Before Anyone Gets Too Excited about the CFTC Guidance on Carbon Credit Derivatives…
Late last week, the Commodity Futures Trading Commission (CFTC) finalized its guidance for regulated exchanges that list derivatives products based on carbon credits. Many commentators quickly praised the guidance as improving oversight for the troubled voluntary carbon markets, which face continuing criticism over their integrity problems. In particular, many carbon credits do not represent the greenhouse gas (GHG) emissions reductions they are intended to represent. While the guidance is a positive step towards improving voluntary carbon market integrity, it’s only a small one: The guidance is extremely limited in reach.
The guidance applies only to a tiny sliver of transactions one step removed from voluntary carbon markets’ core. When most people think of voluntary carbon markets, they think of companies purchasing carbon credits that represent GHG emissions reductions generated by climate-related projects and using those credits to offset their own GHG emissions. The guidance applies only to carbon credit derivatives listed on CFTC-regulated exchanges. (A derivative is a financial product that investors often use to hedge, i.e., manage their exposure to “the risk of disadvantageous movements in the price of an underlying asset,” or to speculate, i.e., to earn profits by successfully predicting the underlying asset’s price movements.) Only three carbon credit derivatives currently trade on CFTC-regulated exchanges (the same number as when the CFTC proposed the guidance last year, according to the CFTC’s counts).
The Institute for Policy Integrity highlighted the guidance’s limited reach in its comment letter on the proposed guidance and in a related blog post. To be sure, the guidance has some potential to improve integrity in voluntary carbon markets, but only indirectly, by influencing carbon credits that underlie exchange-listed derivatives. The guidance has no direct impact on the core voluntary carbon market transactions where buyers, mostly companies, purchase carbon credits to offset their GHG emissions.
In addition, unlike statutes and regulations, agency guidance is not legally binding. In fact, the CFTC went out of its way to “emphasize[] that its guidance does not establish new obligations for [exchanges],” noting that “[an exchange’s] obligations remain those that are set forth in the [Commodity Exchange Act] and the [CFTC’s] regulations.” Instead, the guidance “is intended to assist [exchanges] in addressing existing obligations.” Regulated exchanges may be “expected to follow the guidance,” but the guidance does not create new legal requirements for the CFTC to enforce.
The CFTC took a positive step last week. Despite the guidance’s limited reach, it could indirectly improve voluntary carbon market integrity, especially if the market for carbon credit derivatives takes off. But much remains to be done to bring voluntary carbon markets in line with genuine climate mitigation.
