OECD Conference 2-3 December 2004 Economic Aspects of Environmental Compliance Assurance Incentive Framework for Firms t

1. OECD Conference 2-3 December 2004 Economic Aspects of Environmental Compliance Assurance Incentive Framework for Firms to Comply with Regulations Presentation by Dirk Hazell, BIAC Environment Committee; Chief Executive, Environmental Services Association.

2. A context:- The smart Hierarchy of public policy tools 1 Voluntary initiativesshould be preferred, since these often provide the most flexible and, ultimately, overall most cost-effective way to achieve a desired result. 2 Negotiated agreementscan provide high operational flexibility if focused on what is required rather than on how it is to be achieved. 3 Economic instrumentscan provide incentives but must be carefully designed to avoid unintended, unwanted consequences-such as the creation of perverse subsidies. 4 Command-and-control regulationsare needed to outlaw unsafe and unacceptable behavior and to provide the framework within which innovation can flourish. Alone, however, they cannot deliver continuous improvements, since the most effective solutions cannot be predicted or prescribed in advance. Source Holliday and Pepper (2001) Sustainability through the Market: seven keys to success Comment: Weighting of 1-3 increasingly important compared to 4. Move to more numerate (on-line) regulation focussed more on monitoring compliance systems than site inspection.

3. Illustration of Voluntary initiative/Negotiated agreements Under threat of regulation from the European Commission, EU paper industry made voluntary commitment to increase paper recycling to 56% by 2005. In the UK the Government and newspaper publishers agreed a voluntary target to increase recycled content of newspapers to 70% by 2006 (current figure is 65%) and some mills already utilise 100% recycled content. Negotiation of voluntary targets in UK appears to have secured commitment of all participants to targets agreed to be economically, environmentally and physically possible.

4. Optimal mix of policy instruments should be determined by:- Environmental effectiveness Economic efficiency Flexibility of response Administrative feasibility Fiscal neutrality Equity and level playing field Transparency of compliance Acceptability Simplicity and complementarity Shift from goods to bads Confidence in regulatory environment Gradual introduction and progressive implementation Sources: de Andraca and McCready 1994, Schmidheiny 1992 as reproduced in Walking the Talk: the Business Case for sustainable development

5. Economic Perspective: “business” does not compare compliance and non-compliance costs and choose least costly alternative. Responsible regulated business plans on basis of compliance with law. However, key issues for business include: Minimising compliance costs (e.g. using own management systems for environmental protection); & achieving required environmental outcomes without reducing rate of return on capital of company or across economy: implies risk based and outcome focussed environmental parameters, and smart regulation working with grain of market (e.g. cap and trade).

6. Again, Responsible regulated business plans on basis of compliance with law. This means formula in the briefing paper x = pF Where x is cost of non-compliance p is probability of detection and F is severity of (non-)financial sanction is most relevant to criminals. Within the UK, ESA strongly supports use of market oriented instruments (and less strongly supports fiscal instruments) to achieve environment outcomes for legitimate business but ESA has also been the strongest advocate for the environmental regulator having resources to increase p for criminals.

7. No suggestion that SMEs inherently more dishonest: often powerful local community pressures on conduct. But authorities have duty to inform SMEs of non-obvious legal duties and keep as simple as possible: 75% of UK’s business (i.e. most SMEs) do not know their legal duties as producers of waste. When EU/UK waste laws being tightened, imperative to educate SMEs if criminals are not to supplant legitimate regulated waste management industry.

8. Market increasingly more apt than command and control Potentially easier and more environmentally effective for regulator to concentrate on monitoring outputs than detail of process. Data requirements internalised: decisions made on existing management data. Flexibility for companies on how to comply – market cost of abatement/innovation against price of permit.

9. In Colorado existing homeowners get permits to burn wood based on historic use. People wanting new wood stoves must retire two existing permits. A trading system modelled progressively to design out wood burning. UK recovers 50% packaging, Germany recovers 80% packaging. Germany’s Scheme costs 25 times as much as UK’s. Which is better?

10. Market itself can be driver for better environmental standards: insurance costs, adjusted for inflation, of extreme weather events 1000% higher in the 1990s than in the 1950s, averaging US $40 billion each year in 1990s. Although obvious problem with timescales: e.g. need to spend money to mitigate global warming now to prevent phenomena such as flooding of World’s major conurbations in late 21st Century.

11. Another reason why the market is increasingly important: character of environmental regulation will be fundamentally changed by EU/OECD work on topics like life cycle analysis, resource efficiency and…producer responsibility. Producer responsibility illustrates new purpose of environmental regulation in developed world: less regulation of industrial process, more focus on overall impact including use and post use phases. By compelling producers to design in environmental sustainability, “irresponsible” producers do not get free ride: EU’s WEEE model requires producers to pay for recovery of their own products. Producer responsibility transfers environmental costs to consumers and can also reduce authorities’ costs.

12. Biffa, the largest UK owned waste management company, estimates that environmentally neutral end of life strategy for ‘fridges would cost an extra 8% on the retail price, 2.5% for brown goods (televisions), 4% for tyres, 0.5% for cars, and 15% for glass containers but for fluorescent lights, an extra 44%: equivalent to factory gate price.

13. Community Pressure/CSR/Reputation/social norms Often this is the key driver: can be more important than level of monetary fines. Perhaps the single most salient characteristic of the Johannesburg World summit was the promotion of and open commitment to CSR agenda-with a strong environmental component-by global business leaders: particularly the leadership of the two largest groups-Suez and Severn Trent-in ESA’s membership. There was a strong emphasis on practical outcomes and the role of formal regulation was relatively limited.

14. CSR can determine reputation and a company’s “licence to operate” among investment/local communities, politicians and media. e.g. Thames Water on pollution: “Every single incident is one that we regret…the fine itself is a huge issue, but then there is the reputational damage and the matter of pride: every time an incident happens…the organisation hurts. None of us want to cause damage…the type of people that are attracted to our business are predominantly people who are environmentally aware…When we try to buy companies in the US, our pollution record and our prosecution record is actively used against us…all in all, these combined issues have a huge impact. There is absolutely no benefit to us in continuing these activities, and we want to prevent them.” John Sexton, Managing Director Thames Water 

15. Similarly SITA’s reports to Suez Environment consider only three aspects of SITA’s activity: financial performance health and safety environmental compliance. Environment compliance is therefore a key determinant of performance considered at the international group level. 

16. Companies’ environmental performance increasingly matters to the investment community: Business in the Environment asked financial services analysts in London to rate importance of a company’s environment and social/community record. Increase in analysts rating environment as “fairly or very important” was 20% in 1994 and 33% in 2001. 176 companies participate in BiE Index of Corporate Environmental Engagement, including 74 FTSE 100 companies. Environment scores of participants are rising and are particularly high for utilities. Larger businesses typically companies listed on stock exchanges so accountable to non-environmental regulators and owners.

17. CSR/Environmental performance increasingly seen as area for competition for employees.

18. NB in global markets level playing field not confined to one Country: ESA’s manifesto for European Parliament Elections in 2004 recommended:- support for new EU Member States (where progress to compliance with EU environmental law costs about 3% GDP); and Enhanced power for European Environment Agency to audit EU Member States’ compliance with EU environmental law.