The joint conference paper, 'Third-party effects of water trading and potential policy responses' by Anna Heaney (ABARE), Gavan Dwyer (PC), Stephen Beare (ABARE), Deborah Peterson (PC) and Lili Pechey (ABARE), was presented to the American Agricultural Economics Association conference, Providence, Rhode Island, 25 - 27 July 2005. A key feature of water policy reform in Australia has been the separation of water access entitlements from land titles and the establishment of markets for water. However, the separation of water entitlements from land entitlement is not a sufficient condition to ensure that water markets are complete. In the absence of fully defined property rights, water markets will be incomplete and trade has the potential to create third-party effects. However, property rights over natural resources are seldom completely specified, because of the existence of transactions costs. The benefits from eliminating third-party effects need to be sufficient to warrant intervention. The objectives in this paper are to identify key potential third-party effects of water trade under existing property rights structures in Australia, and to examine policy responses to address these effects. The discussion draws on the concepts of exclusiveness and rivalry as key characteristics that determine the applicability of property rights solutions to third-party effects of trade. It is likely that many of the third-party effects of trade discussed in this paper do not warrant policy intervention at the national or state level. In some instances, effects are likely to be relatively minor, although some may be significant at the local level. The costs of addressing some third-party effects may outweigh the benefits. Where there are significant gains from trade, the existence of these third-party effects should not been seen as a reason to impede trade. There are first-best policy instruments to address these effects at an appropriate scale. *ABARE (Australian Bureau of Agricultural and Resource Economics); PC (Productivity Commission) **The views expressed in this paper do not necessarily reflect those of the Productivity Commission.