Nicholas Institute for Environmental Policy Solutions
February 2016

Managing Risk in Environmental Markets

Managing Risk in Environmental Markets

Environmental markets use voluntary approaches to meet regulatory requirements and to target cost-effective, flexible, and efficient means to achieve environmental results. Although these markets create opportunities, they also involve some risk for regulated buyers, project developers (sellers), landowners, and the public. This paper reviews five types of risk these actors face—technical risk, extreme events, behavioral uncertainty, regulatory uncertainty, and market uncertainty—in four markets that commonly engage agricultural and forest landowners in the United States—wetland and stream mitigation banking, conservation banking, greenhouse gas offsets, and water quality trading. These markets involve transactions that range from annual to permanent transfers of environmental benefits. Thus they entail different risks and liabilities. Given robust risk management strategies and significant similarity across programs there are but a few risk management mechanisms that have yet to be tried in all markets and that present opportunities for improvement. These mechanisms include clarifying rules about how water quality and carbon offsets projects can sell into multiple markets, thereby enhancing flexibility and reducing risk for buyers and sellers. None of the markets currently use but all could consider purchase guarantees to encourage supply generation. Another opportunity may be vertical integration of regulatory programs, in which buyers become project developers to control risk. Finally, water quality trading markets could use credit banks to connect buyers and sellers. These banks might work best if they serve a clearinghouse function, providing market coordination and information.