Considerations for Participants in the Expanding Market for Compensatory Mitigation Credits

In a recent blog post, we described the basic statutory and regulatory framework supporting the increasing popularity of mitigation banking.  In this update, we offer some additional observations for property owners and other sponsors who may wish to develop a mitigation bank, and identify some of the risks associated with that undertaking.

As described in our previous post, a mitigation bank is a wetland, stream or other aquatic or habitat resource area that has been restored, established, enhanced (or in certain circumstances) preserved for the purpose of providing compensation for unavoidable impacts to aquatic resources resulting from development.  The person or entity that establishes a mitigation bank and undertakes the restoration activities is sometimes referred to as a “mitigation banker” or “bank sponsor.”  Bank sponsors can generate “compensatory mitigation credits,” which can be sold to developers whose permits under Section 404 of the Clean Water Act (and similar federal and state regulatory authorities) impose mitigation obligations.  We have outlined below the basic steps that a sponsor seeking to establish a mitigation bank would need to follow to generate marketable credits. 

The first step in the process of establishing a mitigation bank is to identify and, if necessary, purchase a suitable project site.  Candidate properties should be limited to those that offer the greatest likelihood that they can be restored or enhanced at a cost that corresponds favorably with the likely value of the credits to be generated.  Factors relevant in assessing the ecological suitability of a potential project site include the soil characteristics of the site, landscape features of the surrounding watershed or habitat area, and reasonably foreseeable effects the project might have on the surrounding ecosystems.

In addition, because regulatory obligations generally require that the mitigation occur within the same watershed or habitat area in which the ecological damage occurred, a prospective sponsor should also consider the amount and nature of development taking place and expected to take place within the subject watershed or habitat area.  This assessment can assist the sponsor in selecting the optimal project site and restoration plan.

Once the sponsor decides to move forward with a restoration project at a particular location, a prospectus and mitigation plan must be submitted to a regulatory body known as the “Interagency Review Team” (“IRT”); this is a group of federal, tribal, state, and local regulatory and resource agency representatives who historically have been headed by the local district engineer for the Army Corps of Engineers.  These initial submissions serve to document the key aspects of the proposed project, and also provide the primary source of information for the public during the public comment period (which begins within 30 days of the IRT’s receipt of the prospectus and continues for an additional 30 days).

The prospectus should provide a summary of information concerning the proposed bank, as well as more specific information pertaining to its establishment and operation, long-term management strategies, and the bank’s proposed service area.  The prospectus should also address the technical feasibility of the restoration project.

The mitigation plan must provide a description of the nature of the project to be undertaken (i.e., restoration, establishment, enhancement, or preservation), documentation of the needs of the local watershed or habitat area, and a description of the factors considered during the site selection process.  The mitigation plan should also identify the number of compensatory mitigation credits to be issued by the bank upon completion of the project.

Following regulatory review of the prospectus, a draft banking instrument must be prepared that conforms with the terms of the prospectus.  It should describe the physical and legal characteristics of the mitigation bank as well as the protocols pursuant to which the bank will be established and operated.  In addition, the banking instrument identifies the number of credits to be issued in connection with the mitigation bank, provides a description of the protocols governing management of the bank, and includes a long-term operation and maintenance plan for the site.

The draft banking instrument is subject to review by the appropriate regulatory authorities (depending on whether the project is a watershed or habitat restoration).  The review process typically includes some evaluation of the economic viability of the proposed project.  Upon completion of the review process, the draft banking instrument is subject to a 30-day comment period, following which the sponsor may be required to make additional revisions to the document.  

Once the sponsor has addressed any remaining concerns regarding the terms of the draft banking instrument, it may submit the final version of the instrument, together with supporting documentation detailing any changes from the draft, to the regulatory authorities for approval.  Only after this documentation has been submitted and approved may the sponsor begin selling credits into the mitigation banking market.

Although the potential financial and ecological benefits of establishing a mitigation bank are well-documented, there is some uncertainty associated with the endeavor.  Like any major construction project, there is always the risk of substantial cost overruns due to delays in the regulatory review process or other unforeseen circumstances.  There can also be uncertainty resulting from variability over time in the market value of the compensatory mitigation credits to be generated. 

Some of the risks inherent in restoration projects can be addressed through a thoughtful and comprehensive due diligence effort at the outset.  For example, because the existence of conflicting property rights (for example, preexisting easements) can pose an obstacle to the timely and cost-effective completion of a restoration project, a thorough title search should be performed during the early stages of the project.  In addition, because of the variability in the value of the compensatory mitigation credits to be generated by the project, early consideration of possible hedging strategies might be prudent.