April 18, 2024
The Commodity Futures Trading Commission (CFTC) released preliminary guidance regarding the trading of voluntary carbon credits on designated contract markets. This marks a notable step in enhancing the credibility and integrity of the voluntary carbon market. Before we delve into the details of the CFTC’s proposals, let’s first outline the significance of carbon offsetting, the voluntary carbon market, and the broader responsibilities of the CFTC.
Carbon offsetting is a government-created market aimed at reducing carbon emissions by utilizing carbon credits. These credits are produced through actions that either remove greenhouse gases from the atmosphere or prevent their release into it. Each carbon credit symbolizes the removal or prevention of one metric ton of carbon dioxide or its equivalent.
Voluntary Carbon Markets (VCMs) facilitate the buying and selling of these credits. This enables individuals and organizations to offset their carbon footprint voluntarily. The VCMs help fight climate change by allowing private individuals and organizations to fund projects that either remove greenhouse gas emissions from the air or reduce emissions related to various human activities like industry, transportation, energy, buildings, agriculture, and deforestation.
Companies, governments, non-governmental organizations, and other groups take part in VCMs. Companies join to invest in projects that create tradable greenhouse gas credits, offset their own emissions voluntarily, or support efforts to reduce emissions or remove greenhouse gases from the air. They do this to meet their climate targets, stand out from competitors, build brand recognition and loyalty, and market products as “carbon neutral.”
The CFTC is an independent agency of the U.S. federal government. Its primary mission is safeguarding the U.S. derivatives market. This entails upholding market integrity, preventing price manipulation, safeguarding customer funds, and mitigating systemic risk. Additionally, the CFTC encourages responsible innovation and fair competition within the derivatives markets.
Voluntary carbon credit markets facilitate the transition to a low-carbon economy through market-based mechanisms. Carbon credits are traded either over-the-counter or on spot exchanges. The CFTC holds enforcement authority and regulatory oversight over VCMs and any trading activities within these markets. Furthermore, the CFTC exercises anti-fraud and anti-manipulation enforcement powers over spot markets associated with carbon credits. CFTC jurisdiction extends to carbon allowances and other environmental commodities products linked to futures contracts as well.
VCMs also help direct private financing to climate-action projects that would not otherwise get off the ground. The Institute of International Finance estimated that demand for carbon offset credits could increase by a factor of 15% or more by 2030. The McKinsey Sustainability group estimated that the market for carbon credits could be worth upward of $50 billion by 2030.
The CFTC’s proposed guidance focuses on voluntary carbon credit derivative contracts traded on designated contract markets (DCMs). These contracts allow parties to trade carbon credits to offset emissions. The guidance outlines requirements for DCMs concerning the quality of carbon credits, delivery methods, and inspection rules.
A significant part of the guidance emphasizes maintaining the integrity of traded carbon credits. DCMs are expected to provide detailed information about eligible carbon credits, including transparency, permanence, and reliability of quantification. By following established standards like the Integrity Council for the Voluntary Carbon Core Carbon Principles, the guidance aims to promote fair and transparent trading while reducing the risk of fraud.
Additionally, the guidance clarifies the role of carbon crediting programs and registries in facilitating credit delivery. DCMs are urged to evaluate the governance frameworks and tracking mechanisms of these registries to prevent double counting and ensure credit accuracy.
Although the proposed guidance represents progress in improving transparency and integrity in the voluntary carbon market, challenges remain. There are uncertainties about enforcement mechanisms, the effectiveness of voluntary compliance, and reliance on carbon crediting programs. Nevertheless, by setting clear expectations and aligning with established standards, the CFTC’s guidance lays the groundwork for a more resilient and trustworthy market for voluntary carbon credits.
One of the most important tools in the CFTC’s fraud-fighting arsenal is its Whistleblower Program. The CFTC’s Whistleblower Program is aimed at safeguarding and rewarding whistleblowers for reporting potential violations of the Commodity Exchange Act (CEA), including violations related to the voluntary carbon markets. The CFTC’s Whistleblower Program not only offers financial incentives to whistleblowers but also ensures privacy, confidentiality, and safeguards against retaliation. Whistleblowers who provide voluntary information leading to the recovery of at least $1 million in penalties by the CFTC (or related authorities) may qualify for awards of up to 30% of the collected penalties.