Briefing

November 01 2022

The Energy Transition: Recent developments in trade and competition law – What you need to know

We recently gathered a group of experts from Freshfields and Frontier Economics to share insights into competition and trade developments relating to the energy transition. Here are some of the key ideas discussed during the event:

Introduction

Tom McGrath, Partner in the Freshfields (London) Antitrust, Competition and Trade team

Legislators across Europe agree that urgent action is needed to fight climate change, but there is often an uneasy relationship between sustainability objectives and antitrust rules. This raises the important question of how companies can mitigate antitrust risk in practice. The legal framework for unlocking public financial support (e.g., subsidies) is key to enabling institutional investors and the private sector to mobilise investment with a sustainable impact. It will also be important to consider international trade law and the impact of carbon taxes, subsidies for green energy and local content requirements.

Antitrust: Legal Framework

Sarah Jensen, Counsel in the Freshfields (London) Antitrust, Competition and Trade team

Key takeaways:

• Green collaborations modelled on accepted principles based on the latest available guidance, or a framework approved by a competition authority are likely to be more easily defensible from a competition law perspective. In this rapidly developing area, ESG and commercial colleagues should align with antitrust counsel in designing and implementing sustainability projects.

• Implement ring-fencing measures (e.g., clean teams, NDAs) where appropriate, coupled with antitrust training, to manage the risk of illegal information exchange.

Companies are coming under increased pressure to accelerate their efforts to effect real change. One way of achieving this is through collective action or industry collaborations. The obvious brake on such collaborations is competition law. Penalties for antitrust infringements can be very high – and can include significant financial penalties, damages litigation, individual sanctions (civil and criminal) and reputational damage. For example, in July 2021, the European Commission imposed a $875m fine on auto manufacturers for alleged collusion in the development of certain aspects of emission cleaning technology for new diesel cars.

Several European authorities have indicated that they will take an open and flexible approach to legitimate ESG initiatives. However, with the arguable exception of Austria, which has specifically included sustainability in its legislation as an example of when benefits for consumers might outweigh a restrictive effect, most authorities are responding to the need for increased legal certainty by publishing guidance on how businesses should self-assess their arrangements and by offering individual guidance on specific cases when appropriate. Many stakeholders welcomed the new chapter dedicated to sustainability agreements in the European Commission’s updated draft guidelines for horizontal cooperation agreements, but there remains a need for greater clarity on several issues, such as:

• the line between impermissible collective action and unilateral action in pursuit of a goal which each company has unilaterally chosen to follow;
• the potential conflict between the Commission’s view - that where there is demand for sustainable products, co-operation is not indispensable, but consumers must be willing to pay more for sustainable products in order to demonstrate that they value the product and are receiving a fair share of the benefits; and
• how companies should evidence consumers’ willingness to pay in practice.

The Competition and Markets Authority (CMA) has set up a Sustainability Taskforce which is engaging with stakeholders to develop guidelines in the UK and is offering to provide informal advice to businesses, when appropriate. Most authorities have reported, however, that not many companies are coming forward with cases in practice.

For sustainability agreements with a restrictive effect, the parties need to demonstrate that the arrangement results in sustainability benefits which outweigh any negative effects to consumers and in particular that: the agreement produces clear, objective benefits; collaboration is essential to achieving those benefits; consumers receive a fair share of the benefits; and competition between the parties is not eliminated. Doing so involves companies working hard to gather supporting evidence, ensuring full transparency, and strictly limiting any restrictive elements to what is absolutely necessary to achieve the stated goals.

Antitrust: Economic Assessment and Evidence

David Foster, Director at Frontier Economics

Key takeaways:

Maintain a helpful evidence bank from the start. Clearly articulate green objectives, reasons for the green collaboration and precisely quantify environmental and other benefits for consumers.

From an economics standpoint, companies must consider how they evidence that the relevant legal criteria are satisfied. This means putting forward compelling economic evidence to quantify the sustainability benefits from any cooperation. However, quantification alone is not enough. Competition authorities will worry that, if a consumer is willing to pay for a benefit, then the market can deliver it without cooperation. Indeed, they may even worry that competition could drive firms to invest even more in sustainable solutions: after all, markets are exceptionally good at delivering what customers want. It will therefore be necessary to put forward a clear case regarding the so-called “market failure” involved: setting out why the market won’t deliver the benefits that cooperation can.

One obvious market failure is that the costs of unsustainable consumption and production are felt by society as a whole, rather than by individual purchasers. Unfortunately, however, the Commission has been reluctant to fully take into account benefits to society as a whole and has stressed the need to identify benefits which accrue to consumers within the affected market. The rejection of these so-called “out of market efficiencies” means that making a compelling benefits case for cooperation is potentially challenging. One alternative is to argue that other market failures are involved: for example, behavioural economics evidence can be used to demonstrate that benefits which consumers genuinely value are hard to deliver through the competitive process.

In addition, in its latest draft guidelines, the European Commission has offered another partial solution to this challenge. Companies can argue that their product produces “collective benefits”. These benefits sit outside the tradition framework of consumers’ “willingness to pay”, but rather involve allocating a “fair share” of the societal benefits of sustainability benefits to the market in question. But it remains a largely open question how the Commission will tackle the question of what is the right way to allocate collective benefits.

EU State Aid

Merit Olthoff, Partner in the Freshfields (Brussels) Antitrust, Competition and Trade team

Key takeaways:

Unlocking public funding is recognised to be essential in order to achieve sustainability initiatives – better and more flexible access to funding, but also stronger “greening conditionality” is required.

The green transition will affect many businesses through increased costs as a result of necessary investments in carbon-free production processes and the use of more expensive sources of energy. The European Commission recently estimated that over €200bn annually of investments will be needed to achieve climate neutrality by 2050. The EU State aid rules, which set the rules for public spending and are designed to avoid undue distortions to competition in the Internal Market, contain a general prohibition on State aid which is a clear barrier to this. That said, many exceptions and exemptions exist, meaning that public spending which is designed in compliance with the rules would ensure that so called “green aid” would be compatible aid. Authorities in the EU have indicated that they will be flexible in favour of supporting the green transition, but uncertainty remains.

The EU’s main target has been to facilitate an increase in public spending across the continent in order to mobilise more private investments, as green transition is likely to be very expensive and can only be shouldered if public spending is made available alongside private investments to serve as an appropriate incentive for private stakeholders. The European Green Deal specifically mandates that EU State aid rules should be revised to reflect the EU’s sustainability objectives. For example, the Guidelines on State aid for climate, environmental protection and energy (CEEAG) have been revised with a view to achieving greater flexibility and allowing higher amounts of aid to be channelled to the market (e.g., by extending the scope to new areas such as biodiversity).

Other EU efforts include:

• The creation of a specific set of rules for the assessment of State aid to Important Projects of Common European Interest (IPCEIs) (Member State-funded cross border projects).

• The revised Framework for Research, Development, and Innovation (RDI) which introduces the possibility of granting aid in favour of “technology infrastructures” (e.g., technology testing labs).

• The launch of a number of funding instruments (e.g., the Recovery and Resilience Facility and Horizon EU) which are available to private investors wishing to engage in green interments.

• Further EU support to strategic sectors where large investments are required, e.g., in the form of the Chips Act.

While different policy instruments will have to be combined in a smart way to achieve the EU Green Deal objectives, it is evident from the revision of the European Commission’s State aid framework that it considers targeted and proportionate public support as a solution for many industries on the way to net-zero emissions. However, an overarching concern is that the revised State aid rules in the EU may be difficult to navigate; the framework is fragmented, and the Commission is yet to develop its practice on the implementation of the revised framework. Furthermore, the revised rules may result in stakeholders in larger Member States benefitting from the revised rules more than others.

Businesses will need to balance the possibility of combining different funding options (resulting in significantly higher funding of individual projects) with the fragmented framework, potentially resulting in inefficient segmentation of large innovative projects.

UK Subsidy Control

Martin McElwee, Partner in the Freshfields (London) Antitrust, Competition and Trade team

Key takeaways:

Engage in dialogue with the relevant public authority to ensure self-assessment is conducted properly for all funding under the new principle-based regime in the UK.

Since Brexit, the UK has been forging its own subsidy control path and earlier this year – on 28 April 2022 – it enacted the Subsidy Control Act.

The Subsidy Control Act consolidates the UK subsidy control regime. While the regime is not expected to come into full effect until the SAU has been sufficiently staffed, which is expected to be this autumn, public authorities and businesses should already start considering the impact of the new regime and how future analyses will differ to those previously conducted against the EU’s State aid framework. In addition, businesses and public authorities should continue to apply the principles set out in the Trade and Cooperation Agreement (the TCA), and any other applicable international obligations) in the interim.

The treatment of green subsidies under the UK subsidy control regime is intended to be more flexible than the EU State aid regime. However, in practice, the assessment of the principles which the public authorities need to self-assess against is expected to be less straightforward.

These general principles require that subsidies:

• pursue a common interest;

• are proportionate and necessary;

• are designed to change economic behaviour;

• do not cover costs that would be borne by the beneficiary in any event;

• are the least distortive means of achieving the goal; and

• minimise negative effects on competition and investment in the UK.

In addition to these general principles, energy-specific subsidies must (among other requirements):

• be targeted at secure, affordable, sustainable energy systems and well-functioning markets, OR increase levels of environmental protection;

• not relieve the beneficiary from liabilities as a polluter;

• not cut across rules in the EU/UK Trade and Cooperation Agreement on electricity generation adequacy, renewable energy or co-generation; and

• be well-targeted (in the case of subsidies for decarbonisation and improving energy efficiency).

This increased flexibility, though implies a trade-off in terms of certainty, which is of critical importance to investment decisions. Subsidies in sensitive sectors which meet certain thresholds would need to be referred to the CMA’s State Advice Unit (SAU) for review. But the SAU’s role is advisory only; it is for the public authority to work out whether funding or contractual arrangements involves financial assistance or subsidy. Private stakeholders would therefore need to work closely with public authorities when structuring support for green energy projects so that they fall outside of the scope of subsidy, or so as to minimise the risk of successful challenge.

Key considerations for private stakeholders include:

• whether it is possible to design the arrangement such that it does not involve a subsidy which warrants referral to the SAU or CMA in the first place;

• ensure that the self-assessment is conducted properly for all funding, even where this is designed not to be a subsidy;

• seek contractual protections which cover the public authorities’ self-assessment duties and allocate financial and legal challenge risks appropriately;

• think carefully about the extent to which private stakeholders should self-assess in parallel with the public authority’s assessment; and

• have a defence strategy ready in case any arrangement is challenged as involving a subsidy.

Trade

Lorand Bartels, Counsel in the Freshfields (London) Antitrust, Competition and Trade team

Key takeaways:

Robust international rules are necessary to minimise protectionist side-effects of environmental legislation and to encourage global approaches to fostering the energy transition.

World Trade Organisation (WTO) law sits above national law, operating at the supra-national level. It therefore has an impact on all of the other areas of national (and EU) law discussed above. A good way to think about it is as “the rules that govern the rules”.

From a business perspective, it can be used to interpret what goes at a national level, as well as to bring disputes in cases where national law is found to be in conflict with international law. More generally, from an environmental perspective, robust international rules are necessary to minimise the protectionist side-effects of environmental legislation and to encourage global approaches to fostering the energy transition.

There are three points worth noting in relation to trade law and the energy transition:

• The WTO’s approach to green subsidies is a lot stronger than EU and UK subsidy control regimes – on the face of the WTO rules, there are no exceptions to its prohibition on subsidies. But this is politically unrealistic. However, there is only one case where a workaround to this was attempted in an environmental context, relating to Ontario’s granting of subsidies to green electricity producers in the form of feed-in tariffs (a guaranteed wholesale price for producers of green electricity), which discriminated in favour of domestic products and was therefore illegal under WTO law. Such measures are also known as a local content requirement (LCRs). We have not seen any other cases challenging green subsidies: countries are reluctant to take legal action against each other as most of them are either already using such measures or are thinking about using them in an effort to promote their domestic green industry.

• LCRs are prohibited under WTO law, but they are common features of green initiatives, including subsidies and regulatory (e.g., biofuels). They are very popular politically as a good way of building up green industry domestically but are rarely successful when challenged under international trade law. The UK recently withdrew an LCR under threat of EU litigation. It is theoretically possible to justify discrimination where there is a clear global benefit, but there have not been any concrete climate change cases yet.

• Legislators are currently combatting carbon leakage with carbon border taxes, which will provoke challenges in the WTO – an example of such measures can be seen in the EU’s carbon border adjustment mechanism (CBAM) initiative. This is a regulatory system on the back of the emissions trading systems, but is effectively a charge which forces people to buy certificates for pollution emitting installations. What the EU had done until now was to exempt installations which were exposed to foreign competition, giving them free certificates. Now the EU is going to withdraw these free certificate allowances and will instead target foreign imports where these are not made using green means. This is guaranteed to provoke challenges in the WTO, as it is inherently discriminatory. The legislative process to introduce a similar CBAM scheme in the UK is currently underway.

Please do not hesitate to reach out to your usual Freshfields contact or any of the speakers at the event if you have any questions about the topics discussed.