US regulator floats guidelines for unruly emissions offset market

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US regulators will propose the first federal guidelines for voluntary carbon credit derivatives, as Washington tries to bring order to a market for the offset of emissions described as the “wild west”.

The Commodity Futures Trading Commission will announce on Monday standards that call on exchanges to verify the quality of voluntary carbon credit derivatives, which base their prices on those of financial instruments bought by companies to offset emissions.

The value of the carbon trading market worldwide could expand to $100bn by 2030, up from $2bn in 2022, according to Morgan Stanley. The fledgling voluntary carbon derivatives sector, meanwhile, includes just three contracts with meaningful trading volume, while 15 more are listed but have limited trading, according to the CFTC.

CFTC chair Rostin Behnam told the Financial Times that the guidance was “the first of its kind from a US market regulator” that creates standards for derivatives exchanges in relation to voluntary carbon credits.

The guidelines seek to clamp down on manipulation and to foster accurate pricing by pushing exchanges to ensure that the terms of listed contracts are in accordance with US federal laws and CFTC regulations.

The move comes as agencies worldwide try to craft frameworks to oversee a nascent market that faces scant regulatory oversight. It comes a day after the International Organization of Securities Commissions, the top agency representing securities watchdogs, launched a consultation on standards for voluntary carbon markets at COP28 in Dubai.

Voluntary credits are typically bought by companies looking to offset their emissions, and differ from those that are part of mandatory programmes such as the EU’s emissions trading scheme. Environmentalists have argued they give businesses a way to keep polluting and do little to arrest global warming.

Behnam said there was a “legislative vacuum in this space”, and that Congress was not expected to authorise an agency to police voluntary carbon markets “anytime soon”.

He added that there was a “lack of integrity” and “issues around standardisation” in the market, and said some products were susceptible to fraud and manipulation.

The CFTC’s guidance puts the onus on exchanges registered with the watchdog. But Behnam believes a “larger pool” of players will look to it “as a baseline standard”. The guidance is not the same as agency regulation, which has more teeth.

Behnam added this may be a first step to crafting new rules. The regulator in June called on whistleblowers to submit tips on misconduct in carbon markets.

According to the proposal, exchanges should consider whether a carbon derivatives contract includes “additionality”, which ensures that a project creates emission reductions that would not occur without it.

The CFTC is also trying to minimise “double-counting”, which occurs when multiple carbon credits are backed by the same trees, for example.

Todd Phillips, assistant professor at Georgia State University, described the carbon credit market in the US as “the wild west”.

“We need someone to show the market that they are . . . going to ensure that offsets that are sold in the United States are high quality and believable,” Phillips said. “In other jurisdictions . . . the price of carbon is $50 [or higher]. The fact that you can buy carbon offsets in the United States for $2 just shows that they are of laughable quality.”

In addition to derivatives, Behnam believes the CFTC is well-placed to police the carbon credits spot market, an argument he has made to Congress in relation to cryptocurrencies.

“We have futures in both markets and we have interest in ensuring that the underlying market is healthy because that has a direct impact on our derivatives market,” he said.

Behnam has discussed with members of Congress broadening the CFTC’s authority to capture spot carbon credits “but I don’t think there’s an appetite and you don’t see the scale . . .[and] sensationalism in this space as you do in the crypto environment”.

US Treasury secretary Janet Yellen told the FT in a statement that the proposal was an “important step by the CFTC toward promoting the integrity of carbon credits and enabling greater liquidity, price discovery, and responsible product innovation for credits that underlie derivatives products listed” on exchanges registered with the agency.

The Treasury earlier this year had warned of challenges in the voluntary carbon markets linked to transparency and credit integrity.

The CFTC’s proposal will face a public comment period before its final implementation.