Lynn Strongin Dodds looks at the CFTC guidelines for the VCC market and the steps exchanges need to take to comply.
The Commodity Futures Trading Commission (CFTC) issued the first guidelines for trading voluntary carbon credit (VCC) derivative contracts, a move expected to help bolster the US’ nascent market.
These contracts are financial instruments that derive their value from carbon credits, which represent the right to emit one metric ton of carbon dioxide or an equivalent amount of greenhouse gases. They work in a similar way to their traditional counterparts in commodities or financial markets but in this case the hedge or speculation is on the future price of carbon credits.
VCCs are typically bought by companies looking to offset their emissions and differ from those that are part of mandatory programmes such as the European Union’s emissions trading scheme, the oldest cap and trade system. It was launched in 2005 to combat climate change under the European Green Deal and reduce green house gas (GHG) emissions cost-effectively.
The unregulated carbon credit market also has the potential to make a difference. Figures from Morgan Stanley estimate that it could grow to $100bn by 2030 from $2bn in 2022. However, to date there have only been a handful of contracts due to concerns over quality, double-counting, and potential price manipulation.
The guidelines, which were initially proposed in December, are designed to provide reassurance. They are a culmination of five years of consultations, research and discussions with a wide range of sources including farmers, ranchers, loggers, traders, carbon credit rating agencies, exchanges and academics. The objective is to put the onus on exchanges to mitigate greenwashing, tighten scrutiny and enforce higher standards by making certain that VCC derivatives comply with CFTC regulation as well as US law).
More specifically, they outline the factors that exchanges need to consider in the design and listing process. This not only means ensuring the integrity of the listed derivatives but also that markets have the capacity to “prevent manipulation, price distortion, and other disruptions through market surveillance, compliance, and enforcement practices and procedures.”
The CFTC said standardisation is another key plank because of the greater transparency and liquidity it will bring. “For the first time ever, a US financial regulator is issuing regulatory guidance for contract markets that list financial contracts aimed at providing tools to manage risk, promote price discovery, and foster the allocation of capital towards decarbonisation efforts,” said CFTC chairman Rostin Benham in a statement accompanying the new guidance.
He added the new CFTC guidance complements the work already underway by the International Organisation of Securities Commissions (IOSCO) which launched a consultation report on Voluntary Carbon Markets (VCMs) and is still in the review process.
Benham, who co-chairs the work on carbon markets by IOSCO’s Sustainable Finance Task Force, along with Verena Ross, chair of the European Securities and Market Authority, said that IOSCO’s work, “has been focused on how regulators can promote sound market structure and enhance financial integrity in the voluntary carbon markets so that high-quality carbon credits can be traded in an orderly and transparent way.”
Boosting the reputation of carbon markets has been a main political priority for the President Joe Biden’s administration. This is due to the potential of attracting private sector money into renewable energy and conservation. There have been several initiatives in the VCC market over the past couple of years with the most recent one being in May with the US Treasury, Energy and Agriculture departments producing a set of “principles for responsible participation.”
This means carbon credits accurately representing genuine decarbonisation efforts while adhering to strict atmospheric integrity standards. Corporate buyers are also urged to prioritise measurable emissions reductions within their value chains, and public disclosure of purchased and retired credits. In other words, these credit-generating activities should not cause environmental or social harm or actively support co-benefits, transparency and inclusive benefit-sharing.
If managed effectively, the government believes that carbon credits can serve as powerful tools in advancing progress toward the objectives outlined in the Paris Agreement. In fact, research suggests that companies engaged in the VCMs are surpassing their peers in the main areas of climate action, accountability and ambition, rather than simply using credits as a method to ‘buy their way out’.
This is based on a report published by Ecosystem Marketplace on behalf of non-profit group Forest Trends, using CDP Climate Change data from 2022. It found that out of the 7415 companies polled, 59% of buyers in the VCM reported a decrease in gross emissions on an annual basis due to reduced emissions and/or increased utilisation of renewable energy. This compared to only 33% of businesses that were not engaged in carbon markets.
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