CFTC Proposes Guidance on Trading Voluntary Carbon Credit Derivatives
The Commodity Futures Trading Commission (CFTC) has introduced proposed guidance on the trading of voluntary carbon credit (VCC) derivative contracts. This guidance provides designated contract markets (DCMs) with specific provisions to address under the Commodity Exchange Act (CEA) and CFTC regulations. The proposal seeks input on various VCC-related issues and is part of the Biden Administration’s focus on climate change. Comments on the proposal can be submitted until February 16, 2024.
The proposed guidance from the CFTC aims to advance integrity, transparency, liquidity, and price discovery in carbon markets. Chairman Rostin Behnam stated that this action is the result of a two-year examination of carbon markets and extensive work on the impact of climate change on financial markets. The guidance outlines three key considerations for DCMs: listing only resistant derivative contracts, monitoring contract terms, and adhering to product submission requirements. These guidelines align with ongoing initiatives to enhance VCC quality and market integrity, including the recent launch of the Core Carbon Principles (CCPs) by the Integrity Council for the Voluntary Carbon Market (ICVCM).
The CFTC’s proposed guidance also emphasizes the importance of considering essential VCC commodity characteristics when designing derivative contracts. This includes focusing on quality standards, delivery points and facilities, and inspection provisions. These guidelines are tailored to fit within the existing market and regulatory framework of the CFTC and the commodity-related markets it oversees.
Voluntary carbon credits (VCCs) are tradable instruments that allow for the voluntary buying and selling of rights to claim greenhouse gas (GHG) emissions reductions or removals. However, the VCC market faces challenges in assessing the quality of VCCs and determining appropriate carbon pricing. The CFTC’s guidance aims to address these concerns by establishing criteria for VCCs, such as transparency, additionality, permanence and risk of reversal, and robust quantification. These criteria align with the Core Carbon Principles (CCPs) established by the ICVCM.
While the CFTC’s guidance focuses on technical criteria for VCCs, it does not explicitly address broader social and environmental considerations. The agency is seeking feedback on whether DCMs should consider these concerns in the design of VCC derivatives, even if it is not part of the current proposal. The CFTC does not have direct statutory authority to impose standards on the VCC market but relies on its anti-fraud and anti-manipulation authority and oversight of CFTC-regulated exchanges.
The CFTC has been taking steps to establish standards for carbon markets. Last year, U.S. lawmakers urged the CFTC to address the integrity of carbon credit markets and regulate them. The proposed guidance interprets principles related to VCC derivatives and guides exchanges on demonstrating compliance with regard to susceptibility to manipulation. While many of the provisions outlined in the guidance may already be part of exchanges’ diligence processes, it emphasizes the need for rigorous vetting of deliverable VCCs and thorough reviews of accreditation and verification providers. Failure to comply with these requirements may invite regulatory scrutiny.
Looking ahead, DCMs should remain attentive to evolving consensus on voluntary carbon standards, even if they are not explicitly included in the final guidance. The CFTC guidance emphasizes the importance of vigilance in various areas and recognizes that voluntary carbon credit derivatives are new and evolving products that require careful consideration in product design and listing to promote transparency and liquidity in carbon markets.