After two years of meetings and consultation with the public, an unknown federal regulator this month final guidance on the trading of derivatives based on carbon credits, the certificates companies buy and sell on a voluntary basis to say that they have offset their greenhouse gas emissions.
Experts had hoped the guidance from the Commodity Futures Trading Commission, or CFTC, would address widespread concerns about carbon credit-related fraud — essentially the fear that credits are not delivering their promised emissions reductions. Scientific articles and media investigations over the past few years has revealed that many credits are based on forest conservation projects in areas that were never in danger of being cut down, or that they sequester carbon in ways that are unlikely to last more than a few years not.
In a statement, CFTC Chairman Rostin Behnam called the guidance “a critical step in support of the development of voluntary carbon markets with high integrity.” But experts and environmental groups are not so enthusiastic. Some don’t think it will make much of a difference, due to its limited scope, while others worry that the guidance will lend undue legitimacy to the idea of carbon credits – the majority of which they believe should not be traded in the first place not. place.
“It gives this imprimatur to a system that has no credibility to begin with,” said Clara Vondrich, senior policy counsel for the nonprofit Public Citizen.
To understand what is going on, it is important to understand the purpose of the CFTC. The agency was created by Congress in 1974 to regulate the US market for derivatives, contracts in which prices are derived from the value of an underlying asset or benchmark. One easy-to-understand derivative is called a futures contract, a promise to sell an asset at a specified price at a certain point in the future. Farmers may sell futures contracts to lock in a sale price for wheat, protecting themselves against a future price collapse. In that case, the CFTC’s job is to ensure that the wheat is actually delivered.
Since 1974, however, the CFTC has sought to regulate increasingly complex derivative products. Carbon credit-based futures are a prime example: In this case, a company buys a contract for credits based on emission reductions that have not yet occurred, but are promised to occur at some point in the future. Compared to the wheat example, it is much less clear what counts as legal delivery of the carbon credit. It largely depends on whether the credits will actually produce the emission reductions that buyers expect from them.
As was the CFTC setting up his guidanceexperts urged the agency to play a proactive role in regulating not only carbon credit-based derivatives, but also the credits themselves. No other federal agency has taken on that task, and there was hope that the CFTC could do so — possibly by invoking its anti-fraud authority over markets for products whose derivatives are listed on CFTC-regulated exchanges. “If there’s a commodity and if that commodity has a derivative on a regulated exchange,” said Todd Phillips, an assistant professor of law in the Robinson College of Business at Georgia State University, “the CFTC has authority over the underlying” commodity.
Last year there were indications that the CFTC might be ready to regulate carbon credits. In June 2023, the agency issued a whistleblower warning asking the public to report manipulation in the voluntary carbon market, and not long after, it announced a new Environmental Fraud Task Force to help investigate cases of “fraud and misconduct” in clearing-related markets. One of the CFTC’s five commissioners, Christy Goldsmith Romero, expressly stated in December that the agency’s anti-fraud authority should extend to the underlying market for carbon credits — “given the potential for impact on the derivative markets.”
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But the final guidance — which is not legally binding but rather intended to help clarify exchange obligations under existing CFTC regulations — falls short of what many experts had hoped. The 99-page document mostly calls for futures exchanges to comply with an existing set of best practices for carbon accounting, as defined by a nonprofit governing body called the Integrity Council for the Voluntary Carbon Market, or ICVCM. These best practices involve transparent calculations of greenhouse gas emissions, third-party verification, and reporting on whether credits represent emission reductions that would otherwise not have occurred.
There are two potential problems with this approach. First, according to Phillips, the CFTC’s deference to the ICVCM essentially limited its authority.
“What the CFTC did with this guidance is they said that only offsets that meet the ICVCM standards can be listed on exchanges,” he said. “Which means there are no low-quality settlements that will be listed on exchanges, which means the CFTC does not have anti-fraud authority there.”
In other words, the CFTC has designed its guidance so that it can do nothing about the underlying voluntary markets’ low-quality carbon credits, which are most likely to be fraudulent. The guidance is “extremely limited in scope,” as Erin Shortell, a legal fellow at the nonprofit Institute for Policy Integrity, put it in a blog post.
The second issue is that not everyone trusts the ICVCM standards to insure against issues such as reversals, where credit projects release their stored carbon prematurely – such as when a forest linked to carbon credits is destroyed by wildfire – or double counting, where the same emission reductions are counted by two separate entities. Rebecca Sanders-DeMott, director of ecosystem carbon management for the pro-carbon market nonprofit Clean Air Task Force, said in a statement that the CFTC “continues to rely on credit protocols that need a major overhaul.”
In response to Grist’s request for comment, the ICVCM referred Grist to Nat Keohane, one of the organization’s senior advisers and president of the nonprofit Center for Climate and Energy Solutions. Keohane said the ICVCM’s standards for carbon credits were developed in a “transparent and rigorous” manner intended to model a regulatory process, and that they adequately address concerns about credits’ legitimacy.
“These are expert issues,” he added. “They take a lot of specialized expertise … and I don’t think anyone would say that the CFTC has the kind of requisite understanding of the real issues and the details involved” not to mention the knowledge of other groups like the ICVCM.
While Sanders-DeMott’s organization believes better regulation is needed to help the voluntary carbon market grow — and “play a meaningful role in addressing climate change” — other advocacy groups think the market is too plagued with problems to be redeemed.
According to Phillips, the root of the problem is that the CFTC was never designed to be a climate watchdog for the federal government. To the extent that markets for carbon credits and their derivatives should exist, he said, Congress should create a new agency — or designate an existing one — to be their watchdog.
As an example he pointed to the Public Company Accounting Oversight Boarda non-profit corporation created by the federal government in 2002 to oversee audits of US listed public companies. Previously, corporate auditors were completely self-regulated – much like the voluntary carbon market is today.
Right now, “everyone has an incentive to just cut corners and allow low-quality offsets to exist,” Phillips said. “There is no government entity whose job it is to ensure that low-quality outlets are removed from the market, and someone has to have that responsibility.”
