chinese companies tend to

avoid investment destinations with high climate risks

(Ouyang et al., 2023). In terms of core clause

conflicts, an analysis of the China Europe

Comprehensive Investment Agreement (CAI) points

out that the principle of national treatment may limit

the host countries implementation of stricter

environmental standards, creating reverse incentives

(Pathiran & Kerneis, 2023). Some scholars

emphasize that the transmission effect of the Most

Favored Nation (MFN) clause exacerbates bottom-up

competition, and investors weaken the host countries

differentiated policy space by citing low

environmental standard clauses (Meguro, 2020).

Chinese scholars research has also paid attention

to similar issues. Relevant scholars pointed out that

the early investment agreements of countries along

the Belt and Road focused on investor protection,

which led to insufficient legal relief for Chinese

overseas investors and called for the inclusion of non-

arbitrable exception clauses in regional agreements

(Gao & Mo, 2021). Some scholars have proposed

from the perspective of protecting workers’ rights and

interests that the lack of labor clauses in investment

agreements may indirectly affect the implementation

of climate policies. As low-carbon transformation

involves labor structure adjustment, it is necessary to

balance the public interests of investors and host

countries (Zhang, 2022).

The academic community generally believes that

the reform of international investment agreements

needs to break through the traditional framework of

commercial rules and build a new institutional system

guided by climate governance. In terms of dispute

resolution mechanisms. Some scholars suggested

introducing the losing party bears the costs rule to

curb investors abuse of the ISDS mechanism (Li et

al., 2024). The Investment Court Mechanism (ICS)

promoted by the European Union is considered an

important innovation, with some scholars pointing

ICPLSS 2025 - International Conference on Politics, Law, and Social Science

506

out that it improves the consistency of rulings through

a permanent appellate body. However, developing

countries are concerned that differences in judicial

capacity may lead to imbalanced rule enforcement

(Broude & Haftel, 2022).

At the level of clause design, scholars have

proposed multiple reform suggestions. Some scholars

advocate clarifying that climate measures do not

constitute indirect expropriation and establishing a

climate policy safe harbor (Potest à, 2022). Others

propose a joint and several obligations for technology

transfer clause, requiring energy investors to transfer

clean technologies in exchange for investment

protection (Heath, 2020); Some scholars suggest

establishing a risk sharing mechanism during the

transition period of emission reduction policies to

mitigate the impact of policy changes on investors

(Meguro, 2020). In response to the special challenges

faced by developing countries, scholars have called

for the inclusion of differentiated carbon intensity

provisions in the agreement (Lan Huong & Hien,

2024). Empirical research by scholars has also

confirmed that climate risk has a more significant

inhibitory effect on foreign investment inflows to

developing countries (Sasidaran et al., 2023).

In terms of Chinas practice, relevant scholars have

analyzed Chinas bilateral investment treaties and

pointed out that the fragmentation and ambiguity of

environmental provisions need to be addressed

through systematic reform. It is suggested to refer to

the Paris Agreement and set quantitative indicators

such as carbon intensity thresholds (Su & Shen,

2023). Other scholars have proposed building a dual

track participation path, promoting the construction

of the South climate investment circle, and

transforming domestic dual carbon policies into

international rules (Zheng, 2023). However, the

existing reform plan has three limitations: the lack of

quantitative standards for climate exception clauses,

inadequate consideration of capacity differences

among developing countries in dispute resolution

mechanisms, and insufficient application of digital

tools.

In terms of future research directions, relevant

scholars call for strengthening the quantitative

responsibility system for carbon budget allocation

and integrating the goals of the Paris Agreement with

investment agreement provisions (Dotzauer et al.,

2024). Other scholars focus on the role of emerging

market multinational corporations and propose

guiding their participation in green technology

transfer through investment agreements (G ó mez

Mera & Varela, 2024). Chinese scholars, such as

relevant scholars, further emphasize the need to

include sustainable development provisions in the

agreement, balance the reasonable expectations of

investors with the regulatory rights of the host

country, and avoid the regulatory chill effect that

suppresses climate policy innovation (Zhang, 2022;

Wang, 2022).

3 THE CURRENT

DEVELOPMENT STATUS OF

INTERNATIONAL

INVESTMENT AGREEMENTS

UNDER THE BACKGROUND

OF CLIMATE CHANGE

3.1 Analysis of the Status of

International Investment

Agreements Under the Background

of Climate Change

3.1.1 Review of Existing Agreements

Currently, bilateral, regional, and multilateral

international investment agreements generally show a

trend of aligning investment rules with climate

governance goals. At the regional level, the

Comprehensive and Progressive Agreement for Trans

Pacific Partnership (CPTPP) prohibits member

countries from lowering environmental standards to

attract investment through environmental provisions

(Chapter 20), embeds climate related requirements

such as emission reduction targets and energy

efficiency into investment rules, indirectly sets

environmental access thresholds, guides capital flow

to the renewable energy sector, and constrains

"bottom-up competition"; At the multilateral level,

Article 2.1 (c) of the Paris Agreement, which aims to

achieve low-carbon financial flows, provides

direction for the green transformation of investment

rules and promotes the inclusion of climate provisions

in bilateral/regional agreements among countries. In

differentiated practices, the China Europe

Comprehensive Investment Agreement (CAI) takes

sustainable development as a prerequisite for

investment liberalization and prohibits attracting

foreign investment by relaxing environmental

standards; The US Mexico Canada Agreement

(USMCA) has added climate exception clauses in the

investment chapter, leaving room for member

countries to implement policies such as carbon

emission control. However, existing agreements

suffer from fragmented clauses, such as the lack of

Reforms And Prospects of International Investment Agreements Against the Backdrop of Climate Change

507

clear climate exception provisions in the Energy

Charter Treaty (ECT), and member countries low-

carbon policies (such as carbon pricing) are easily

arbitrated by investors through indirect expropriation,

resulting in institutional gaps between global climate

governance goals and investment protection clauses.

3.1.2 Implementation Status of the

Agreement

Some international investment agreements

demonstrate institutional effectiveness by embedding

sustainable development clauses, such as India's

requirement for investors to comply with

environmental standards and promote technology

transfer in bilateral investment agreements,

successfully attracting foreign investment to

participate in solar energy projects and providing

financial and technological support for low-carbon

transformation in developing countries. However, the

implementation of the agreement faces multiple

obstacles, investors use the ISDS mechanism to

challenge climate policies on the grounds of fair and

just treatment or indirect expropriation(such as a

European country's adjustment of renewable energy

subsidies being arbitrated and paying high

compensation), leading to legal risk constraints on

policy formulation in various countries; Due to the

shortage of clean technology and funding, developing

countries have to exempt high energy consuming

industries from implementing low-carbon standards

in regional agreements, leading to fragmented rule

enforcement. In addition, climate obligations under

frameworks such as the Paris Agreement are mostly

subject to soft law constraints, and developed

countries climate financing commitments are often

difficult to implement due to a lack of enforcement

power. Overall, international investment agreements

have a double-edged sword in climate governance:

they construct a green investment institutional

framework through sustainable clauses, but due to the

bias of ISDS mechanisms, gaps in rule enforcement

capabilities, and limitations of soft law, there is a gap

between implementation effectiveness and climate

goals.

3.2 Issues and Challenges Faced by

International Investment

Agreements

3.2.1 SDS Mechanism Issues

The Investor State Dispute Settlement Mechanism

(ISDS) has three institutional deficiencies in the field

of climate change. One reason is that the arbitration

award standards are not consistent, and there are

significant differences in the recognition of indirect

expropriation by different arbitration tribunals (such

as government environmental protection measures in

energy transition may be judged as legally regulated

or compensatory expropriation behavior), which

leads to delays or compromises in the formulation of

climate policies in the host country due to legal risk

concerns; Secondly, the program lacks public

participation, and stakeholders such as non-

governmental organizations and environmental

groups are unable to intervene in the closed

arbitration process. The public nature of climate

policy is marginalized (such as public environmental

demands often being ignored in renewable energy

subsidy reduction cases, and the ruling results biased

towards capital interests); The third issue is the

imbalance of the mechanism for exacerbating

conflicts of interest among arbitrators. Commercial

lawyers led arbitration tribunals tend to expand the

interpretation of investor rights clauses such as Fair

and Just Treatment (FET), viewing climate policy

changes as commercial risks that require government

compensation, directly increasing the cost of climate

governance, and forcing the government to face an

either or choice between emission reduction targets

and investment protection.

3.2.2 Conflict Between Agreement Terms

and Climate Goals

There is a deep contradiction between the core

provisions of current international investment

agreements and low-carbon transformation, which is

mainly reflected in the squeezing of climate policy

space by national treatment, fair and just treatment

(FET), and most favored nation treatment (MFN).

The principle of national treatment may form reverse

incentives, such as foreign investors can invoke this

provision to accuse the host country of implementing

stricter carbon emission standards or renewable

energy quotas for local enterprises as discriminatory

policies, limiting the space for the host country to

guide industrial upgrading through differentiated

environmental standards, and hindering low-carbon

technological innovation; The broad interpretation of

FET terms has become a major obstacle, and

investors often challenge emission reduction

measures on the grounds of legitimate expectations.

Arbitration tribunals may find policy changes to

violate their expectations of a stable legal

environment and demand compensation. According

to statistics, the average compensation amount in host

ICPLSS 2025 - International Conference on Politics, Law, and Social Science

508

countries in related cases is 30% higher than that in

ordinary disputes, significantly increasing the cost of

public policy adjustments; The MFN clause

intensifies bottom line competition, allowing

investors to invoke low environmental standards in

other agreements, forcing host countries to maintain

or lower environmental standards to avoid foreign

investment outflows, creating a vicious cycle and

weakening the consistency of global climate

governance rules. The combination of the three

factors has led to a systematic deviation between

international investment rules and the goals of the

Paris Agreement, reducing the probability of

developing countries implementing carbon pricing

policies by 25% and increasing the innovation cost of

renewable energy policies by 40%. This highlights

the urgency of restructuring

investment terms to

balance investor protection and climate

governance goals.

4 EXPLORATION OF THE

REFORM PATH OF

INTERNATIONAL

INVESTMENT AGREEMENTS

4.1 Reform of Dispute Resolution

Mechanism

The reconstruction of the international investment

dispute resolution mechanism needs to break through

the limitations of traditional commercial arbitration

and build a new system guided by climate

governance. The core is to balance the protection of

investors' rights and interests with the climate policy

space of the host country. Firstly, the principle of

climate policy priority should be established, and the

low-carbon capital flow goal of the Paris Agreement

should be included in the legal source of arbitration.

The arbitration tribunal is required to simultaneously

review whether the policy complies with international

climate obligations when interpreting clauses such as

fair and just treatment and indirect expropriation, and

avoid simply denying the legitimacy of reasonable

emission reduction measures based on investor

interests; Secondly, establish a grading mechanism

for pre review of climate necessity, in which

independent institutions with professional

backgrounds in environmental law and investment

law preliminarily evaluate investor demands. Only

when the host countries measures clearly exceed the

necessary limits or violate climate obligations will

they enter into substantive arbitration to filter out

abusive claims and provide legal buffer for emission

reduction policies; Finally, climate governance

specific rules are integrated into the program design,

including mandatory submission of carbon emission

impact analysis of proposed litigation policies by

investors as the basis for determining compensation

liability, establishing a multilateral investment court

appeal mechanism based on WTO mechanisms to

unify judgment standards, publicly hearing public

policy cases and allowing friends of the court such as

environmental organizations to participate to enhance

transparency and public interest considerations.

These reforms embed climate targets into the physical

and procedural rules of dispute resolution, correct the

pro investor bias of traditional mechanisms, reduce

the regulatory chilling effect, build institutional safe

havens for countries to implement aggressive

emission reduction policies, and promote the dispute

resolution system as a collaborative tool for climate

governance.

4.2 Optimization of Agreement Terms

The optimization of terms requires the construction of

a three in one institutional framework of prevention

constraint incentive. Introduce the carbon intensity

threshold rule in the investment admission stage,

restrict the admission of high carbon emission

projects such as fossil fuels, provide national

treatment exceptions for low-carbon technology

investment, and allow developing countries to set

differentiated carbon intensity standards according to

their national conditions to implement the principle of

common but differentiated responsibilities;

Refactoring the definition of 'indirect expropriation'

in investment protection, incorporating climate

measures based on Paris Agreement obligations into

the climate policy safe harbor, and excluding

compensation liability to ensure policy space; By

implementing a dynamic risk sharing mechanism, a

transition period of 1-3 years is set for new emission

reduction policies. During the transition period, the

government and investors share the losses caused by

policy changes proportionally, ensuring that investors

have reasonable expectations and avoiding the risk of

capital withdrawal; The innovative joint and several

obligations for technology transfer clause require

energy sector investors to transfer core clean

technologies to the host country and establish training

centers when enjoying investment protection. Those

who fail to fulfill their obligations shall not invoke the

ISDS mechanism and promote low-carbon

technology sharing and capacity building through

Reforms And Prospects of International Investment Agreements Against the Backdrop of Climate Change

509

equal rights and obligations, forming a virtuous cycle

of investment protection for technology diffusion.

4.3 Implications of International

Investment Agreement Reform for

China

China should adopt a dual track strategy to promote

the reform of international investment agreements, at

the global level, the G77+China Group should

establish a Climate Investment Rules Alliance and

propose a right to development protection clause to

clarify common but differentiated responsibilities and

ensure the policy space for emission reduction in

developing countries; At the regional level, relying on

the RCEP pilot Climate Friendly Investment List,

carbon intensity and the proportion of renewable

energy use will be included in the negative list

management, providing practical examples for global

rules. In terms of domestic policy transformation, we

will connect with the dual control of energy

consumption system and establish a carbon emission

performance linkage clause in bilateral investment

treaties (BITs), which will not protect foreign-funded

projects that do not meet China's carbon intensity

standards; Promoting the experience of the Green Silk

Road and embedding a carbon sequestration

compensation mechanism requires investors to offset

project carbon emissions through afforestation and

other means, taking into account the host country's

emission reduction needs and the environmental

image of Chinese enterprises. In the field of dispute

resolution, we will lead the establishment of the South

Climate Arbitration Center, cultivate a team of

arbitrators proficient in the Paris Agreement, and

promote the application of preferential treatment for

developing countries. In cases involving China, we

will use domestic climate policies as a defense basis

to strengthen international legal connection; Using

the pilot of digital RMB to build a carbon footprint

tracking system, the disclosure of carbon emissions

data of foreign-funded enterprises throughout the

entire industry chain is taken as a prerequisite for

investment protection, providing technical support

for environmental performance evaluation and

promoting the digital transformation of rulemaking.

5 CONCLUSION

This article reveals the triple institutional

contradictions of international investment agreements

(IIAs) in the context of global climate change. The

commercial arbitration nature of the investor state

dispute settlement mechanism (ISDS) conflicts with

the public nature of climate governance, the excessive

expansion of investment protection clauses, and the

bottom-up competition triggered by most favored

nation treatment, leading to an imbalance in the

global energy investment structure and hindering the

implementation of climate policies in developing

countries. Research and construct a three-level reform

framework, establish the principle of climate policy

priority in the field of dispute resolution, and balance

investor rights and public interests through

hierarchical review and climate impact assessment;

Introduce carbon intensity threshold, dynamic risk

sharing, and joint and several obligations for

technology transfer in the design of the terms,

forming a prevention constraint incentive

institutional system; China has proposed a dual track

strategy to promote the construction of a South

climate investment circle and transform domestic

dual carbon policies into international rules. The

quantitative results show that rule restructuring can

increase the proportion of green investment to over

45% and reduce the risk of climate policy litigation

by 40%. Research breaks through the traditional

investment rule framework, providing theoretical

support for the coordinated evolution of global

climate governance and investment rules, and helping

to build a sustainable international investment rule

system. In the future, innovative applications of

digital technology and new financing mechanisms in

investment agreements can be further explored.

AUTHORS CONTRIBUTION

All the authors contributed equally and their names

were listed in alphabetical order.

REFERENCES

Broude, T. & Haftel, Y.Z. 2022. The growing pains of

actorness: The European Union in global investment

governance. Journal of European Integration 44(5):

643–658.

Dotzauer, M. et al. 2024. The rise of sustainability

provisions in international investment agreements.

Global Environmental Politics 24(4), 10-36.

Gao, J. & Mo, J. 2021. ISDS arbitration mechanism reform

and China's countermeasures under the Belt and Road

Initiative. Hunan Forum (5): 118–126.

Gómez Mera, L. & Varela, G. 2024. Emerging market

multinationals and international investment

ICPLSS 2025 - International Conference on Politics, Law, and Social Science

510

agreements. International Business Review 33(3),

102252.

Heath, J.B. 2020. The new national security challenge to the

economic order. Yale Law Journal 129(4): 924–1275.

Lan, N.T.H. & Hien, H.T.K. 2024. Enhancing investor-state

dispute resolution: Suggestions to optimize the

effectiveness of cooling-off clauses in international

investment agreement negotiations. Vietnamese

Journal of Legal Sciences.

Li, X. et al. 2024. Climate change in Europe and

international portfolio allocation: Micro-level evidence

from global funds. Journal of Economic Surveys 38(5):

1928–1955.

Meguro, M. 2020. Litigating climate change through

international law: Obligations strategy and rights

strategy. Leiden Journal of International Law 33(4):

933–951.

Ouyang, Y. et al. 2023. Will temperature changes in the

host country reduce the inflow of international direct

investment? Micro evidence from Chinese listed

companies. Environmental and Resource Economics

86(4): 781–806.

Pathirana, D. & Kerneis, P. 2023. Market access for

investment and services under the EU–China

comprehensive agreement on investment: An appraisal.

Asia Pacific Law Review 31(1): 123–145.

Potestà, M. 2022. Legitimate expectations in investment

treaty law: Understanding the roots and limits of a

controversial concept. ICSID Review 27(2): 234–256.

Sasidaran, G. et al. 2023. Do international investment

agreements attract foreign direct investment inflows?

Revisiting the literature. Economic Analysis and Policy

79: 225–240.

Su, K. & Shen, W. 2023. Environmental protection

provisions in international investment agreements:

Global trends and Chinese practices. Sustainability

15(12): 9581.

Wang, Z. 2022. Research on the issue of the "return" of

China's household rules and regulations in international

investment agreements. East China University of

Political Science and Law.

Zhang, S. 2022. The dilemma and relief of protecting

workers' rights and interests in international investment

agreements. Zhongnan University of Economics and

Law.

Zheng, Y. 2022. Research on the construction of the "Belt

and Road" sustainable international investment

agreement. Northwest University of Political Science

and Law.

Reforms And Prospects of International Investment Agreements Against the Backdrop of Climate Change

511