After two years of meetings and consultation with the public, a little-known federal regulator this month issued its final guidance on the trading of derivatives based on carbon credits, the certificates companies buy and sell on a voluntary basis to say they’ve offset their greenhouse gas emissions.
Experts had hoped that the guidance from the Commodity Futures Trading Commission, or CFTC, would address widespread concerns about carbon credit-related fraud — essentially, the fear that credits are not delivering their promised emissions reductions. Scientific articles and media investigations over the past several years have revealed that many credits are based on forest conservation projects in areas that were never in danger of being chopped down, or that they sequester carbon in ways that are unlikely to last more than a few years.
In a statement, CFTC Chair Rostin Behnam called the guidance “a critical step in support of the development of high-integrity voluntary carbon markets.” But experts and environmental groups aren’t so enthused. Some don’t think it’ll make much of a difference, due to its limited reach, while others worry the guidance will lend undue legitimacy to the idea of carbon credits — the majority of which they believe shouldn’t be traded in the first place.
“It’s giving this imprimatur to a system that doesn’t have credibility to begin with,” said Clara Vondrich, senior policy counsel for the nonprofit Public Citizen.
To understand what’s going on, it’s important to understand the purpose of the CFTC. The agency was created by Congress in 1974 to regulate the U.S. market for derivatives, contracts in which prices are derived from the value of an underlying asset or benchmark. One easy-to-understand derivative is called a futures contract, a promise to sell an asset at a particular price at some point in the future. Farmers might sell futures contracts to lock in a selling price for wheat, protecting themselves from a future price collapse. In that case, the CFTC’s job is to ensure that the wheat actually gets delivered.
Since 1974, however, the CFTC has sought to regulate increasingly complicated derivatives products. Carbon credit-based futures contracts are a prime example: In this case, a company buys a contract for credits based on emissions reductions that have not yet happened, but are promised to occur at some point in the future. Compared to the wheat example, it’s much less clear what counts as legitimate delivery of the carbon credit. It depends in large part on whether the credits really will cause the emissions reductions that buyers expect them to.
As the CFTC was drafting its guidance, experts urged the agency to take a proactive role in regulating not only carbon credit-based derivatives, but also the credits themselves. No other federal agency has taken on that task, and there were hopes that the CFTC could do so — potentially by invoking its anti-fraud authority over markets for products whose derivatives are listed on CFTC-regulated exchanges. “If there is a commodity and if that commodity has a derivative on a regulated exchange,” said Todd Phillips, an assistant professor of law in the Robinson College of Business at Georgia State University, “the CFTC has authority over the underlying” commodity.
Last year, there were indications that the CFTC could be gearing up to regulate carbon credits. In June 2023, the agency put out a whistleblower alert asking the public to report manipulation in the voluntary carbon market, and not long after, it announced a new Environmental Fraud Task Force to help investigate cases of “fraud and misconduct” in offset-related markets. One of the CFTC’s five commissioners, Christy Goldsmith Romero, explicitly said in December that the agency’s anti-fraud authority should extend to the underlying market for carbon credits — “given the potential for impact to the derivatives markets.”
But the final guidance — which is not legally binding, but rather intended to help clarify exchanges’ obligations under existing CFTC regulations — came up short of what many experts were hoping for. The 99-page document mostly asks futures exchanges to conform to an existing set of best practices for carbon accounting, as defined by a nonprofit governance body called the Integrity Council for the Voluntary Carbon Market, or ICVCM. These best practices involve transparent calculations of greenhouse gas emissions, third-party verification, and reporting on whether credits represent emissions reductions that would not have otherwise taken place.
There are two potential problems with this approach. First, according to Phillips, the CFTC’s deference to the ICVCM essentially restricted its purview.
“What the CFTC has done with this guidance is they have said that only offsets that meet the ICVCM standards can be listed on exchanges,” he said. “Which means there are no low-quality offsets that will be listed on exchanges, which means the CFTC does not have anti-fraud authority there.”
In other words, the CFTC designed its guidance in such a way that it cannot do anything about the underlying voluntary markets’ low-quality carbon credits, which are the most likely to be fraudulent. The guidance is “extremely limited in reach,” as Erin Shortell, a legal fellow at the nonprofit Institute for Policy Integrity, put it in a blog post.
The second issue is that not everyone trusts the ICVCM standards to insure against issues like reversal, where credit projects prematurely release their stored carbon — such as when a forest tied to carbon credits is destroyed by a wildfire — or double-counting, where the same emissions reductions are counted by two separate entities. Rebecca Sanders-DeMott, director of ecosystem carbon management for the pro-carbon market nonprofit Clean Air Task Force, said in a statement that the CFTC was “continuing to rely on crediting protocols that are in need of a major overhaul.”
In response to Grist’s request for comment, the ICVCM referred Grist to Nat Keohane, one of the organization’s senior advisers and president of the nonprofit Center for Climate and Energy Solutions. Keohane said the ICVCM’s standards for carbon credits were developed in a “transparent and rigorous” fashion meant to model a regulatory process, and that they adequately address concerns about credits’ legitimacy.
“These are expert issues,” he added. “They take a lot of specialized expertise … and I don’t think anybody would say that the CFTC has the kind of requisite understanding of the real issues and the details involved” not to defer to the knowledge of other groups such as the ICVCM.
While Sanders-DeMott’s organization believes better regulation is needed to help the voluntary carbon market grow — and “play a meaningful role in addressing climate change” — other advocacy groups think the market has been too plagued with problems to be redeemed.
According to Phillips, the root of the problem is that the CFTC was never designed to be a climate watchdog for the federal government. To the extent that markets for carbon credits and their derivatives should exist, he said, Congress needs to create a new agency — or designate an existing one — to be their overseer.
As an example, he pointed to the Public Company Accounting Oversight Board, a nonprofit corporation created by the federal government in 2002 to oversee audits of U.S.-listed public companies. Previously, corporate auditors had been entirely self-regulated — much like the voluntary carbon market is today.
At present, “everyone has an incentive to just cut corners and allow low-quality offsets to exist,” Phillips said. “There is no government entity whose job it is to ensure that low-quality offsets are taken off the market, and someone needs to have that responsibility.”
