Stockholm (NordSPI) – Carbon credit markets have come under scrutiny recently, particularly from the perspective of certification. They are important, albeit at time controversial, parts of the climate transition, potentially contributing to the correct pricing of pollution within global production value chains.
Derivative contracts, such as futures, are helpful to facilitate transactions and price discovery and an important part of any market. In the EU, carbon quotas known as emission allowances, and their derivatives have been regulated by the Directive on Markets in Financial Instruments (MiFID2) since 2018.
On September 20th, the Commodity Futures Trading Commission (CFTC), the USA’s regulator for the financial derivatives market, approved a final guidance regarding the listing for trading of voluntary carbon credit (VCC) derivative contracts.
Fostering Transparency and Price Discovery?
According to the statement of support of CFTC Chairman Rostin Behnam, “The CFTC’s unique mission focused on risk mitigation and price discovery puts us on the front lines of the now global nexus between financial markets and decarbonization efforts. Leveraging the CFTC’s personnel and expertise demonstrates our commitment to taking a thoughtful and deliberate step toward building a financial system that provides effective tools in achieving emission reductions.”
The guidance outlines factors to be considered for markets hosted by exchanges regulated by the CFTC including factors relating to the submission of new derivative contracts, and contract amendments to the CFTC. The guidance also outlines CFTC regulations that are relevant to the listing for trading of voluntary carbon credit derivative contracts.
“These voluntary carbon credit characteristics are: (i) transparency, additionality, permanence and accounting for the risk of reversal, and robust quantification of emissions reductions or removals, for consideration when addressing quality standards; (ii) governance, tracking mechanisms, and measures to prevent double counting, for consideration when addressing delivery procedures; and (iii) third-party validation and verification, for consideration when addressing inspection or certification procedures. A Contract Market’s consideration of these characteristics in connection with the design of the contract and the listing process should promote accurate pricing, reduce susceptibility of the contract to manipulation, help prevent price distortions, and foster confidence in the voluntary carbon credit contracts. Consistent with the current statutory and regulatory requirements, Contract Markets would retain reasonable discretion to comply with the DCM Core Principles and the Commission’s regulations,” Behnam added.
A Solution in Search of a Problem?
In her dissenting statement, Commissioner Summer K. Mersinger, questioned the validity and necessity of the VCC derivatives guidance. “Today’s non-binding guidance[1] to designated contract markets (“DCMs”) regarding listing of voluntary carbon credits (“VCCs”) derivative contracts is a solution in search of a problem,” Mersinger said.
According to Mersinger, “this new VCC Guidance on a singular class of derivatives contracts does very little to provide clarity, and it most certainly does nothing to foster transparency. Because the VCC Guidance is just guidance, it “does not establish new obligations for DCMs.”[5] So why are we engaged in a non-binding exercise that does little to provide clarity, does not foster transparency, and does not establish new obligations? It seems the only explanation is to set the stage for the Commission to promote a political agenda.”
Addressing
The dissent might not be entirely representative of market participants’ opinions. According to Holland & Knight, a multinational law firm, “the Final Guidance addresses a number of common critiques about the quality of the voluntary carbon market – as highlighted in previous Holland & Knight alerts – to the extent the CFTC’s jurisdiction allows.” According to the law firm’s analysis, “the Final Guidance will lead to a higher degree of diligence, transparency and rigor in physical VCC markets overall and may help prevent potential misconduct, including greenwashing.”
