This article was originally published by the [UK] CEED Bulletin [number 35, September 1991], published by the Centre for Economic and Environmental Development. It also appeared as OECD Room Document 3 at a meeting of the Joint Working Party of the OECD Committee for Agriculture and the Environment Policy Committee, held in Paris on 13 December 1994.
This article is 1400 words long. You may like to read a more detailed 15000-
A novel way of injecting self-
For example, consider the objective of halving some broadly-
What will determine the price of the bonds? Most obviously the market's assessment of how likely, and when, the targeted level of air pollution will be reached. Interest rates on alternative investments will also be a factor. The bonds might sell for as little as one penny if people thought there were virtually no chance of air pollution being halved in their lifetime. People will differ in their valuation of the bonds, and their views will change as events occur that make achievement of the targeted objective a more or less distant prospect. But the bonds, once issued, would be publicly quoted just like those of ordinary bonds or shares.
Assume that the bonds targeting air pollution have been issued, and that they sold for one pound. People, or institutions, now hold an asset that can quintuple in value once air pollution is halved. The bondholders therefore have a strong interest in seeing air pollution reduced.
The most important purchasers of EPBs are likely to be those who finance initiatives aimed at reducing air pollution. They could use their own capital, or borrow on the strength of the redemption value of their bonds, [or on the strength of any increase in the value of their bonds], to support projects targeting air pollution. Other purchasers might be polluting firms, whose bondholding would directly offset the cost of any programmes aimed at reducing their pollution output.
The first category of purchasers has an incentive to undertake these types of initiatives:
helping to defray the costs of firms' air pollution reduction programmes;
bribing firms to stop production of pollution-
subsidising production, or consumption, of less polluting alternatives to existing products or services; and
subsidising research into alternatives to existing, pollution-
Bondholders can also be expected to discover and finance other pollution-
Currently, many of these initiatives are taken by government, regional or local authorities. However, there is a crucial difference: under an EPB regime the motivation arises from the self-
For the EPB regime to be effective, three processes would need to be carefully carried out:
The environmental objective must be capable of being quantified. 'Air pollution' for example, could be calculated as an average of reading as measured at many sites around the country.
Thought would need to be given to the definition of the objective to be targeted by the bonds. In the case of air pollution, it would be unsatisfactory to redeem the bonds when pollution levels had fallen below the target level for only a short time. The objective is a sustained cut in air pollution, and that is how it would have to be defined when the bonds are issued. Air pollution itself could be defined in terms of the concentrations of all significant pollutants, weighted according to their threat to the environment.
Progress toward the attainment of the environmental objective would need to be regularly and reliably assessed by bodies independent of investors in EPBs.
Many bondholders will want to sell their bonds before redemption; that is, before the environmental objective has been achieved. A secondary market for the bonds is necessary to ensure that these holders will be able to realise any capital appreciation experienced by their bonds. This is important, because many investors may be able to help speed up only one, or a few, of the processes necessary for the targeted objective to be achieved. Once these investors have done their bit, they may have no wish to speculate on the speed at which the remaining processes will be carried out.
Comparison with other market-
Environmental Policy Bonds make policy objectives more transparent. By focusing on ends, rather than means, environmental objectives are explicitly identified, while indirect, as well as direct, means of achieving them are encouraged -
EPBS have informational advantages, especially when targeting broad objectives. Water pollution, for example, results from many sources and from many different processes. Immense quantities of information would be needed to establish and monitor a comprehensive system of pollution control using taxes or tradeable permits to pollute. By contrast, EPBs would target society's objective -
Tradeable permits and taxes can work well with intrinsically large-
The environment needs cleaning up on all fronts, and broadly-
Those charged with monitoring and enforcing tradeable permits or tax regimes may have little incentive to be diligent; typically they would be government agents whose rewards would not correlate with their efficiency. With EPBs it would be in the bondholders' interest to see, for example, that bribes to firms to cut their pollution do, in fact, result in such cuts.
The EPB concept involves the surrendering of policy instruments to the private sector, and this may be difficult for politicians to swallow, even though, under an EPB regime, they would continue to set and finance society's environmental goals. But the bonds need initially play only a small role: a small number of bonds could be issued for any one objective and work in tandem with other regulatory mechanisms. In such a way the concept could gain gradual acceptance.
Once established at the national level Environmental Policy Bonds would readily lend themselves to global application. Bonds targeting the planet's wellbeing could be issued by the developed countries, to encourage developing countries to cut their pollution. This form of encouragement, by appealing to financial self-
My blog has numerous posts on the environment including these:
Target environmental ends, not means -
Betting against extinction -