Financial Mechanisms For Environmental Compliance in Infrastructure Projects

Environmental impact assessments (EIA) are the main regulatory tool governments use to balance the development and environmental values at stake in infrastructure development. Currently, however, project developers’ incentive for environmental performance dissipates as soon as environmental approval and financing are secured. To really protect the environment, EIAs need to be accompanied by intelligently structured financial incentives.

Both governments and banks can provide these incentives. Governments must lead, because they control most of the decisions on the planning and implementation of infrastructure. Whether governments own projects or not, they establish the rules and provide the enforcement capacity needed to secure compliance. Banks, for their part, can use a blend of positive and negative incentives during the life of a given loan. Beyond the period of a loan, banks’ most powerful incentive is conditioning future access to, or the price of, credit on past environmental performance.

Incentives should be scaled to be on par with the cost of environmental compliance and operate over the entire period of time in which a project’s environmental risks are present, which may be longer than the project itself. They should also avoid pushing projects to lessFdemanding lenders, and aim for fair and politically feasible cost sharing between lenders, private companies, governments and recipients of environmental services.

  • Among the options presented in this paper, we highlight several for their promise:
  • Performance bonds for avoidable impacts of projects, specified in each project’s mitigation requirements.
  • UpFfront deposits for compensation of inevitable impacts, with funds earmarked for specific offsetting compensation in longFterm habitat conservation or restoration.
  • A carbon depositFrefund system would be a special case of the previous two points, providing an upFfront deposit, a part of which could be refunded (like a bond), based on longFterm avoidance of impacts.
  • Accelerated depreciation in return for high compliance, with corresponding tax penalties for poor performance.
  • Access to credit and public contracts conditioned on past environmental performance. At an extreme, any lapse in compliance would relegate developers to a list on which they had no access to credit (from banks participating in the rating scheme) or public bids. Another approach would be to include the environmental score in the overall rating of public bids and as a determinant of the interest rate charged.

We propose several other measures here, approaches that are already widely used, such as fines, and ones that are more exotic, such as variable interest rates. With the right combination of targeted and timely incentives the coming wave of infrastructure development can be done in a way that’s economically sound and conserves natural ecosystems.