The Case for Compliance Markets
By Matthew Hay, Natural Capital Manager, NattergalIf you can’t beat them, join them!
There is a depressing ring of truth to Fredric Jameson and Slavoj Žižek’s observation that “it is easier to imagine an end to the world than an end to capitalism”. As a species, our willingness to cross planetary boundaries relating to the climate, biosphere, freshwater flows and more seems far greater than any effort to explore different economic models for organising our societies. Like it or not, we live in a world subject to market forces, where capital is expected to generate a return.
If we accept this premise, it becomes clear that anything we wish to achieve – such as combatting the climate and biodiversity crises – must be done within the parameters of a capitalist system.
This is not necessarily a reason for pessimism. When harnessed effectively, capitalist economies can achieve unbelievable things, from improving living standards for millions of people to driving innovations into lifesaving medicines like vaccines. The key aspect will be getting governments to actually harness capitalism for positive change, creating what Mariana Mazzucato calls ‘mission economies’, where target-driven public / private cooperation is tasked with achieving the modern day equivalents of putting a man on the moon.
For those of us working in the natural capital sector, the first way in which we need our economic systems to be harnessed is with the acknowledgement that pollution and environmental harms can no longer be treated as “externalities”. For centuries, natural capital has been converted into financial capital, without accounting for the loss of the former. Forests were felled for timber, soil health diminished to increase agricultural output, fisheries exploited to feed growing populations and minerals mined to produce the materials a modern society consumes. Bringing our economies back within planetary boundaries will firstly require the costs of these activities to be accounted for and then, ultimately, paid.
This is the so-called “polluter pays” principle. If implemented economy-wide, it would require all businesses to pay for their environmental impacts, from greenhouse gas emissions and watercourse pollution to degradation of natural assets like the soil and seabed.
Clearly, this could not be done overnight. Businesses would need time to adapt and factor the additional costs into their operations. However, without a widespread implementation of the “polluter pays” principle, it is hard to see how our societies and economies can navigate the next half-century successfully.
Natural capital and nature markets
The natural capital sector is almost entirely dependent on the “polluter pays” principle. It is the bedrock of any demand for natural capital products, be they carbon credits, biodiversity units or nutrient mitigation. At the moment, the sector exists in a strange space, where the majority of natural capital or nature markets are prefaced on a voluntary application of that principle by businesses. However, that might be starting to change.
It is important to acknowledge what these voluntary nature markets have achieved. For those of us operating in the land management sector, they have introduced an entirely new category of product and, in parts of the country, have completely changed the way we think about and value land. There is no doubt that the Woodland Carbon Code and Peatland Code, in particular, have sparked huge interest in and undertaking of both woodland creation and peatland restoration.
But the shortcomings of voluntary markets are now coming to the fore. For sellers of carbon, prices are inconsistent and demand is patchy, with transactions often more dependent on corporate relationships than ratified co-benefits. For voluntary biodiversity, there is currently little solid demand at all, with the relevant drivers like the Taskforce for Nature-related Financial Disclosures (TNFD) focusing minds on ‘within value-chain’ mitigation rather than offsetting.
Given the hopes placed on biodiversity credits at COP15 as a mechanism to fund the Kunming-Montreal framework’s 2030 targets, this is a potentially massive problem.
Voluntary no more
Ultimately, nature markets need to move beyond being voluntary. We cannot have challenges as big as reversing the decline of biodiversity contingent on ephemeral demand. Paying for environmental harms should not be something that businesses can opt out of or defer. Compliance with the polluter pays principle, at some point, needs to become economy-wide and mandatory.
England has already made a good start on this transition from voluntary to mandatory. The Environment Act (2021) introduced legislation to create a compliance market for developers, known as biodiversity net gain (BNG). That legislation came into force this year and, while there are still several issues to be ironed out, the nascent BNG market represents a symbolic milestone, both for the UK and the world. It has enshrined the “polluter pays” principle into the core functioning of a vital sector of the economy and opened the door to long-term funding for land managers wanting to deliver nature restoration.
Further good news can be found in the government’s intention to allow nature-based carbon removals to supply the UK’s compliance carbon market, the Emissions Trading Scheme (UK ETS). This, again, would provide a bedrock of demand for nature-based solutions (NbS) that can deliver certified carbon units. As the scope of the UK ETS is broadened to include additional sectors of the economy in the future, there is also the potential for the scale of that demand to grow.
Of course, the devil will be in the detail of how any integration of nature-based solutions into the ETS is handled. For example, we at Nattergal completely disagree with the government’s current stance to prohibit the inclusion of peatland carbon units. In our view, there is no better form of nature-based emissions abatement than peatland restoration but, overall, we strongly welcome the inclusion of nature-based carbon projects within the UK ETS.
Certainty of demand is the basis of any market. It allows suppliers, in this case land managers, to plan ahead, make informed decisions and commit to the long-term or permanent changes in land use that nature recovery requires. This is why it cannot be up to the polluter to determine whether, when or how much they pay. A ‘mission economy’ approach and the creation or expansion of compliance markets is, in our view, the best way to price in environmental externalities and ultimately preserve a habitable world for future generations.
A bumpy road ahead?
Calling for more compliance markets is clearly a lot easier than creating them. It took many years, a lot of back and forth between stakeholders and multiple iterations to get BNG ready for launch. There is also the challenge of thinking about how some sectors, like fishing, even function if their impacts are priced in and, ultimately, the risk that any costs are just passed onto consumers.
All of this makes compliance markets inherently political. The recent challenge of getting the EU’s ‘Nature Restoration Law’ adopted reminds us that any legislation is vulnerable to the whims of democracy. In fact, this is probably the biggest risk to compliance markets, the clear caveat to any greater certainty of demand they provide.
But when set against the current fiscal backdrop and the now legally-binding targets most European governments have to restore 20% of their land and sea areas by 2030, we hope and believe compliance markets will be seen as an effective tool to fund that crucial action.
Whatever the challenges of creating and implementing markets that make polluters pay, they pale into insignificance against the challenge of restoring the natural world. Like the eddies on a river, our governments need to harness the major flows of capital around the world and redirect some of that financial firepower back upstream, to conserve and regenerate the systems our economies are dependent on.
While, undoubtedly, this idea will be met with fierce resistance, as generations with more skin in the game come of age, we believe there will be a growing acceptance of the “polluter pays” principle. That paying to restore the living systems on which we all ultimately depend is just the cost of doing business.