On December 4, 2023 the CFTC issued proposed guidance regarding the listing of voluntary carbon credit ("VCC") derivative contracts ("Proposed Guidance"). The Proposed Guidance outlines factors that designated contract markets ("DCMs") should consider when addressing certain provisions of the Commodity Exchange Act ("CEA") and CFTC regulations relevant to the listing of VCC derivative contracts for trading. By the proposal, the CFTC has requested comments on a broad range of VCC-related issues, including 17 specific questions, with a comment deadline of Feb. 16, 2024. This effort continues and sharpens a string of CFTC actions aimed at carbon and climate issues under the Biden Administration.
What Are VCCs?
VCCs are tradeable, intangible instruments which enable market participants to buy and sell, on a voluntary basis, the right to claim (upon retiring the VCC) a reduction of greenhouse gas ("GHG") emissions or removal of atmospheric GHGs. The voluntary carbon markets ("VCMs") face challenges in accurately ascertaining VCC quality, along with associated pricing challenges. The CFTC is concerned these issues may erode confidence in the VCC market. In response, the Proposed Guidance outlines factors that an exchange should consider in specifying and monitoring the terms and conditions of VCCs and derivative contracts to ensure compliance with existing statutory Core Principle requirements under Section 5(d) of the CEA.
What Does the CFTC Propose?
Generally, the Proposed Guidance provides that DCMs must: (1) list only derivative contracts that are not readily susceptible to manipulation; (2) monitor a derivative contract's terms and conditions as they relate to the underlying commodity market; and (3) satisfy the product submission requirements under Part 40 of the CFTC Regulations and CEA section 5c(c).
The Proposed Guidance, especially the discussion of contracts "readily susceptible to manipulation," is in close conversation with ongoing private and multi-stakeholder initiatives to improve VCC quality and the integrity of VCMs overall. Thus, many of the issues discussed by the CFTC will be familiar to VCM stakeholders who have followed initiatives like this year's closely watched launch of the ten Core Carbon Principles ("CCPs") by the Integrity Council for the Voluntary Carbon Market ("ICVCM"). The Proposed Guidance fits these issues into the unique market and regulatory framework of the CFTC and the commodity-related markets it oversees.
Along with other considerations, the CFTC believes that, at a minimum, a DCM should consider the following VCC commodity characteristics when addressing the criteria in the design of a VCC derivative contract:
- Quality standards;
- Delivery points and facilities; and
- Inspection provisions.
The CFTC's preliminary list of commodity characteristics relevant to quality standards for VCCs are (i) transparency; (ii) additionality; (iii) permanence and risk of reversal; and (iv) robust quantification—corresponding, respectively, to CCPs 7, 1, 2, and 3. The discussion of "delivery points and facilities" covers the CFTC's views on the crediting programs that issue and track VCCs, as opposed to the instruments themselves. These include governance, systems for VCCs tracking (issuance, transfer, and retirement), and protections against double counting—corresponding to CCPs 4, 5, and 6, respectively. The discussion of "inspection provisions" focuses on third-party validation and verification—corresponding to CCP 8.
The CFTC does not, however, propose to extend its guidance to the broader social and environmental considerations increasingly prevalent in voluntary quality efforts. For example, CCPs 9 and 10 require environmental safeguards beyond a project's GHG impacts, positive sustainable development impacts, and avoidance of GHG-reduction activities that tend to also lock in GHG-intensive practices and technologies in the overall economy. Still, the CFTC specifically requests comment on whether DCMs designing VCC derivatives should consider these kinds of environmental and social safeguards, even though not included in the CFTC guidance as proposed.
Even if those or other voluntary standards are not specifically incorporated in the final CFTC guidance, DCMs should keep an eye on evolving consensus in the VCM. The CFTC guidance clearly is, and the Proposed Guidance expressly cautions, for DCMs to do the same in several areas.
The Proposed Guidance stems from the CFTC's recognition that VCC derivatives are a new and evolving class of products, and therefore providing guidance that outlines factors for a DCM to consider in connection with product design and listing which may help to advance the standardization of such products in a manner that promotes transparency and liquidity. As VCMs and the broader carbon management ecosystem evolve, we expect the CFTC to increase their scrutiny on these products and participants in markets for VCCs and their derivatives.
Comments to the Proposed Guidance should be submitted to the CFTC by February 16, 2024. Commissioner Johnson specifically requested comments addressing transparency, additionality, risk of reversal, robust quantification, governance, tracking and double counting, inspection provisions, and sustainable development benefits and safeguards. Similarly, Commissioner Goldsmith Romero is interested in comments on whether the guidance adapts the right parts of the ICVCM standards to encourage integrity and transparency in these markets and if the Commission's adaptation provides clear, workable expectations. Commissioner Romero also specifically requested comments on whether market integrity can be improved by exchanges relying on a crediting program's processes and diligence, as assumed in the Proposed Guidance, or if there is a benefit to exchanges conducting additional due diligence into specific categories, protocols, or projects.
 Those actions include establishing a Climate Risk Unit; holding a first and second Voluntary Carbon Markets Convening; issuing a request for information on climate-related financial risk and a call for carbon market whistleblowers; and establishing a new environmental fraud task force.
 There are generally two processes by which a DCM may list a new derivative contract for trading. The DCM may elect to list the contract for trading by providing the Commission with a written certification – a "self-certification"– stating that the contract complies with the CEA, including the CFTC regulations thereunder. Alternatively, the DCM may elect voluntarily to seek prior Commission approval of the contract. See 7 U.S.C. § 7a‑2(c)(4)-(5). See also 17 C.F.R. § 40.3.