Voluntary Carbon Markets: Is It the CFTC’s Time to Shine?
January 17, 2024
Companies have identified that the voluntary carbon markets may play an important role in contributing to a reduction in their net greenhouse gas (GHG) emissions, and, therefore, in meeting their GHG emissions reduction goals. However, they have also exercised caution in embracing the voluntary carbon markets due to complicated standards, carbon credit quality issues and lack of market and pricing transparency. Since 2020, the Commodity Futures Trading Commission (CFTC) has shown an increasing interest in regulating the voluntary carbon markets, and this interest has culminated in significant developments in 2023, including the Whistleblower Alert, establishment of its Environmental Fraud Task Force, the Second Voluntary Carbon Markets Convening and now the Proposed Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts. These CFTC initiatives have the potential to address some of the well-known challenges in the voluntary carbon markets, which may lead to a healthier and more robust market. We begin with a brief overview of the voluntary carbon markets before discussing the CFTC’s recent actions in this area.
Voluntary Carbon Markets Overview
Voluntary carbon markets allow carbon emitters to purchase credits that are awarded to projects that remove or reduce atmospheric carbon. These credits offset the carbon emitters’ own GHG emissions in furtherance of a voluntary commitment to reduce “net” emissions. Each credit typically corresponds to one metric ton of reduced, avoided or removed carbon dioxide or equivalent GHG. Within the voluntary carbon markets, there are two main types of carbon credits:
i. avoidance credits, which correspond to projects that prevent or reduce carbon emissions that would have otherwise occurred, such as renewable energy projects, energy efficiency improvements and recycling projects; and
ii. removal credits, which correspond to projects that capture and store existing atmospheric carbon, such as afforestation, reforestation and implementation of carbon capture and storage technology.
Not all carbon credits, however, are created equal, and differences in pricing reflect the market’s faith in the “quality” of the specific carbon credit. For example, some believe that nature-based credits suffer from increased challenges because they may not offer permanence – e.g., there is always a risk that the trees that were planted as part of a project that generated the credits burn down – and this is often reflected in lower prices for these nature-based credits.
The voluntary carbon markets can be distinguished from “compliance” carbon markets, 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 a cap-and-trade program.
In recent years, the CFTC has taken various, often compounding, actions to address fundamental issues in the voluntary carbon markets. The CFTC’s focus on climate change and the voluntary carbon markets began in earnest 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. In response, in March 2021, then CFTC Acting Chairperson Rostin Behnam established the Climate Risk Unit. In June 2022, the CFTC held its first Voluntary Carbon Markets Convening, and, in concert, issued a Request for Information (RFI) on Climate-Related Financial Risk. For more information regarding the CFTC’s actions from 2020 through 2022, please see our January 2023 memo “Voluntary Carbon Markets: An Overview of U.S. Regulatory Developments,” available here.
2023 saw acceleration of the CFTC’s focus on the voluntary carbon markets. On June 20, 2023, the CFTC’s Whistleblower Office in the Division of Enforcement issued an alert on how to identify and report potential Commodity Exchange Act (CEA) violations connected to fraud or manipulation in the carbon markets. Shortly thereafter, on June 29, 2023, the CFTC announced it had established an Environmental Fraud Task Force. The purpose of the Task Force is to combat fraud and misconduct in regulated derivatives markets and relevant spot markets (such as voluntary carbon markets) relating to purported efforts to address climate change and other environmental risks. On July 19, 2023, the CFTC held its Second Voluntary Carbon Markets Convening. The purpose of the Convening was to discuss current trends and developments in the cash and derivatives markets for carbon credits, public sector initiatives related to carbon markets, recent private sector initiatives for high quality carbon credits and market participants’ perspectives on how the CFTC can promote integrity for high quality carbon credit derivatives. The Convening confirmed that the CFTC intends to take a two-prong approach to its role in addressing potential fraud and manipulation in the voluntary carbon markets, exercising both: (i) its enforcement authority to prevent fraud and manipulation in the markets and (ii) its regulatory role to develop guidance relating to environmental products.
Most recently, on December 4, 2023, the CFTC issued for public comment Proposed Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts. The Proposed Guidance acknowledges that participants in the voluntary carbon markets have faced challenges such as lack of standardization, transparency and integrity, and seeks to address these challenges through guidance issued to designated contract markets (DCMs) over which the CFTC, as primary regulator, has clear authority. In particular, the Proposed Guidance identifies certain factors that DCMs should address in the design of voluntary carbon credit derivatives contracts to avoid the possibility of manipulation. These factors include:
- Quality Standards such as (i) transparency, (ii) additionality, (iii) permanence and risk of reversal and (iv) robust quantification;
- Delivery Points and Facilities, taking into account the governance framework and tracking mechanisms of the crediting program underlying the VCCs, as well as the crediting program’s measures to prevent double-counting; and
- Inspection Provisions or certification procedures for verifying compliance with the latest procedures in the voluntary carbon markets.
Further, the Proposed Guidance places an affirmative obligation on DCMs to perform diligence on voluntary carbon credits underlying listed derivatives, and encourages DCMs to push crediting agencies towards robust quality standards, tracking mechanisms and internal governance in pursuit of heightened diligence standards, which, in turn, should foster market participant confidence in the contract and enhance liquidity.
For more information on the Proposed Guidance, please see our December 2023 alert memo, available here, and January 2024 alert memo, available here. Comments on the CFTC’s proposal are due on February 16, 2024.
Challenges with the voluntary carbon markets, such as complicated standards, carbon credit quality and integrity issues and lack of market transparency, have served as a barrier to entry for many companies, as well as a barrier to an efficient secondary market. But the voluntary carbon markets offer a promising alternative through which companies may offset their unavoidable emissions and therefore meet net GHG emissions goals. At COP28, the voluntary carbon markets were a main focus, and John Kerry, the U.S. climate envoy, said that the carbon markets may become “the largest marketplace the world will have ever known.”
The CFTC is increasingly asserting its role in maintaining the integrity of the markets and thus fostering the market’s potential for growth. We expect that the voluntary carbon markets will remain an area of focus for the CFTC, as the regulator seeks to shore up the markets against the possibility of manipulation and fraud. Notably, the Proposed Guidance seeks to improve transparency regarding the quality of not only the voluntary carbon credit derivative contract, but also of the underlying GHG avoidance or removal project. This increased transparency would provide companies with a way forward to conduct their own diligence regarding carbon credits, and would therefore help them to better assess both the carbon credits and the associates derivatives that they are trading in the markets. Boards of directors and executives, particularly those who have expressed skepticism regarding the reliability of the voluntary carbon markets, should monitor the CFTC’s rulemaking and guidance in this area, as increased regulation may help to address some of the current shortcomings of the voluntary carbon markets and make those markets a more attractive source of achieving their environmental ambition. In the interim, boards of directors and executives should continue to look at how these markets evolve and whether they can support their companies’ net zero commitments while keeping track of disclosure obligations as public filers.
This article was republished by Law360.
 See Commodity Futures Trading Commission Press Release, “CFTC’s Climate-Related Market Risk Subcommittee Releases Report” (September 9, 2020), available here; 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” (2020), available here. We also note that in the Securities and Exchange Commission (SEC) and CFTC’s joint 2012 product characterization final rule, the regulators discussed environmental commodities, such as emissions allowances, carbon offsets/credits or renewable energy certificates, that can be physically delivered and consumed as one example of intangible nonfinancial commodities that could underly a transaction subject to the forward contract exclusion from regulation as a swap. See Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48208, 48233 (August 13, 2012).
 DCMs are CFTC-regulated exchanges that provide participants in the derivatives markets with the ability to execute or trade derivative contracts with one another. Commodity Futures Trading Commission, Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts; Request for Comment, RIN 3038-AF40 (Dec. 4, 2023), available here (“Proposed Guidance”) at 3 (citing 7 U.S.C. 1a(6)).
 See Proposed Guidance at 12-13.
 See generally id. at 23-37.
 See generally id. at 19-23.
 Notably, the SEC’s climate rule is now on its Reg-Flex agenda for April 2024. See Securities and Exchange Commission, Agency Rule List – Fall 2023, available here. While a final climate rule has not yet been adopted, the proposed rule would require (i) 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 and (ii) 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, among other disclosure requirements. For additional information on the SEC’s Climate Disclosures proposal, see our April 2022 alert memos available here; see also Securities and Exchange Commission, Proposed Rule: The Enhancement and Standardization of Climate-Related Disclosures for Investors, Securities Act Release No. 33-11042, Exchange Act Release No. 34-94478 (March 21, 2022), available here.