The CFTC’s Second Voluntary Carbon Markets Convening Provides Insight Into the CFTC’s Views on Its Regulatory and Enforcement Role in the Carbon Markets

July 19, 2023

On Wednesday, July 19, the CFTC held its Second Voluntary Carbon Markets Convening to discuss developments in the spot and derivatives markets for carbon credits, public and private initiatives for high quality carbon markets, and market participants’ perspectives on the CFTC’s role in promoting transparency and integrity in the carbon credits markets.

Wednesday’s Convening follows two announcements by the CFTC’s Enforcement Division last month, first seeking whistleblower tips related to fraud and/or manipulation in the carbon markets, and second launching the Environmental Fraud Task Force to combat environmental fraud and misconduct in derivatives and relevant spot markets. The event was highly anticipated following the significant industry response to the CFTC’s Request for Information which followed the first convening last year.

The Convening confirms that the CFTC intends to take a two-prong approach to its role in the voluntary carbon markets, exercising both its enforcement authority to prevent fraud and manipulation in the markets and its regulatory role to develop guidance relating to environmental products. The Convening also confirms that the CFTC and market participants are aligned in developing robust voluntary carbon markets and mitigating the concerns that market participants have expressed, particularly relating to the lack of transparency as to the price and quality of the carbon credits being traded in the voluntary carbon markets. While the CFTC’s Director of Enforcement indicated that the Enforcement Division has a number of open cases in the voluntary carbon markets space, it is less clear when the CFTC will issue any guidance or in what areas the CFTC will seek to exert its regulatory influence, but this is an opportunity for the CFTC to provide leadership and enhancements to the safety and soundness of the carbon markets that industry participants may welcome.

A summary of each of the Convening’s panels are provided below, along with links here to the Chairman and Commissioners Johnson, Goldsmith Romero, and Mersingers’ opening remarks.

Director of CFTC Division of Enforcement, Ian McGinley

Director McGinley gave opening remarks in which he addressed the wide range of allegations involving fraud and misconduct in the carbon markets and the CFTC’s jurisdiction to address such misconduct. Director McGinley noted that the CFTC has regulatory authority over futures and enforcement authority over anti-fraud/manipulation in spot markets, and that carbon credits are listed as underlying commodities for future contracts listed on derivative exchanges that the CFTC regulates. As such, Director McGinley confirmed that the CFTC would take an active role in exercising its authority, as reflected by two major steps that the Division had taken in June – an alert issued by the Whistleblower Office notifying the public on how to report a violation of fraud or manipulation, and the creation of an Environmental Fraud Task Force, which is a collaboration between line attorneys and supervisors from CFTC offices and other agencies.  Director McGinley ended with the reminder that while carbon credit markets are relatively new, the Division of Enforcement has long possessed the tools to prosecute fraud and manipulation, and that it would use those tools as appropriate in these new markets.

U.S. Federal Government

Representatives from several different Federal agencies spoke about the efforts that their agencies have been making in the carbon emissions space. Carol A. Petsonk, Assistant Secretary for Aviation and International Affairs, Department of Transportation, spoke about the importance of ensuring the integrity of the market, as well as the Department of Transportation’s willingness to participate in whatever way to reduce emissions. Sean Babington, Senior Advisor for Climate, Office of the Secretary, U.S. Department of Agriculture (“USDA”) discussed agriculture’s unique position as both vulnerable to climate change and a large source of domestic emissions itself. He noted that USDA has been focused on looking to nature-based solutions and working as an incentivizing entity, rather than a regulator. From Domestic Finance, Department of the Treasury, Counselor D. Wilson Ervin emphasized that Treasury is following initiatives that look to improve market function, especially given the enormous potential of voluntary carbon markets. He pointed that the price disparity for credits for low- and high-quality CO2 is too high, and that urgent repair work needs to be done in this space. Lastly, Molly Peter-Stanley from the Department of State stated that the State Department is dedicating considerable energy and time to voluntary carbon markets because of the potential to channel new private investments to actions that generate verified climate results. Engagement with public-private initiatives like the Leaf Coalition has been important, as these initiatives help provide a model for the government.

VCM Markets Overview

Speaker Kyle Harrison, the Head of Sustainability Research at BloombergNEF, presented on an analysis of the voluntary carbon market and forecasts for the transition to a low-carbon economy.  Harrison stated that corporations and the private sector were well-poised to lead the transition to achieve net-zero targets, but that all companies would require verified reduction certificates to achieve this goal. He showed that, while the voluntary carbon markets have scaled up significantly, the demand for carbon credits fell in 2021, after peaking in 2022, even as the supply of carbon credits increased significantly. Harrison attributed the decrease in demand to concerns about greenwashing, integrity, and liquidity. He stated that this has resulted in the cost of carbon credits falling to around $9.5 per ton. He stated that the there is a need to regulate supply to boost integrity so that prices rise to the level required to make companies make significant changes.

Private Sector Standards, Initiatives, and Credit Ratings

Speakers addressed the CFTC from a wide variety of private sector organizations, including the Integrity Council for the Voluntary Carbon Market (ICVCM), ISDA, the World Bank, environmental nonprofits (Center for Climate and Energy Solutions and Environmental Defense Fund) and carbon credit standard-setters and ratings, certification, and registry providers (Gold Standard, Verra, Sylvera and BeZero Carbon). There were three common themes throughout many of these comments. First, these organizations welcome oversight from the CFTC, particularly in the ambit of its anti-fraud and anti-market manipulation authority, and encourage the CFTC to draw on the work of the private sector. Second, integrity is key to scaling the voluntary carbon markets. There are three key dimensions of integrity: (i) integrity of supply – accomplished through guidelines and standards for environmental and social integrity, (ii) integrity of demand – companies’ use of carbon credits should not detract from, or be a substitute for, other actions taken to reduce supply chain emissions and (iii) integrity in exchange – ensuring transparency and preventing fraud in the market. Third, carbon credits are by nature heterogenous, and it is currently difficult to get a hold of high-quality credits. There is nonetheless strong demand in the market for verified, high-quality carbon credits.  Demonstrating that carbon credits are high quality is not just a matter of information transparency, but of analyzing and processing the information in a way that is digestible to investors.

Spot Exchanges & Markets

Key market participants presented updates on developments in the carbon industry. Former CFTC Commissioner the Honorable Dan M. Berkovitz noted the importance of the CFTC staying in sync with industry standards and underscored the CFTC’s attention to addressing novel methods of fraud and manipulation in this space. Panelists included a representative from Xpansiv, a developer and operator of registry infrastructure which services several of the biggest registries currently in operation; Incubex, a carbon product developer; Climate Impact X and AirCarbon Exchange, marketplaces and exchanges based in Singapore; and the UN Sustainable Stock Exchanges Initiative, a global platform for exploring how exchanges can enhance performance on ESG issues and encourage sustainable investment. The overarching theme of the comments from the panelists was the importance of data collection in standardization throughout the market and increased price transparency and liquidity. Participants highlighted the importance of regulatory alignment with industry standards to aid in the CFTC’s goal of preventing fraud and manipulation. Participants discussed the growth of various platforms and exchanges despite short term cooling periods resulting from negative media coverage and high interest rates, and the evolution of well-functioning markets with best practices. Additionally, the meeting highlighted the significance of transparency and data tracking to promote a credible and robust carbon market. Overall, the industry demonstrates ongoing efforts to enhance market integrity and encourage sustainable investment in environmental initiatives.

Derivatives Exchanges

Speakers with different relationships to the market spoke on derivatives exchanges and how they can be used to increase transparency and liquidity in the carbon market. First, Vincent McGonagle, Director of the CFTC Division of Market Oversight, spoke on how the CFTC works with entities developing NEW products. The CFTC reviews products and, in the case of entities self-certifying, ensures that the products comply with the requirements before listing and during its lifespan. McGonagle reports that out of 60 carbon contracts certified, 24 have attracted liquidity and three are within the top 100 futures contracts traded, indicating significant interest. Second, Mike Kierstead, Head of Environmental Products at the Intercontinental Exchange (ICE), described the difficulty for buyers of credits who make a net-zero pledge to understand and navigate markets. He supported government-mandated markets and recommended following the IOSCO recommendations for the carbon market. Third, Peter Keavey, Managing Director & Global Head of Energy & Environmental Products at CME Group, reported that CME’s voluntary carbon futures had seen a lot of activity with the amount of non-U.S. business much higher than for other commodity contracts. He stated that because carbon futures are relatively new, participants tend to hedge more, and that voluntary carbon futures are an asset class that should be treated as a commodity product with similar procedures for other commodity products. Finally, Caroline Gentry, Director of Environmental Products at Nodal Exchange, described how EEX Group has tried to break down the barrier to entry in voluntary carbon contracts by expanding the offerings and ensuring liquidity. She stated that the exchange provides clearing and risk management, and that confidence will grow in the products as they standardize and there is innovation.

Market Participants

Stakeholders had the opportunity to give brief statements to close out the Second Voluntary Carbon Markets Convening. These stakeholders ranged from academics to carbon trading brokers to private forestland owners. All participants agreed that the primary issue that the CFTC needs to respond to is the lack of quality transparency in the carbon market, and several participants emphasized the unique opportunity to scale the carbon market at this point in time. However, stakeholders were divided on two main issues. The first is who – whether the CFTC or the private sector – should develop standards to measure the quality of carbon credits. Those who believe the private sector should develop the standards argued that the private sector has more resources and expertise to allocate to the task, while those who believe it should be the CFTC suggested that this is exactly the kind of oversight and enforcement role the CFTC is meant to take on. The second topic of division was whether the CFTC should be looking into how carbon reductions and credits are being used. While some stakeholders believed data on the environmental impact of the use of carbon reductions and credits is universally important, others argued that it is beyond the scope of the CFTC’s role to collect such data.