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CFTC Issues Proposed Guidance Regarding Voluntary Carbon Credit Derivative Contract Listings

Client Updates
On December 4, 2023, the Commodity Futures Trading Commission (CFTC or Commission) approved proposed guidance for derivatives exchanges concerning the listing of voluntary carbon credit (VCC) derivative contracts (the "VCM Proposed Guidance").1  The VCM Proposed Guidance is intended to foster improved standardization, transparency and liquidity in the voluntary carbon markets and outlines factors CFTC-regulated designated contract markets (DCMs) should consider when designing and listing VCC derivative contracts for trading under the Commodity Exchange Act (CEA) and CFTC rules. The comment period for the VCM Proposed Guidance will be open through February 16, 2024.

Overview of the VCM Proposed Guidance

In order to ensure compliance with existing CEA Core Principle requirements and CFTC rules, the VCM Proposed Guidance (i) identifies issues an exchange should consider in connection with the specification and monitoring of VCC derivative contract terms and conditions, and (ii) outlines certain factors to be addressed in connection with submission of new derivative contracts under the CFTC’s Part 40 regulations. Specifically, the guidance addresses the following key areas:
  • To ensure compliance with CFTC DCM Core Principle 3, that a DCM shall only list for trading derivative contracts that are not readily susceptible to manipulation,the preliminary guidance highlights three areas of interest specific to listing of VCC derivative contracts:

    • Ensuring VCC derivative contracts are designed to meet quality standards including: transparency on underlying specifics of the program; that the VCC represents greenhouse gas emissions that would not have been developed and implemented in the absence of the added monetary incentive created by the revenue from the sale of carbon credits;that the crediting program can demonstrate it has addressed and accounted for risk of reversal due to recall or cancelation of VCCs; and conduct robust quantification of emissions reductions or removals. 

    • Design of physically settled VCC derivative contracts must include consideration of delivery points and facilities which include effective governance at the carbon crediting program, tracking the issuance, transfer, and retirement of VCCs, and processes to ensure no double counting.

    • Inspection provisions which include independent third-party validation and verification should be specified in the VCC derivative contract’s terms and conditions. A DCM’s consideration of these factors during the design of a derivative product’s terms and conditions should promote accurate pricing, reduce susceptibility of the contract to manipulation, help prevent price distortions, and foster confidence in the VCC contracts.

  • To ensure compliance with CFTC DCM Core Principle 4, DCMs are required to prevent manipulation, price distortion, and disruption of the physical delivery or cash-settlement process through market surveillance, and enforcement practices and procedures.3  The CFTC articulates that DCMs should continually monitor the terms and conditions of physically-settled VCC derivative contracts to ensure they conform or reflect latest certification standard applicable for that VCC. 

  • In complying with product submission requirements under Part 40 of the CFTC’s regulations and CEA section 5c(c),4 the VCM Proposed Guidance states that DCMs should provide qualitative explanations, analysis, and evidence related to VCC derivative contract compliance with the CEA, CFTC regulations and core principles at the time of listing and as requested by Commission staff. This applies to new derivative contracts listed either via self-certification or Commission approval.

  • While the VCM Proposed Guidance focuses primarily on physically settled VCC derivative contracts, the Commission indicates that it believes that DCMs should consider the same factors when developing terms and conditions of cash-settled VCC derivatives contracts.

In addition to the proposed guidance terms, the Commission specifically seeks comment on a list of 17 specific questions related to the listing of VCC derivatives contracts; these include questions concerning: (i) transparency, (ii) additionality, (iii) risk of reversal, (iv) robust quantification, (v) governance, (vi) tracking and double counting, (vii) inspection provisions, and (viii) sustainable development benefits and safeguards.

Entities Affected by the VCM Proposed Guidance

  • DCMs – This VCM Proposed Guidance does not supersede existing requirements for listing of derivatives contracts, but rather gives additional insight into the CFTC’s expectations concerning the listing of VCC derivative contracts. DCMs retain reasonable discretion in establishing the manner of compliance with the CFTC’s regulations. 

  • Swap Execution Facilities (SEFs) – The VCM Proposed Guidance focuses on listing of VCC derivative contracts by DCMs, but the CFTC noted that the principles articulated in the guidance should additionally be considered by SEFs that may seek to permit trading in (i) swap contracts that settle to the price of a VCC or (ii) physically-settled VCC swap contracts.

  • Other Participants in Underlying VCC Markets – While not the direct subject of the VCM Proposed Guidance, all entities active in the voluntary carbon markets (including trading platforms, project developers, registries, and carbon credit buyers and sellers) may be indirectly impacted by the implementation of the guidance as proposed, particularly due to its focus on spot market activity underlying physically settled VCC derivative contracts.
CFTC Priorities

The VCM Proposed Guidance is a culmination of two years of CFTC active consideration of the environmental commodity markets and related market conduct and jurisdictional issues. Chairman Rostin Behnam stated that the guidance “is an important step in shaping the development of high-integrity voluntary carbon markets.” Thus, the articulated guidance for DCMs and SEFs appears intended to indirectly influence other market participants and impact the voluntary carbon markets as a whole. 

Nevertheless, some CFTC Commissioners view the VCM Proposed Guidance as just the first regulatory step and believe the CFTC should go even further in its continuing attention to the voluntary carbon markets. For example, Commissioner Kristin Johnson supported the proposed guidance, but noted she believes the guidance could go further to address the environmental commodity products traded off exchange because the underlying spot markets are “rife with fraud.” She added when “[a]pplying the approach adopted in the proposed guidance, there may be several interventions that may bring similar needed reforms to over-the-counter traded environmental commodities – material risk disclosures, good faith and fair dealing, and clearing.” Accordingly, further CFTC regulatory and enforcement focus on the voluntary carbon markets should be expected.

Key Takeaway

Business entities active in the carbon markets and potentially impacted by this VCM Proposed Guidance should assess the scope of the guidance and the Commission’s specific requests for comment and consider submitting comments to the CFTC. Market participants should also begin assessing potential compliance measures necessary to conform with the proposed guidance should it be finalized in its current form. Baker Botts has experienced lawyers who are ready to assist you with drafting comments to the proposed guidance, preparing compliance materials, or assessing the applicability of the VCM Proposed Guidance to your business operations. 

1The VCM Proposed Guidance and CFTC press release can be found here

2CEA section 5(d)(3), 7 U.S.C. 7(d)(3).

3CEA Section 5(d)(4), 7 U.S.C. 7(d)(4). See also 17 CFR §§ 38.250-258.

47 U.S.C. 7a-2(c)(1); CEA section 5c(c)(1).

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