On September 20, 2024, the Commodity Futures Trading Commission (CFTC) issued its long-awaited, non-binding final Guidance (“the guidance” or “the September guidance”) with respect to regulations on the listing of voluntary carbon credits (VCCs) derivative contracts on designated contract markets (DCMs).

The guidance does not impose new obligations on DCMs, and it neither modifies nor supersedes existing CFTC rules and regulations. Rather, the guidance is intended to be “an efficient and flexible vehicle to communicate”¹ the CFTC’s current views on factors DCMs should consider when listing VCC derivative contracts. Effectively, the CFTC is preemptively providing regulatory clarity to the marketplace.

There are currently 29 VCC futures contracts listed on various CFTC-jurisdictional DCMs; these are physically-settled products. No cash-settled VCC derivative contract has been listed on a US DCM, although they are listed and traded on European exchanges. The CFTC guidance is nonetheless ripe as industry-led standardization and accountability mechanisms are rapidly evolving and the packaging, buying, and selling of carbon credit contracts burgeons.

The guidance follows two years of CFTC-industry engagement. The CFTC organized the first VCM Convening in June 2022, and shortly thereafter issued a Request for Information (RFI) on Climate-Related Financial Risk. In July 2023, a second VCM Convening occurred, and in December 2023, the CFTC issued draft guidance on the trading of VCC derivative contracts on VCMs. Moreover, in May 2024, the White House issued the Voluntary Carbon Markets Joint Policy Statement and Principles, lauding “high-integrity VCMs,” while encouraging private-and public-sector actions to address demand integrity concerns. As of October 9^th, the CFTC guidance is not published on the Federal Register.

Why “regulate” VCMs?

The impetus to regulate VCMs came about due to a number of factors, chief among them being widespread concern over carbon credit quality—i.e., would the credits actually deliver the reduction in CO₂ emissions they purported to achieve?

The industry has responded to concerns over carbon-credit quality through self-regulation. In 2021, the Taskforce on Scaling Voluntary Carbon Markets (TSVCM)² established the Integrity Council for the Voluntary Carbon Market (IC-VCM). The IC-VCM is now the leading non-profit, independent governance body that formulates standards for high-integrity VCMs. In 2024, the IC-VCM launched the Core Carbon Principles (CCP) initiative, wherein the IC-VCM will evaluate carbon credits issued by major registries and affix a CCP label on qualified credits, thereby affirming credit quality. Moreover, the International Emissions Trading Association (IETA),³ the International Swaps and Derivatives Association (ISDA),⁴ and the International Organization of Securities Commissions (IOSCO)⁵ have all issued a series of guidance documents and form contracts in an effort to harmonize VCC practices.

What does the CFTC guidance say and do?

The CFTC September guidance effectively codifies the regulatory treatment of VCCs as listed, tradable products by obligating DCMs (and their respective boards of trade) listing VCCs to adhere to the twenty-three “Core Principles” established under Section 5(d) of the Commodity Exchange Act (CEA). The CFTC embraced widely-accepted carbon credit quality criteria, emphasizing VCC derivative contracts should retain the quality standards of (i) transparency, (ii) additionality, (iii) permanence and risk of reversal, and (iv) robust quantification.

The CFTC also provided more targeted guidance for DCMs.

• Transparency over project information in a VCC contract. A DCM “should provide, in the terms and conditions of a physically-settled VCC derivative contract, information about the VCCs that are eligible for delivery under the contract.”⁶ The CFTC further advised a DCM consider “quality standards, delivery points and facilities, and inspection provisions,” when assessing a VCC derivative contract. Moreover, details regarding project category, such as nature-based solutions (i.e., reforestation and afforestation) and engineered solutions (i.e., direct-air capture with carbon credit storage and bio-energy carbon capture and storage), should be explicit.
• Sufficient buffer reserves to mitigate the risk of reversal. Because some projects are prone to reversal, or can fail to deliver a carbon credit, the CFTC encourages DCMs to consider “whether a crediting program has a buffer reserve in place to help address [these] risk[s].”⁷ The CFTC, however, acknowledged that a crediting program may have alternative mitigation measures.
• Robust methodologies. Given the absence of a standardized methodology or protocol to quantify GHG reductions or removals, the CFTC believes, “in connection with the design of a VCC derivative contract, a DCM should consider whether there is reasonable assurance that the quantification methodology(ies) or protocol(s) used by the crediting program for calculating emission reductions or removals for underlying VCCs is robust, conservative, and transparent.”⁸
• Position limits. To the extent that DCMs are already required to adopt exchange-set position limits for speculators, DCMs estimating a VCC’s deliverable supplies should strive to rely on a “robust, conservative, and transparent”⁹ quantification methodology or protocol. Relatedly, the delivery procedures for a physically-settled derivative contract should seek to minimize or eliminate any impediments to making or taking delivery. DCMs should consider the governance framework and tracking mechanisms of the crediting program.
• Tracking the issuance, transfer, and retirement of VCCs. In an effort to underpin VCC quality, the guidance suggests DCMs consider whether crediting programs have sufficient procedures in place to track the issuance, transfer, and retirement of VCCs. While the guidance does not provide quantifiable benchmarks, it suggests DCMs consider the extent to which crediting programs use a registry, whether a crediting program has procedures to prevent the double counting of emission reductions or removals, and whether there are measures in place to identify who owns or retires a VCC to both prevent double counting and ensure that each VCC is “uniquely and securely identified and associated with a single emission reduction or removal.”¹⁰ The CFTC also acknowledged the importance of preventing double counting across multiple carbon registries, especially with respect to international projects.
• Recordkeeping and market monitoring. A DCM should monitor a derivative contract’s terms and conditions as they relate to the underlying commodity market. DCMs are already required to have rules that obligate their market participants to maintain records of trading activity.
• Submission requirements for VCC derivative contracts. The CFTC highlighted three submission requirements associated with the listing VCC derivative contracts either through self-certification or CFTC approval.
  • First, a contract submission must include an “explanation and analysis” of the contract and the contract’s compliance with relevant CEA provisions.
  • Second, such “explanation and analysis” should be substantiated, and accompanied by relevant documentation or citations to data sources.
  • Third, a DCM must provide “additional evidence, information or data” demonstrating the contract’s compliance with CEA requirements and CFTC regulations, in response to a CFTC inquiry.¹¹

The CFTC rejected calls for greater regulation and exercised great restraint, acknowledging that “industry-recognized standards for high-integrity VCCs . . . can serve as tools for a DCM.”¹² It recognized its jurisdiction extends only to VCC derivative contracts rather than the verified carbon credit contracts traded in cash (sometimes called “spot”) or secondary markets. The CFTC went so far to explicate that it considers carbon credits issued by registries to be verified carbon credits, rather than voluntary carbon credits (VCCs), which are intangible commodities underlying a derivative contract.¹³ The CFTC does, however, retain anti-fraud and market manipulation authority over spot markets under CEA section 6(c).

Who is impacted by the CFTC guidance?

The guidance directly applies to CFTC-regulated DCMs and communicates to the market how the CFTC interprets the regulations that apply to those exchanges when they list VCC futures. The guidance also directly impacts drafters of VCC futures contracts, who should bear in mind the CFTC guidance when preparing contract documents and applications.

The guidance will likely have the largest indirect impact on carbon registries, which are unregulated and enjoy great flexibility when formulating methodologies and verifying and registering credits. The effect of this guidance is that if the registries do not address the guidance’s stipulations, futures product developers and DCM Boards will be reluctant to rely on those registries when developing futures contracts. The registries’ products would become less demanded and therefore less valuable.

While the CFTC guidance largely reflects the standards already articulated by the IC-VCM, ISDA, IOSCO, and the registries themselves, to avoid potential issues in the future, registries should (1) adhere to quality standards that meet best practices regarding transparency, additionality, permanence/reversal, and robust calculation methods; (2) ensure that their crediting program has a transparent governance structure and process for tracking credits; and (3) pursue third-party auditing of the registry.

What are the implications of the CFTC guidance and what is on the horizon?

In practice, the CFTC guidance imposes no new affirmative obligations or introduces novel ideas. The CFTC is not interfering with the achievements already accomplished by the private sector and state governments. The CFTC guidance affirms the integrity of the carbon market and therefore enhances the credibility of a necessary financing source for climate protection. It also provides some guardrails and direction to those who want to either enter the carbon market or expand it.

There are, nonetheless, three key regulatory questions shaping VCMs.

First, the guidance must be read and understood in the context of the CFTC’s enforcement authorities.  If the DCMs do not follow the guidance (which is more detailed than the regulations) when listing VCC futures, the DCMs could potentially be exposed to enforcement actions. Cash market participants for VCCs would also want to be mindful of the guidance and understand whether the registries are hewing to it. Moreover, CFTC Rule 180 has a recklessness standard. If a registry is not following this guidance, and a counterparty to a bilateral VCC transaction knows this, but buys a credit registered there anyway, and there is some type of alleged “misrepresentation” embedded in the contract, the CFTC could potentially investigate the party trading the credit. In this respect, while the guidance does not create potential liability or exposure for the market participant directly, it would inform the CFTC’s view about whether the market participant recklessly engaged in fraudulent or manipulative conduct.

Second, the guidance comes two months ahead of the UNFCCC COP 29 conference in Baku, Azerbaijan, where discussions over Article 6 of the Paris Agreement regulating VCMs will continue. While the outcome of Article 6 negotiations will not necessarily impact US derivative markets, it will certainly shape global trends.

Third, the CFTC guidance was issued within the last sixty days of the 2024 legislative calendar, rendering it potentially susceptible to Congressional review and revocation under the Congressional Review Act’s (CRA) lookback provision when the newly-elected Congress convenes in January 2025. While there currently does not appear to be any interest in revoking the CFTC guidance, this is always a possibility.

A special thanks to Dentons Energy law clerk, Dena Sholk for her contributions to this client alert.

1. CFTC, Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts 80 (September 2024), https://www.cftc.gov/media/11301/FederalRegister092024_VCCDerivativesGuidance/download↩
2. Taskforce on Scaling Voluntary Carbon Markets, https://www.iif.com/tsvcm (last visited Sept. 30, 2024).↩
3. Trading Documents, IETA, https://www.ieta.org/resources/trading-documents/ (last visited Sept. 27, 2024).↩
4. ISDA Launches Standard Definitions for the Voluntary Carbon Market, ISDA (Dec. 13, 2022), https://www.isda.org/2022/12/13/isda-launches-standard-definitions-for-the-voluntary-carbon-market/↩
5. IOSCO, VOLUNTARY CARBON MARKETS: CONSULTATION REPORT (Dec. 2023), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD749.pdf↩
6. Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts, at 86.↩
7. Id. at 90.↩
8. Id. at 90.↩
9. Id.↩
10. Id. at 93.↩
11. Id. at 98.↩
12. Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts, at 74.↩
13. The CFTC considers carbon credits issued by registries to be verified carbon credits, rather than voluntary carbon credits (VCCs), which are intangible commodities underlying a derivative contract. See Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts, n. 31 at 8.↩