On September 20, 2024, in a 4-1 vote, the Commodity Futures Trading Commission (“CFTC” or “Commission”) approved final guidance for derivatives exchanges concerning the listing of voluntary carbon credit (“VCC”) derivative contracts (the "VCC Derivatives Guidance"). The VCC Derivatives Guidance has not yet been published in the Federal Register. Commissioner Summer Mersinger voted in opposition and issued a dissenting statement.

The VCC Derivatives Guidance directly applies only to registered derivatives exchanges subject to CFTC oversight and outlines factors for such exchanges to consider when listing certain VCC futures and other derivatives contracts for trading. The VCC Derivatives Guidance does not apply directly to VCC cash markets or spot trading on physical voluntary carbon markets. Though the non-binding guidance has limited scope and applicability, it may ultimately have indirect influence on the broader voluntary carbon markets.  Accordingly, carbon market participants should be aware of the key principles addressed in the guidance. The core elements of the VCC Derivatives Guidance are outlined below.

Background

The CFTC initially issued proposed VCC guidance in December 2023 (“VCC Proposed Guidance”)¹after conducting a series of carbon market industry convenings in 2022 and 2023 and issuing a Request for Information on Climate-Related Financial Risk in 2022.² After consideration of approximately 90 comments on the proposal, the CFTC adopted the final VCC Derivatives Guidance largely as proposed, with modest clarifications and revisions.

Overview of Final VCC Derivatives Guidance

On its face, the VCC Derivatives Guidance is intended to advance the standardization of VCC derivative contracts and to promote transparency, market integrity, and liquidity. In addition, the CFTC intends the VCC Derivatives Guidance to indirectly promote standardization, market integrity, and transparency in the underlying spot markets as well. Specifically, according to CFTC Chairman Behnam, the guidance is intended to “drive standardization and efficient capital allocation to scale the underlying cash market for high integrity VCCs.”

To accomplish these objectives, the VCC Derivatives Guidance identifies factors for derivatives exchanges to consider in connection with the contract design and listing of VCC futures and other derivatives contracts for trading. The VCC Derivatives Guidance applies to CFTC designated contract markets (“DCMs”).³ DCMs must comply with certain Commodity Exchange Act (“CEA”) requirements and CFTC rules related to the futures and derivatives contract they list for trading (these requirements are referred to as Core Principles and related CFTC rules are contained in Part 38 of the CFTC’s regulations). The guidance provides factors for DCMs to consider related to their various Core Principle compliance obligations when listing VCC derivative contracts for trading on their markets. The guidance focuses on physically settled derivative contracts⁴ and, among other things, identifies issues for exchanges to consider to ensure contracts are not susceptible to manipulation as required under DCM Core Principle 3.⁵

More specifically, the guidance outlines issues DCMs should examine and disclose related to underlying carbon crediting programs for VCCs that are the subject of a derivatives contract. The guidance addresses a broad range of factors for DCMs to consider related to VCCs underlying a derivatives contract and the process by which they are issued, including the following:

• Social and Environmental Factors: When addressing quality standards in connection with derivative contract design, DCMs may consider whether a VCC crediting program has implemented measures to ensure credited mitigation projects/activities (i) meet or exceed best practices on social and environmental safeguards and (ii) would avoid resulting in greenhouse gas (“GHG”) emissions, technologies, or practices incompatible with achieving net-zero GHG emissions by 2050.
  
  
• Transparency: In a VCC derivative contract’s terms and conditions, DCMs should provide information about the issuing crediting program and what types of projects/activities the credits represent. DCMs should consider whether the relevant crediting program makes information about the program’s procedures and the projects/activities generating credits publicly available.
  
  
• Additionality: Because the CFTC believes additionality is a cornerstone characteristic of high-quality VCCs, DCMs should consider whether a crediting program assesses and provides reasonable assurance regarding additionality. However, the CFTC did not finalize a definition of additionality for these purposes.
  
  
• Permanence and Accounting for the Risk of Reversal: DCMs should consider whether the crediting program for the underlying VCCs addresses and accounts for the risk of reversal by requiring a buffer reserve or other measures.
  
  
• Robust Quantification: DCMs should consider whether emissions quantification methodologies are robust, conservative, and transparent.
  
  
• Governance: DCMs should consider whether a crediting program issuing the underlying VCCs has a publicly available governance framework in place to support the credit program’s independence, transparency, and accountability.
  
  
• Tracking and Double-Counting: DCMs should consider whether the crediting program for the underlying VCCs ensures certainty for the issuance, transfer, and retirement of VCCs. Each VCC must be associated with a single emissions reduction or removal of one metric ton of carbon dioxide, and DCMs should consider whether crediting programs ensure emission reductions and removals are not double-counted.
  
  
• Third-Party Validation and Verification: Contract terms and conditions should include verification of compliance with quality or delivery requirements for physically-settled VCC derivative contracts. Because third-party confirmation that mitigation projects achieve GHG reductions or removals supports the VCC market’s integrity, DCMs should consider whether crediting programs have sufficient procedures to verify that projects meet the crediting program’s standards.

The CFTC emphasized that the VCC Derivatives Guidance does not establish new obligations for DCMs but instead is intended to “assist DCMs in addressing existing obligations, when designing and listing such VCC derivatives.” While this final guidance does not impose new requirements for DCMs or other market participants, it identifies key factors related to high quality VCCs that eventually may be adopted more broadly in the voluntary carbon markets.

Dissenting Statement

Commissioner Summer Mersinger opposed the adoption of the VCC Derivatives Guidance and issued a dissenting statement in which she criticized the Commission’s outsized attention to VCC derivative contracts when compared to other Commission priorities. Commissioner Mersinger emphasized that VCC derivative contracts are “an emerging class of products that have very little open interest and comprise a miniscule percentage of trading activity on CFTC-regulated DCMs.” According to Commissioner Mersinger, the final non-binding guidance does little to provide clarity to market participants and instead is an attempt to “inject and memorialize certain political ideologies into CFTC regulatory decisions.” Commissioner Mersinger also stated that, in her view, the CFTC’s focus on ESG and net-zero goals is generally immaterial to the ability of listed derivatives products to meet regulatory obligations.

Key Takeaways

The CFTC adopted the VCC Derivatives Guidance to support the standardization of VCC derivative contracts and promote transparency and liquidity in VCC derivatives contracts. However, the CFTC also intended the VCC Derivatives Guidance to indirectly promote standardization, market integrity, and transparency in the underlying cash markets, resulting in higher quality VCCs.

As a result, though the VCC Derivatives Guidance is non-binding and has limited scope and applicability, it may ultimately have indirect influence on the operation of the broader voluntary carbon markets. In addition, this regulatory action is just the latest step in the CFTC’s oversight of the environmental commodity markets. The CFTC’s adoption of this guidance highlights the potential for continued CFTC regulatory and enforcement oversight concerning VCCs and related derivatives. Market participants should expect the CFTC to continue its focus on the environmental commodity markets on an ongoing basis. In addition to the VCC Derivatives Guidance, the CFTC has established an Environmental Fraud Enforcement Task Force⁶ and prioritized investigation of potential fraud and manipulation in the voluntary carbon markets. The principles addressed in the VCC Derivatives Guidance may become issues of examination in future CFTC enforcement inquiries.

Accordingly, market participants active in VCC derivatives trading and the broader voluntary carbon markets should be aware of the key principles and interpretations addressed in the VCC Derivatives Guidance. Further, market participants should consider developing tailored compliance policies related to their voluntary carbon market activity and VCC derivatives trading and incorporate such policies as appropriate into their overall compliance framework. CFTC regulatory training for relevant personnel conducting carbon market commercial activities should also be considered to ensure compliance with applicable CFTC environmental market fraud and manipulation prohibitions.

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