The Regulatory Potential of Financial Security to Reduce Environmental Risk

Abstract

This article argues that requiring operators to hold financial security, such as insurance, bonds or guarantees, to cover their environmental liabilities offers considerable regulatory potential to restrict the incentives for environmental irresponsibility created by the doctrine of limited liability. It is contended that this regulatory potential derives from the fact that the incentive structures created by various financial security measures could motivate operators to reduce their environmental risk, this being defined as the probability that their activities will cause an environmental accident. It is concluded that the measures which appear to exhibit the greatest potential to reduce environmental risk do so through the contractual governance of the operator’s behaviour and the provision of economic incentives to improve safety levels and/or financial standing. This finding raises the prospect of third party providers of financial security functioning as ‘surrogate’ regulators of the operator’s activities. In doing so, they may augment the monitoring and enforcement capabilities of public regulators, thereby creating a more robust regulatory regime.