3.1. Examples of Markets for Ecosystem Services

One of the first prominent examples of the use of a marketable permit or emissions trading scheme as a component of a US federal environmental regulatory programme was the emissions trading programme designed to abate acid deposition that was adopted as part of the Clean Air Act (CAA) amendments of 1990.^{Footnote 15} That programme is widely regarded as having achieved reductions in harmful sulphur dioxide (SO₂) emissions at significantly lower costs than predicted at the time the programme was adopted, or than could have been achieved solely through traditional, source-by-source regulation.^{Footnote 16} Based perhaps on the perceived success of that programme, market-based programmes began to appear in other US regulatory contexts, including not only pollution control programmes such as the one for acid deposition control,^{Footnote 17} but also habitat and ecosystem preservation programmes.^{Footnote 18}

The market that has developed for the protection of wetlands is perhaps ‘the most mature and robust ecosystem service market in the United States’.^{Footnote 19} Section 404 of the federal Clean Water Act (CWA) restricts the development of privately owned wetlands, requiring a permit from the US Army Corps of Engineers that is supposed to include potentially costly protective measures,^{Footnote 20} including a commitment to provide compensatory mitigation for unavoidable wetlands losses.^{Footnote 21} Developers may meet mitigation requirements by creating wetlands elsewhere or by purchasing credits from the sponsors of mitigation banks, which ‘typically involve larger, more ecologically valuable parcels, and more rigorous scientific and technical analysis, planning and implementation than permittee-responsible mitigation’.^{Footnote 22} Private entrepreneurs have created ‘banks’ of preserved wetlands which are marketed as credits to land developers, who may meet their section 404 CWA obligations by using the credits they purchase to compensate for (or offset) the adverse impacts of wetlands development in which they engage.^{Footnote 23} By 2009, several hundred wetlands mitigation banks were operating in the US, each of which sold credits to land developers whose purchases allowed them to satisfy regulatory mitigation requirements.^{Footnote 24} Wetland mitigation banking reportedly accounts for more than 30% of all regulatory mitigation conducted under the CWA section 404 permit programme.^{Footnote 25} Developers may also meet compensatory mitigation requirements by purchasing credits from governmental entities or non-governmental organizations (NGOs) that operate in-lieu fee programmes. The compensatory mitigation obligations of permittee/credit purchasers is transferred to the in-lieu programme sponsor.^{Footnote 26} These markets in compensatory wetlands mitigation have become ‘a mainstream way’ of meeting CWA regulatory requirements.^{Footnote 27}

A second significant US ecosystem services market is tied to regulatory requirements under the federal Endangered Species Act (ESA). Section 10 of that statute prohibits the taking of members of an endangered species,^{Footnote 28} and the US Supreme Court has upheld an Interior Department regulation which defines a ‘taking’ to include some forms of habitat modification.^{Footnote 29} The statute authorizes the agencies that administer the law – the US Fish and Wildlife Service (FWS) and the National Marine Fisheries Service (NMFS) – to issue a permit for any taking that ‘is incidental to, and not the purpose of, the carrying out of an otherwise lawful activity’.^{Footnote 30} However, the agencies may not issue such an incidental take permit unless, among other things, they conclude that the permit applicant (such as a private landowner whose property includes habitat of a listed species) ‘will, to the maximum extent practicable, minimize and mitigate the impacts of such taking’.^{Footnote 31}

That set of statutory provisions has generated a ‘conservation banking’ programme the goals and operation of which are analogous to the wetlands mitigation banking programme that has developed in connection with the section 404 CWA wetlands protection requirements. A landowner who voluntarily agrees to conserve habitat may generate and sell credits (usually measured in acres of affected habitat) to others to enable them to meet the requirements for the issuing of an incidental take permit. This mechanism has developed into ‘the mitigation method of choice’ under the statute.^{Footnote 32} As one report has noted:

Other, more recently created or less fully developed, ecosystem services markets in the US include watershed payment programmes and water quality trading programmes under the CWA that are designed to facilitate improvements in impaired surface water quality,^{Footnote 34} and fish catch-share programmes that allow the sale of rights to catch specified amounts of the total allowable catch of a fishery in areas where fisheries are depleted.^{Footnote 35}

Tradable permit markets have also emerged in the EU. Perhaps the best-known example is the ETS,^{Footnote 36} which has been in operation since 2005 and is regarded as the first international trading system for carbon dioxide (CO₂) emissions in the world.^{Footnote 37} The ETS is a cap-and-trade system, which caps the overall level of emissions allowed; within that limit it allows participants in the system to buy and sell permits as they require. This article discusses some of the operational accountability challenges faced by the ETS in subsequent sections.

Another significant European mechanism is the EU Common Agricultural Policy (CAP)^{Footnote 38} and its related agri-environmental measures (AEMs).^{Footnote 39} Although the CAP is principally an agricultural framework, its AEMs provide incentives to encourage farmers to protect and enhance the environmental attributes of their farmland.^{Footnote 40} Under these measures, farmers are paid in return for the provision of an environmental service. Service contracts are signed with a domestic public regulator and farmers are paid for the additional cost of implementing such commitments and for loss of income arising from, for example, reduced production. The two main objectives are to reduce environmental risks and to preserve nature and cultivated landscapes. AEMs go beyond usual good farming practice^{Footnote 41} – the standard legal obligations and levels of environmental care with which each farmer routinely has to comply, compiled in ‘regional’ codes submitted by Member States to the European Commission for approval. Some AEMs concern productive land management, such as input reduction which includes plant protection products and reduction of fertilizers, crop rotation measures, organic farming, extensification of livestock, conversion of arable land to grassland, under-sowing, cover crops, farmed buffer strips, prevention of erosion and fire and rotation measures, and actions such as late mowing in areas of special biodiversity/natural interest. Also considered are measures that enhance genetic diversity, the maintenance of existing sustainable and extensive systems, farmed landscapes, and water use reduction measures. Other AEMs concern non-productive land management, such as setting aside land, upkeep of abandoned farmland and woodland, and upkeep and maintenance of the countryside and landscape features.

Ecosystem services markets have also emerged in connection with the implementation of international environmental agreements. One example of such an ecosystem service market is the Clean Development Mechanism (CDM) developed as part of the Kyoto Protocol.^{Footnote 42} Article 12 of the Protocol allows parties to receive credits for participation in projects certified on the basis of their capacity to produce ‘real, measurable, and long-term benefits to the mitigation of climate change’. Among the projects capable of meeting these requirements are renewable energy initiatives and carbon sequestration efforts. In particular, developing countries could expand forests that sequester carbon as a means of generating credits that could then be sold to developed countries to help the latter meet their GHG emissions reduction obligations more efficiently than they could have done by pursuing emissions control or other technological solutions.^{Footnote 43} In 2010, one observer described the market for GHG offsets as ‘large and rapidly growing’, although forest carbon offsets accounted for a relatively small percentage of the value of all trades.^{Footnote 44}

3.2. Abuses of Ecosystem Services and Related Markets

As experience with the US CAA deposition control programme demonstrates, the operation of markets in ecosystem services has the potential to achieve ecosystem protection goals at a lower cost than would more traditional regulatory techniques. However, these opportunities for efficient environmental protection and improvement are accompanied by risks. One such risk is that those who generate and get paid for credits will not follow through with their commitments, creating compensatory wetlands, for example, that do not provide the same levels of ecosystem services as those that are developed as a result of a trade. Participants in environmental markets also may engage in market manipulation or outright fraud, thwarting the goals of the particular regulatory programmes to which ecosystem markets are attached and more generally undercutting the legitimacy of markets in ecosystem services. Market participants who claim to have generated tradable credits may seek to be paid for environmental protections and improvements that would have occurred even without the sale of credits if, for example, these results are required independently by other regulatory programmes (thus creating an ‘additionality’ problem).^{Footnote 45} They may seek payment for improvements for which they have already been compensated (‘double-dipping’). They may even claim credit for having made improvements or provided protections that never occurred (‘paper’ or ‘phantom’ trade transactions).^{Footnote 46} An assessment of one relatively early US emissions trading programme characterized it as ‘plagued by … institutional manipulation’.^{Footnote 47} William Rodgers dubbed the CDM an ‘unmitigated disaster’.^{Footnote 48} The problem is that trading programmes ‘create strong incentives to manipulate the numbers and cheat, because credits that are fraudulently created are still worth money’.^{Footnote 49} Described below are four examples of environmental markets gone bad, each of which involved egregious manipulation of the currencies created by trading programmes.

The first example of marketable permits running amok arose under a state pollutant emissions trading programme operated by the state of California (US). The south coast of California has long been plagued by unhealthy levels of air pollution, particularly smog, generated by a mix of stationary sources and vehicle emissions. In an effort to tackle the long-standing surface level ozone problem, state regulators adopted Rule 1610, also known as the ‘car scrapping programme’. Rule 1610 allowed factories to avoid installing expensive pollution control equipment by purchasing pollution credits generated by destroying old, high-polluting cars (and measured by the projected avoided emissions from the destroyed vehicles). The hope was that pollution could be controlled at a much lower cost by taking high-polluting older vehicles off the road than by requiring factories to curtail smokestack emissions through technological fixes.^{Footnote 50}

The programme encountered multiple difficulties. For one, many of the cars whose avoided emissions generated credits were already at the end of their useful lives, and were destined for the scrapheap anyway. Worse yet, some of those who generated and sold credits by allegedly taking old vehicles out of circulation actually failed to destroy them. Instead, they crushed the bodies of the cars whose avoided emissions generated valuable credits and sold many of the engines for reuse in other cars still on the road.^{Footnote 51} The result was that the factories that purchased credits were allowed to emit more than their individual emission caps would have allowed in the absence of trading. But the quid pro quo reductions in emissions of ozone precursors by permanent removal of high-polluting vehicles from the road never occurred because the high-polluting engines were recycled into other car bodies and allowed to continue spewing ozone precursors into the air. Instead of achieving equivalent reductions at a lower cost, the trading programme resulted in higher levels of pollution than would have been legally possible under a traditional regulatory approach.

The second example is also related to efforts to reduce vehicle emissions. In 2005, Congress amended the US CAA by creating a new renewable fuels programme as a means of reducing the use of fossil fuels whose combustion generates GHG.^{Footnote 52} The statute requires ‘obligated parties’ – such as fuel importers, blenders, and refiners – to introduce at least a minimum volume of renewable fuel into the domestic gasoline market each year. The programme includes a credit trading component, which allows an obligated party to generate credits for over-complying with its annual obligation (called a renewable volume obligation (RVO)) and then sell these credits to another obligated party, which may use them to offset the RVO with which it would otherwise have had to comply.^{Footnote 53} Like all trading programmes, the CAA renewable fuels programme holds out the promise of increasing the use of renewable fuels efficiently because an obligated party would not over-comply unless it could sell the credits that resulted from the production of excess renewable fuel volumes for more than it cost to produce them. Conversely, an obligated party would not purchase a credit unless its cost was lower than the cost of producing the renewable fuel volume offset by the credit.

In theory, the trading programme provides an efficient way to tackle climate change. In practice, however, its implementation has been deeply flawed. As the US Environmental Protection Agency (EPA) eventually discovered, some obligated parties sold credits, claiming to have produced amounts of renewable fuels far in excess of their RVOs, even though they imported, blended, and produced no qualifying renewable fuels at all (except on paper), and even though EPA regulations prohibit the sale of invalid credits.^{Footnote 54} The transactions generated enormous profits for the sellers who, after all, incurred no costs at all. On the other side of the ledger, the credit purchasers were left with fraudulent and worthless credits, and the required renewable fuel volumes did not replace the fossil fuels they were supposed to displace. The EPA accused one company alone of selling US$84 million worth of illegitimate credits, and a Maryland jury convicted its owner of 42 counts of fraud, money laundering and CAA violations.^{Footnote 55} In the aftermath of the discovery of instances of fraud, credit purchasers sued their sellers for breach of contract and breach of warranty, even though those sellers had in turn purchased the credits from other sellers responsible for their fraudulent creation.^{Footnote 56} The price of renewable fuel credits plunged, confidence in the credit market disappeared, and the market was ultimately frozen as obligated parties feared they would remain responsible for complying with their initial RVOs despite having spent money purchasing credits that turned out to be invalid.^{Footnote 57} Refiners and the EPA debated whether those who purchase fraudulent credits in good faith should be able to raise that good faith as an affirmative defence to charges of regulatory violations instead of being fined for failing to meet their RVOs. They also fretted over whether the best way to minimize future manipulation of the market would be to put the EPA or independent third parties in charge of certifying credits as valid.^{Footnote 58}

The third example of the perverse operation of environmental markets relates to the Kyoto Protocol’s CDM. The carbon credits available under that programme are valued according to the impact on global warming and the staying power in the atmosphere of particular GHGs once they are emitted into the environment. Methane (CH₄), for example, is 21 times more powerful as an agent of atmospheric warming than is CO₂. The value of a nitrous oxide (N₂O) credit is 30 times greater than a credit for CO₂. HFC-23, a chemical produced as a byproduct of manufacturing HCFC-22 (a refrigerant and feedstock for certain plastic products) is 11,700 times more potent as a GHG than CO₂.^{Footnote 59} Between the initiation of the trading programme and mid-2012, 46% of all credits were awarded to coolant factories, mostly in developing countries.^{Footnote 60} These companies realized that they could generate 11,700 times as many credits by destroying a ton of HFC-23 than by capturing a ton of CO₂. They responded by choosing to generate enormous volumes of HCFC-22 so that they could generate credits by destroying (very cheaply) the HFC-23 that is its waste byproduct. Some of the companies generating CDM credits from the capture of HFC-23 earned nearly twice as much (an average of US$20–40 million each year) from the sale of credits as from the production of HCFC-22.^{Footnote 61} Indeed, many of the plants operated only until they had produced (and destroyed) the maximum amount of HFC-23 eligible for credits and then shut down operations until the following year.^{Footnote 62} They apparently went out of their way to use inefficient manufacturing processes to maximize the production of coolant gases and waste HFC-23.^{Footnote 63} In addition, the incentives to manufacture HCFC-22 as a means of generating CDM credits through the destruction of HFC-23 resulted in the manufacture of so much HCFC-22 that the price of that coolant gas fell, discouraging air-conditioning companies from seeking out less environmentally damaging alternatives.^{Footnote 64} As Michael Wara puts it, ‘[t]he economics of HFC-23 projects create incentives for strategic behavior that, if left unchecked, would undermine the environmental efficacy of the CDM’.^{Footnote 65}

Eventually, regulators caught on and the EU declared that, as of 2012, it would no longer accept CDM credits for the destruction of HFC-23.^{Footnote 66} The United Nations (UN) also acted, refusing to award credits to any factories that are not already in the business of producing HCFC-22 or that expand production of the coolant.^{Footnote 67} The response of some companies in China no longer able to earn credits for destroying HFC-23 has been to vent it into the atmosphere.^{Footnote 68}

The fourth example relates to Europe’s flagship environmental permit trading programme, the ETS, which, despite relative success, has faced serious questions relating to fraud, such as the introduction into the market of recycled trading permits and tax fraud. Early in 2010, in an attempt to raise revenue, the Hungarian government sold permits known as Certified Emission Reductions (CERs), which had been issued under the Kyoto Protocol’s CDM and had already been surrendered by companies to meet their ETS compliance requirements. The government claimed that it sold the credits on condition that they must not be resold in the ETS. However, ten trading houses found they had some of them in their accounts after they bought CERs on the Paris-based bourse, BlueNext. The news disrupted the carbon market, as ETS exchanges ascertained if their own inventories contained the offending instruments. At least three exchanges reacted by temporarily ceasing all trade in CERs. The European Commission moved to safeguard the ETS by subsequently banning such reuse, but how the credits came to be sold on BlueNext remains unclear.^{Footnote 69}

Despite receiving widespread attention only recently, fraudulent activity has been a problem for the ETS since 2008, initially in the form of value added tax (VAT) fraud. In some European countries, governments treat carbon permits as a taxable consumptive good, and so those governments place a VAT on the transfer of carbon credits. Criminals found a way to exploit the tax code variation among countries by opening trading accounts, buying permits in countries without a tax, and then selling them in countries with a tax. Through repeatedly buying and selling the permits, they generated large amounts of money from the VAT that disappeared before the VAT was collected. It has been estimated that in 2009, EU Member States lost a combined total in excess of €5 billion (Germany is reported to have lost €850 million; the Netherlands €300 million).^{Footnote 70}

It is impossible to know how many other cases of scamming and manipulation of environmental credit trading markets have yet to be discovered. The four cautionary tales described above, however, dramatically illustrate the need for building into programmes that encourage the operation of markets for ecosystem services meaningful safeguards to protect against abuses that undercut environmental protection goals and allow participants to reap undeserved profits. The next section describes five sets of safeguards that we regard as indispensable to a well-functioning and accountable market in ecosystem services.

4.1. Financial Safeguards

No environmental market programme can completely eliminate the risk of fraud and abuse, or even well-intentioned participation that falls short of achieving statutory environmental protection goals. It is therefore important that a sound ecosystem services market requires those participating in the market to provide financial assurances to guard against the possibility of project failure.^{Footnote 76} The CWA wetlands banking scheme supervised by the US Army Corps of Engineers provides one model for such a set of financial safeguards. The Corps’ regulations require those applying for a permit to develop protected wetlands to provide ‘sufficient financial assurances to ensure a high level of confidence that the compensatory mitigation project will be successfully completed, in accordance with applicable performance standards’.^{Footnote 77} Among the instruments that may satisfy this requirement are performance bonds, escrow accounts, casualty insurance, letters of credit, or legislative appropriations for government-sponsored projects. In calculating the level of assurance required, the Corps must consider factors such as the cost of providing replacement mitigation, which includes costs of land acquisition, planning and engineering, legal fees, mobilization, construction, and monitoring.^{Footnote 78} Each development permit for a project subject to financial assurance requirements must include a provision requiring that the assurances be in place before the permitted activity may commence.^{Footnote 79}

An additional level of protection may be provided if those responsible for administering an ecosystem services trading programme require that funds to be used for mitigation by bankers or others who have assumed the regulatory obligations of credit purchasers be placed in segregated accounts to minimize the risk of diversion of those funds for non-authorized uses.

4.2. Verifiable Performance Standards

The second pillar of an accountable market in ecosystem services is the adoption of performance standards for activities conducted by a credit seller to meet the regulatory obligations of a credit buyer. Salzman and Ruhl have distinguished between wholesale and retail review of environmental trading, arguing that both are important. Wholesale review involves creation of general rules governing trades, while retail review applies to individual transactions to ensure compliance with those rules and to verify that the promised environmental services are actually being provided.^{Footnote 80} With respect to wholesale review, those structuring an environmental trading programme must balance the ability of detailed trading rules to check abuses with the tendency of detailed rules to reduce the flexibility of market participants to craft, and oversight agencies to approve, innovative arrangements capable of achieving desired levels of protection efficiently. At the retail stage, the more extensive the review, the greater the chance that regulators will be able to halt inappropriate trades before they occur. Extensive retail review, however, increases transaction costs, which may preclude potentially beneficial trades because they are too costly to arrange and implement.^{Footnote 81}

The CWA permit programme for wetlands development provides an example of what both wholesale and retail review mechanisms might look like. The Corps of Engineers in 2008 adopted elaborate rules governing wetlands mitigation trades.^{Footnote 82} The rules require the preparation of baseline aquatic resource inventories, including identification of degraded resources and immediate and long-term aquatic resource needs within watersheds that can be met through trading.^{Footnote 83} The rules also require clear identification of the parties responsible for implementation and long-term management of compensatory mitigation projects.^{Footnote 84} Permit applicants must prepare mitigation plans that specify the legal arrangements to ensure long-term protection of the compensatory mitigation project site.^{Footnote 85} Each plan also must include objective and verifiable performance standards that can be assessed in a practical manner, using the best available science.^{Footnote 86} As the next two sections indicate, the capacity of such requirements to foster an accountable trading system largely depends on follow-through by the administering agencies, with the assistance of stakeholders with access to important information on programme and project performance.

4.3. Transparency and Public Participation Standards

According to the Millennium Ecosystem Assessment, ‘[i]nsufficient participation and transparency in planning and decision-making have been major barriers’ to ecosystem protection, through market-based mechanisms and otherwise.^{Footnote 87} Transparent decision-making and meaningful opportunities for public participation are critical because the interests of traders may not correspond with the broader public interest.^{Footnote 88} Transparency promotes legitimacy by fostering trust in the system that encourages buy-in. Opportunities for public participation promote that same goal,^{Footnote 89} while also facilitating the ability of those managing a trading programme to accumulate information from a diverse array of sources that may assist in identifying which trades (or aspects of trades) would best serve regulatory aims.

Within the EU, the principal framework for accountability in environmental decision-making is founded upon the Convention on Access to Information, Public Participation in Decision-making and Access to Justice in Environmental Matters (Aarhus Convention).^{Footnote 90} As the Convention’s title suggests, one of its key pillars is public participation in environmental decision-making, an obligation that is binding on both signatory states and EU institutions.^{Footnote 91} It is clear under this framework that the development of markets for ecosystem services must be accompanied by robust public participation systems or will otherwise fail regulatory scrutiny.

The implication of these observations for markets for ecosystem services is that, while the Aarhus Convention framework provides a theoretically robust framework for establishing accountability, the complicated nature of ecosystem services and the instruments chosen to realize their value may work to thwart the realization of participation and ultimately the possibilities for ensuring accountability. It is imperative, therefore, that clear principles are articulated in order to mitigate the risks that are contingent upon the adoption of market-based initiatives for ecosystem services. In this regard, the Aarhus Convention provides a very good starting point for articulating a regulatory framework that entrenches accountability as a key requirement for all environmental governance efforts, including the regulation of markets for ecosystem services.

Transparency and opportunities for potential market participants and NGOs, among others, to participate are critical at all stages of the process, including rule development and review of specific trades. Public input at the retail level is particularly important because those potentially affected by projects that a trade would enable may have valuable location-specific information that would be difficult for government overseers to acquire.^{Footnote 92} Transparency in the transfer of funds is also important. Salzman and Ruhl contend that markets can work only if knowledge of their existence is widespread, information about individual transactions is available, and mechanisms exist to allow prospective traders to find trading partners and determine the prices at which transactions are taking place.^{Footnote 93}

One option for enhancing transparency at the project-level stage is the creation of a registry that permits interested members of the public to track transactions.^{Footnote 94} Many US ecosystem trading programmes, including water quality programmes under the CWA, rely on internally created databases and accounting tools rather than external or commercial registries.^{Footnote 95} The Ecosystem Marketplace, a website maintained by the Katoomba Group, is designed to provide a comprehensive source of information on environmental markets around the world,^{Footnote 96} and to become a ‘one-stop shop’ for information about markets and payment schemes for ecosystem services.^{Footnote 97}

Procedures that foster transparency and public participation come at a cost, however, because they increase the length and expense of the trade approval process. One way to balance the benefits and costs of public participation would be to create public boards, staffed by scientific experts as well as representatives of all affected interests, to review and provide input on individual trades, although such an approach would limit opportunities for individual input and pose a risk that board members may be captured. Another option, suggested by Salzman and Ruhl, is to subject all trades to review by ad hoc stakeholder groups acting as mediators. Any agreement reached in approving a trade would be immune from attack by other interested parties.^{Footnote 98} The Millennium Ecosystem Assessment listed other participatory options, including citizens’ juries, community issue groups, electronic democracy, focus groups, and consensus conferences.^{Footnote 99} Local traditions and customs may make some of these options more suitable for a particular place than others.

The US track record on public participation is mixed. Rules issued by federal agencies to govern how trading systems work or the performance standards that trade participants must meet are likely to be governed by the Administrative Procedure Act,^{Footnote 100} which requires issuance of proposed rules and opportunities for public comment. Opportunities for public participation in the formulation and implementation of individual trades have sometimes been less readily available. The California car-scrapping programme that resulted in the recycling of high-polluting engines that should have been destroyed did not provide opportunities for public review of individual trades.^{Footnote 101} The Corps of Engineers’ CWA wetland banking regulations, on the other hand, require the Corps to provide public notice of a proposed permit, including an explanation of the form that compensatory mitigation will take. The regulations specify that ‘[t]he level of detail provided in the public notice must be commensurate with the scope and scale of the impacts’.^{Footnote 102} Other federal and state agencies with environmental expertise also may comment, and the Corps regulations create a dispute resolution process in the event of disagreement between the Corps and other agencies such as the EPA or the FWS.^{Footnote 103}

4.4. Regulatory Oversight Mechanisms

Neither the government nor the public can root out abuses in market-based programmes without access to key information. The fourth pillar of an accountable ecosystem services market, therefore, is oversight through public and private access to information through vehicles such as mandatory monitoring, reporting, and inspections. The function of these tools is to verify that the ecosystem services supposedly being provided by market participants are actually being supplied, and that the result is effective protection in a manner that is consistent with statutory or regulatory goals. In order to ensure the integrity of these markets, accurate monitoring is paramount^{Footnote 104} The same holds true of information that may be gleaned from reports, inspections, and other documents concerning the performance of market-based arrangements.

Within the EU, the provisions of the Aarhus Convention on public access to environmental information were implemented through Regulation (EC) No. 1367/2006.^{Footnote 105} This Regulation sets out the basic terms and conditions for granting access to environmental information held by or for public authorities, aiming to achieve the widest possible systematic availability and dissemination to the public. However, despite this framework, access to information has not been straightforward for some ecosystem market mechanisms. There have been concerns, for example, with the availability of ETS data and its transparency, which have allowed the multiple resale of permits and VAT fraud to take place. In its defence, the Commission has argued that it has taken measures to improve data availability and transparency, noting that the latter increases the ability of participants to make informed trading decisions, and reinforces confidence in market integrity and efficiency, while being one of the main ways to counter misconduct.^{Footnote 106} It points out that exchanges and other organized trading venues display anonymized information about bids, offers, trades, and closing prices for market participants, and that this information is also available to the general public after a short delay. However, despite these mechanisms, over-the-counter transactions are still, in principle, unavailable to other market participants, allowing an opening for market abuse.

The Millennium Ecosystem Assessment remarked that ‘[e]ffective monitoring, assessment, and reporting is a key to success in allocating ecosystem services and implementing response options’.^{Footnote 107} The information provided by monitoring, inspection, and reports can provide feedback on the ongoing success or failure of transactions in environmental markets and allow mid-course corrections and the initiation of enforcement action if regulatory violations or breaches of conditions on project approval have occurred.^{Footnote 108}

Monitoring needs to occur on at least two levels. Firstly, it needs to ensure that the services actually being provided by the sellers match the services that credit buyers were excused from delivering. Secondly, monitoring is required to check whether individual trades and market-based programmes in the aggregate are actually achieving regulatory goals.^{Footnote 109} With respect to the first level, it is important to evaluate whether credit sellers are fulfilling the commitments that allowed buyers to escape regulatory requirements.^{Footnote 110} The US acid deposition control programme under the CAA requires regulated utilities to install continuous emissions monitoring equipment. Coupled with significant penalties for non-compliance, the programme has experienced high levels of compliance.^{Footnote 111} Similar information collection requirements are more difficult to create for programmes that involve a more diverse array of regulated entities and third-party service providers. In those contexts, the need for potentially costly physical inspections is heightened.^{Footnote 112} At the second level, if ambient monitoring shows that the intended environmental protection benefits of trading are not actually being achieved, programme adjustments should ensue.^{Footnote 113}

Reporting requirements for market participants are important because, as the instances of fraud and abuse discussed in Section 3.2 above indicate, profit-motivated buyers and sellers of environmental credits have incentives to cheat. Doing so reduces the costs of doing business. It also frustrates the environmental protection goals of trading regimes, however, requiring the establishment of robust accounting protocols to preserve the credibility of trading programmes.^{Footnote 114} Under the wetlands mitigation banking programme under the US CWA, the approval of mitigation banks is conditioned on the sponsor’s establishment and maintenance of a ledger to account for all credit transactions. Every time an approved credit transaction occurs, the sponsor must notify the Corps of Engineers.^{Footnote 115} The ledger is publicly available on request.^{Footnote 116} Project approval documents must include a schedule for both monitoring and reporting on monitoring results.^{Footnote 117} The information that must be included in these reports ‘must be sufficient for the district engineer to determine how the compensatory mitigation project is progressing towards meeting its performance standards’.^{Footnote 118} The failure to submit required reports allows the Corps to initiate enforcement action.^{Footnote 119} CWA regulations also authorize the Corps to conduct site inspections on a regular basis to evaluate mitigation site performance.^{Footnote 120}

The oversight safeguards built into the Corps of Engineers’ 2008 regulations governing the CWA wetlands mitigation banking programme appear to be rigorous. Yet, without commitment and follow-through by agencies, the requirements of monitoring, reporting, and inspection are likely to fall short of what is needed to mitigate the risks of abuses and under-performance in market-based programmes. In an evaluation of an earlier iteration of the wetlands banking programme, the US General Accountability Office (GAO) identified significant flaws in the programme’s oversight mechanisms.^{Footnote 121} According to the GAO, the Corps’ pre-2008 guidelines for compliance inspections by agency officials were vague on key issues such as how to determine whether mitigation is substantial. The GAO also found that the guidelines were vague about what information had to be included in reports, that required reports were often not submitted, and that compliance inspections often did not take place. Instead, the Corps relied largely on the good faith of permit holders to comply with compensatory mitigation requirements. As a result, the agency was often unable to assess definitively whether compensatory mitigation had been performed.

In some cases, the Corps did not even enter into agreements with third-party sponsors to ensure the agency had legal recourse if compensatory mitigation was not being performed. The result was that some projects were unfinished and permit conditions were not met in some finished projects.^{Footnote 122} Other studies of the wetlands mitigation banking programme concluded that only about 20% of sites met the ecological equivalent of the displaced wetlands.^{Footnote 123} It is not yet clear whether recent revisions to the Corps’ guidance have adequately addressed these problems. Other US ecosystem services markets may suffer from similar flaws. Another GAO report concluded that the FWS does not effectively track monitoring reports required by biological opinions and incidental take permits under the ESA.^{Footnote 124}

The European Commission argues that the ETS Directive^{Footnote 125} gives it a specific monitoring role which is linked but not limited to the introduction of auctioning as the main allocation method. It adds, however, that as financial intermediaries and power companies are the main participants in the European carbon market, any examination of the level of market oversight has to take account of more general legislation relating to both financial and energy markets. The former includes the Market Abuse Directive^{Footnote 126} (which applies to those emission allowance derivatives which are regarded as financial instruments and traded on regulated markets) and the Markets in Financial Instruments Directive.^{Footnote 127} Additionally, the Auctioning Regulation,^{Footnote 128} adopted in November 2010, which establishes a regulatory framework for the auctioning of emission allowances in the 2013–20 trading period, increases regulatory oversight by, inter alia, broadening the scope of the Market Abuse and Markets in Financial Instruments Directives in the carbon market and by extending to auctioning participants a number of measures stemming from the Anti-Money Laundering Directive.^{Footnote 129} Yet, these mechanisms rely on the European Commission essentially marking its own homework.

Third-party verification may be a way to enhance the effectiveness of informational oversight safeguards. Because the self-interest of market participants may make self-monitoring suspect, verification, either by the government or by independent third parties, can perform a valuable function in checking abuse.^{Footnote 130} US states such as Oregon have provided for review of the functioning of offsets in carbon trading markets by academic institutions, or have hired independent third parties to perform cost–benefit analyses.^{Footnote 131} EcoTrust, an advocacy programme for ecosystem services markets in the rain forests of the US Pacific Northwest, requires independent third-party monitoring for projects that create carbon offset credits.^{Footnote 132} California requires third-party verification as part of its GHG cap-and-trade programme.^{Footnote 133} The government should oversee the verification bodies, however, to ensure the accuracy of their reports and findings, and such efforts will add to implementation costs.

4.5. Rule of Law Safeguards

Ultimately, all those participating in ecosystem services markets that are part of a government regulatory programme, including government officials who administer the programme, need to be held accountable for non-compliance with the law. Rule of law safeguards should therefore be built into the operation of ecosystem services markets to establish consequences for non-compliance and procedures to impose those consequences.

Access to the courts should be available to stakeholders, including interested NGOs, to challenge the ground rules for the operation of an ecosystem services market. In addition, judicial review should be available for agency approval of individual transactions.^{Footnote 134} The statutes and regulations establishing programmes for markets in ecosystem services should specify penalties for violating regulatory requirements and contract terms, and authorize the government to impose or seek judicial imposition of those penalties. The Corps of Engineers may assess administrative penalties for violating wetlands protection regulations or permits, suspend or revoke permits, and recommend the imposition of harsher sanctions by the US Department of Justice.^{Footnote 135} The GAO has reported, however, that the agency rarely pursues enforcement actions, relying instead on negotiating with alleged violators.^{Footnote 136}

The available penalties might include bond forfeiture, the withholding of future payments by credit buyers, financial penalties, permit suspensions or revocations, injunctions shutting down projects or requiring restoration, and even the imposition of criminal sanctions for behaviour such as intentionally submitting false reports.^{Footnote 137} Policy-makers should consider making the entity that purchases credits legally responsible for its seller’s failure to meet performance standards or otherwise comply with programme requirements, so that someone other than the government is highly invested in successful ecosystem protection actions.

The threat of sanction imposition must be meaningful, requiring adequate financing of enforcement agencies and the independence of government officials from those who would profit from avoidance of the rules. An accountable market-based programme would include an additional safety net by authorizing judicial review of ongoing project implementation, including performance of contract or regulatory requirements, at the behest of private citizens and public interest groups.^{Footnote 138}