Country and sustainability risk mitigation: a briefing for energy and mining investors

Once the revenue potential of an energy or mining project is assured, governments may begin taking steps for partial or complete nationalisation. This may be accompanied by allegations that multinational firms have gained an unreasonable share of revenues from national strategic resources or performed poorly with respect to ESG factors. Allegations regarding the ESG performance of the government itself also may have a material impact on the cost of capital, continued operations or financial performance of energy and mining investments.

This trend is affecting countries that have attracted investors in renewable energy, minerals and rare earth materials in recent years. It therefore threatens efforts to develop renewable energy infrastructure and supplies of the minerals that are required to power electric vehicles. It is also affecting countries that are stumbling on the road to sustainable and inclusive development. This may have the perverse effect of chilling investment by ESG-conscious foreign investors in those countries’ energy and mining sectors. It follows that the trend has the potential to affect the fortunes of many companies and people, and prospects for a timely transition to a sustainable global economy.

What is country and sustainability risk?

Governments around the world are asserting greater control over strategic extractive resources and associated revenue streams. They are doing this for ideological reasons, to augment national budgets, sustain their hold on power, or respond to demands of local populations for redistribution of national wealth. The trend is particularly pronounced in countries that lack strong environmental, social and anti-corruption laws, stable legislative systems, transparent judicial systems, diversified economies and effective protections for indigenous peoples in mineral rich areas.  Covid-19 has also given impetus to this trend by triggering social unrest and toppling governments in favour of regimes willing to disrupt arrangements with foreign investors.

Growing international competition over renewable energy and scarce minerals may exacerbate the trend towards country and sustainability risk. Steps towards nationalisation tend to appear during elections, periods of rising populism, or environmental or social protests by distressed nationals from resource-rich regions. Host governments and activists easily weaponise the message on social media, and are heard by home-State investors, regulators and courts interested in the ESG performance of multinational companies.

Allen & Overy is closely following the surge in political and ESG risk facing foreign energy and mining investors around the world, including in Latin America, Africa, and Asia and the Pacific.

Please contact us for information about the emerging country and sustainability risks in the specific countries where you operate or invest in the energy or mining sectors.  We also closely track the regulatory and litigation risks that are emerging in the home-countries of energy and mining investors – domestic legal frameworks which increasingly apply to companies’ operations and value chains globally.

What can be done to mitigate the risk?

Energy and mining investors already understand that they work in challenging environments. Strategic resource opportunities are rare and usually cannot be recreated in other jurisdictions, limiting the ability of investors to exit to seek opportunities in countries with better performing or more compliant governments. Extractive industries also involve capital-intensive projects that must be sold or written off should a foreign owner break with a host country.

Heightened interest in ESG from investors, regulators and claimants and easier access to information about events around the world, mean that companies are more sensitive than ever before to allegations regarding their own ESG performance or their association with governments that fail to respect and protect human rights or the environment.

While it is difficult for external investors to thwart resource nationalism or improve the ESG performance of host-country governments, several powerful tools are available to mitigate the risks associated with this trend. Energy and mining investors in emerging markets need to act now to deploy these tools and mitigate the risks they face as they pursue the opportunities presented by the transition to a sustainable global economy.

When investing in countries where the rule of law is not well-established, and regulatory frameworks are weak and unstable, foreign energy and mining and metals investors should:

Structure investments so that they enjoy the protection of bilateral investment treaties and international investment agreements.

Direct and indirect investors, including those who provide project finance, may be able to obtain treaty protection. Treaties ordinarily contain guarantees against arbitrary government treatment and of due process in judicial and administrative proceedings throughout the lifecycle of investments. Protected investors usually may bring arbitration proceedings directly against a host State government in respect of disputes that amount to breaches of investment protections. This allows investors to put pressure on governments and potentially bring them to the negotiating table to dissuade them from taking serious adverse actions, or pursue remedies, including for damages, before neutral, international tribunals. Investment treaties also may be deployed to deter governments from backtracking on commitments they have made to investors that align with the Paris Agreement aims and the UN Sustainable Development Goals, or seek damages where such backtracking causes them damage.

Deploy available ESG risk management tools, and identify and resolve brewing ESG related disputes with host-State communities and governments as soon as they arise.

Companies that comply with the legal and normative ESG frameworks that apply to their industries (based not only on domestic law, but also on international principles of responsible business conduct that refer to international law) are less likely to get into ESG related disputes. There are also best practice ESG standards for undertaking projects and for navigating emerging disputes about ESG issues (such as impacts on the environment or human rights, or failures to maintain social or legal licenses to operate), including how to provide redress and establish and operate effective operational level grievance systems to avoid disputes giving rise to litigation or arbitration. Where disputes do arise, mitigation strategies can be deployed within dispute resolution processes (such as certain claims, defences and counterclaims, creative settlements).

Maintain a close watch on local political and economic developments, and engage with them pro-actively and constructively.

Companies that understand local conditions, politics, and culture, and engage with local communities and address their ESG-related concerns, are less likely to become the primary targets of extreme populist and nationalist fervour. Emerging economies can be expected to impose periodic increases in environmental and social standards, taxes, fees, royalties, local content mandates, requirements for local social investments, and gradual reductions on foreign ownership in favour of local nationals or state organizations. However, they are only likely to nationalise industries or make wholesale changes to regulatory frameworks, with all of the attendant reputational and financial damage such actions entail, when they can write a strong narrative about exploitation by or the poor ESG performance of target companies, and thereby garner public support.

How Allen & Overy’s ESG Disputes Team can help

Country and sustainability risk will remain a significant factor in investment decisions involving high-value extractive resource projects. However, even the best risk assessment cannot predict host governments’ political and economic decisions well into the future, particularly in emerging economies. To work through the inevitable demands of investing in the sustainability transition, investors need a robust team of international lawyers to provide advice on investment protection, ESG risk mitigation and international dispute resolution, with sensitivity to local law, politics, and culture.

Allen & Overy’s ESG Disputes Team is comprised of marketing leading international lawyers who practice in these areas globally. We have extensive experience with the energy and mining sectors, and frequently work alongside our transactional colleagues as they provide legal support to projects from pit or well to port and beyond. We also provide standalone advice and dispute resolution services.

Investment protection and arbitration services

We work with energy and mining investors on structuring their investments to take advantage of the protections offered by investment treaties and to represent them in complex investment treaty arbitrations. We offer the insight of top investment protection practitioners, including the former Chief of Investment Arbitration of the United States, who are particularly attuned to the legal, political, and economic developments in the home and host countries of investors in the energy and mining sectors. We have a deep bench of experienced public international lawyers trained in both the civil and common law, and with diverse backgrounds and language skills.

We have resolved disputes throughout the world arising from whole or partial nationalisations of energy or mining industry assets. This includes disputes involving retroactive regulatory changes in the energy sector (such as cases against Spain under the Energy Charter Treaty), and cases involving claims of poor ESG performance by investors or host-State governments.

Sustainability risk advisory and disputes services

We also advise energy and mining investors on compliance with the legal and normative ESG frameworks that apply to their businesses. Our experienced international human rights and environmental law practitioners also go beyond compliance to help our clients engage meaningfully with the substantive human rights and environmental issues that affect their stakeholders and their businesses. This includes providing advice on the most sensitive ESG related issues, including relationships with security forces and indigenous peoples, operations in conflict affected and disputed territories, and claims of forced or child labour in mining operations or value chains.

We regularly advise on due diligence, investigations and remedy processes with respect to human rights and environmental impacts. We also represent energy and mining companies in ESG related cross-border disputes, including transnational litigation before home-country courts; OECD National Contact Point Special Instances; submissions to United Nations bodies and regional human rights courts; and in regulatory, sanctions, import control and criminal law matters.