Voluntary Carbon Markets: An Overview of U.S. Regulatory Developments
January 17, 2023
As the importance of the voluntary carbon markets to global decarbonization goals grows, so too does U.S. regulatory and legal interest in this area, and the importance to public companies and their boards.
We briefly explain the voluntary carbon markets before discussing related Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) regulatory developments and the potential impact of the Inflation Reduction Act on these markets in the U.S. The development of transparent, sound and efficient voluntary carbon markets is of vital importance to the growing number of companies using carbon credits to help meet their emissions reduction and net zero goals and to comply with growing disclosure and related regulatory mandates.
Voluntary Carbon Markets: A Primer
Voluntary carbon markets allow carbon emitters to purchase credits that are awarded to projects that remove or reduce atmospheric carbon. These credits offset their emissions in furtherance of a voluntary commitment to reduce “net” emissions. These markets can be distinguished from “compliance” carbon markets, which is the term for systems where a government or regulator issues a carbon allowance that participants must not exceed unless they can purchase additional compliance allowances from another participant under the cap-and-trade program. Each credit typically corresponds to one metric ton of reduced, avoided or removed carbon dioxide or equivalent greenhouse gas.
The importance of the voluntary carbon markets is growing. According to the Taskforce on Scaling Voluntary Carbon Markets, voluntary carbon markets need to grow by more than 15-fold by 2030 in order to support the investment required to deliver the Paris Agreement’s goal of limiting the global average temperature increase to below 1.5°C above pre-industrial levels.
CFTC and SEC Interest in the Carbon Markets
The CFTC has shown an increasing interest in carbon. This focus largely began in September 2020 when the CFTC’s Climate-Related Market Risk Subcommittee issued a report titled Managing Climate Risk in the U.S. Financial System. The report concludes that climate change poses a major risk to the stability of the U.S. financial system and, in turn, the American economy, and presents fifty-three recommendations to mitigate the risks that climate change poses to the financial markets. In response, in March 2021, then CFTC Acting Chairperson Rostin Behnam established the Climate Risk Unit. The goal of the CFTC’s Climate Risk Unit is to “[focus] on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy.”
In June 2022, the CFTC issued a Request for Information (RFI) on Climate-Related Financial Risk. The RFI sought responses on questions specific to data, scenario analysis and stress testing, risk management, disclosure, product innovation, voluntary carbon markets, digital assets, greenwashing, financially vulnerable communities, and public-private partnerships and engagement. The CFTC indicated that it intends to use the responses to promote responsible innovation, ensure the financial integrity of all transactions subject to the Commodity Exchange Act, avoid systemic risk, inform the CFTC’s response to the recommendations of the Treasury Department’s Financial Stability Oversight Council 2021 Report on Climate-Related Financial Risk and inform the ongoing work of its Climate Risk Unit.
One key issue that has materialized in the comments in response to the RFI is whether the CFTC should establish a broader regulatory framework for the voluntary carbon markets, including the spot markets. The outcome of this debate is one area to watch as CFTC regulation of the voluntary carbon markets evolves.
In March 2022, the SEC proposed sweeping climate risk related disclosure and reporting rules. Although the issuance of the final rules has been delayed given reactions and challenges to the proposal, the proposed rules call for certain disclosures regarding carbon.
One element of the proposed rule calls for mandatory disclosures by any registrant that “maintains an internal carbon price” regarding the price per metric ton of carbon dioxide, the total price and how it is estimated to change over time, the rationale for the internal carbon price, and how it uses the internal carbon price to evaluate and manage climate-related risks.
Another aspect of the proposed rule requires any public filer who utilizes carbon offsets or renewable energy credits or certificates (RECs) as part of its net emissions reduction strategy to disclose the role of such carbon offsets or RECs in the registrant’s climate-related business strategy. These disclosures include the amount of carbon reduction represented by the offsets or the amount of generated renewable energy represented by the RECs, the source of the offsets or RECs, a description and location of the underlying projects, any registries or other authentication of the offsets or RECs and the cost of the offsets or RECs. The proposed rule also encourages registrants to discuss the role of carbon offsets and RECs in meeting climate-related targets or goals.
Comments submitted to the SEC in response to the carbon disclosure proposals have expressed some concern. For example, NASDAQ expressed concern on behalf of its listed companies that many disclosure requirements, including those related to internal carbon pricing and use of carbon offsets and RECs, only apply when the company has first voluntarily adopted an internal target or program. This, in turn, may have a chilling effect on the adoption of such targets and programs, as companies may seek to avoid the associated disclosure burdens. Other commenters expressed concern that the information that the SEC seeks regarding internal carbon pricing and use of carbon offsets and RECs is, in some cases, commercially sensitive, proprietary and immaterial. The SEC’s upcoming final rulemaking is obviously an important area for boards of directors and executives to watch.
Inflation Reduction Act
August 2022 saw the passage of the Inflation Reduction Act (IRA), which represents the outcome of the significantly more ambitious “Build Back Better” bill. This nonetheless far-reaching law includes provisions to “finance green power, lower costs through tax credits, reduce emissions, and advance environmental justice.” In pertinent part, the IRA is intended to reduce U.S. carbon emissions by roughly 40% by 2030 and to reach a net-zero economy by 2050. In support of these goals, the IRA makes “the single largest investment in climate and energy in American history,” in the amount of $369 billion.
The IRA also opens new pathways to transfer private capital into renewable projects. For example, the IRA includes updates to a tax credit located in Section 45Q of the Internal Revenue Code. This credit incentivizes use of carbon capture, utilization and storage (CCUS) technology. The updates increase the credit values for qualifying technologies, thus increasing the incentive to use these technologies. Further, the updates allow 45Q credit recipients to transfer all or any portion of the credit value to any third-party tax-paying entity in exchange for a cash payment during the credit window. Beyond monetization of 45Q credits, these updates also have the potential to advance the voluntary carbon markets. Projects utilizing CCUS technology may have the opportunity to sell carbon credits into the market representing their carbon abatement. Thus, if more businesses adopt CCUS technology due to the favorable tax treatment under 45Q, this may also lead to an increased supply of carbon credits, and therefore increase trading, in the voluntary carbon markets.
As the voluntary markets are expected to serve a growing role in fulfilling carbon emissions commitments, it is likely that regulation in this space will also increase. Boards of directors and executives, as well as other participants in these markets should keep a close eye on legal and regulatory developments as they consider their use of carbon credits and offsets as part of overall emissions reductions targets and strategy.
 Press Release, CFTC’s Climate-Related Market Risk Subcommittee Releases Report, Commodity Futures Trading Comm’n (Sept. 9, 2020), available here (press release); see also Rostin Behnam et al., Managing Climate Risk in the U.S. Financial System: Report of the Climate-Related Market Risk Subcommittee, Market Risk Advisory Committee of the U.S. Commodity Futures Trading Commission, Commodity Futures Trading Comm’n (2020), available here (full report).
 CFTC’s Climate-Related Market Risk Subcommittee Releases Report, supra n. 4.
 Compare Letter from Walt Lukken to Sec’y Christopher Kirkpatrick,Commodity Futures Trading Comm’n (October 7, 2022) at 10, available here (discouraging the CFTC from establishing a registry); with Letter from Cory A. Booker et al., to Chairman Rostin Behnam, Commodity Future Trading Comm’n (October 13, 2022) at 2, available here (recommending that the CFTC create a registry for carbon offsets, offset brokers and offset registries).
 For additional information on the SEC’s Climate Disclosures proposal, see our April 2022 alert memos available here. Press Release, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors, Sec. & Exch. Comm’n (March 21, 2022), available here; see also Proposed Rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors, Sec. & Exch. Comm’n, Securities Act Release No. 33-11042, Exchange Act Release No. 34-94478 (March 21, 2022), available here (“Proposed ESG Rules”).
 The proposed rules use carbon offsets to refer to “an emissions reduction or removal of greenhouse gases (“GHG”) in a manner calculated and traced for the purpose of offsetting an entity’s GHG emissions.” Proposed ESG Rules, supra n. 9at § 229.1500(a).
 The proposed rules define an REC as “a credit or certificate representing each megawatt-hour (1 MWh or 1,000 kilowatt-hours) of renewable electricity generated and delivered to a power grid.” Id. at § 229.1500(n).
 See id. at 77 & §§ 229.1502(b)(6), (d).
 Id. at § 229.1502(d).
 Id. at § 229.1502(b)(6).
 See Letter from Nasdaq, Inc. to Sec’y Vanessa A. Countryman, Sec. & Exch. Comm’n (June 14, 2022) at 13, available here; see also Letter from Kenneth E. Bentsen, Jr., President and CEO, Securities Industry and Financial Markets Association (SIFMA) to Sec’y Vanessa A. Countryman, Sec. & Exch. Comm’n (June 17, 2022) at 28, available here.
 See, e.g., Letter from Chevron Corporation to Sec’y Vanessa A. Countryman, Sec. & Exch. Comm’n (June 17, 2022) at 12-13, available here; Letter from Amazon.com, Inc. to Sec’y Vanessa A. Countryman, Sec. & Exch. Comm’n (June 17, 2022) at 7-8, available here.
 See 26 U.S.C.§ 45Q (credit for carbon oxide sequestration).
 See Krysta Biniek et al., Scaling the CCUS industry to achieve net-zero emissions, McKinsey & Co. (October 28, 2022), available here; see also Brandon Mulder, 45Q, Financial Uncertainties Hinder Capital Flow for CCS Deployment: Panel, S&P Glob. Commodity Insights (June 16, 2022), available here.