1. Environmental Policy Bonds Injecting market incentives into the achievement of local, national and global environmental goals

2. Environmental Policy Bonds (EPBs) • EPBs do not bear interest • Redeemable for fixed sum once objective has been achieved • Government sets objective • Issues EPBs by auction

3. Example: cleaning up a lake • Local authority sets objective • concentration of pollutants, fish numbers, etc • Local authority will redeem EPBs for $10 each when lake is clean • Sell for $2 when floated • Prospect of capital gain motivates people to clean up lake

4. How Bond prices change

5. Motivation • Bond price will rise as targeted goal becomes closer • Bondholders benefit from this price rise • Bondholders invest in lake-cleaning projects • Bondholders can sell Bonds at any time

6. Cascading incentives Bondholders have incentives to: • pay people and firms to pollute less • pay environmental groups to clean up • invest in lake-cleaning projects and technology • ensure that existing laws against pollution are enforced • co-operate with each other

7. Advantages (1) • Efficiency • Tradability injects incentives to be efficient at all stages • Bond prices generate valuable information • Encouragenew activities • More responsive to events and local situations

8. Advantages (2) • Transparency about goals increases political support • Transparency of costs makes trade-offs clearer • Stable objectives • Flexibility to cope with uncertainty

9. Potential disadvantage • Incentives to achieve targeted objective at the expense of others • Solution: • Specify objective carefully • Enforce existing legislation • Target broad outcomes

10. EPBs: when they work best • to achieve broad objectives • many sources of pollution • sources and scientific knowledge changing rapidly • uncertain causes

11. EPBs: summary • Government sets objective • Government is ultimate source of finance • Bondholders achieve objective • Bondholders have market incentives to be efficient