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The Commodity Futures Trading Commission can raise the bar on voluntary carbon credits 

February 28, 2024

Voluntary carbon credits, which finance projects or activities to remove or reduce carbon emissions, may have a considerable role to play in climate change mitigation. The market for these credits is at a pivotal moment, having peaked at $2 billion in 2021, and is projected to grow by possibly hundreds of billions in the coming decades if integrity can be assured. Over 40% of these credits represent forestry and other land use projects, which otherwise might have few market-based incentives for deployment.  

Unfortunately, there are concerns about the quality of carbon credits that undermine their value both for climate change mitigation, and as a robust commodity. Inadequate standards, inconsistency in project implementation, and the lack of centralized governance have resulted in low-quality credits being certified and sold. Carbon markets need to be carefully designed and regulated so they do not deter emissions reductions through the sale of tranches of cheap, low-quality offsets. Without strong standards, low quality credits can distort prices and keep investment from flowing to high quality projects. CATF is working to address the issue of carbon credit quality in multiple ways. 

Providing effective oversight of voluntary carbon credit derivatives markets 

One opportunity to address the quality of carbon credits is through regulation of voluntary carbon credit derivatives markets. As part of its anti-fraud and anti-manipulation missions, the Commodity Futures Trading Commission (CFTC) is taking several actions to improve the voluntary carbon market, including issuing guidance for listing credits in voluntary carbon markets, posting a whistleblower alert on fraud in carbon markets, and establishing an environmental fraud enforcement task force. Last month, CATF submitted comments on how the Commission can strengthen its proposed guidance for voluntary carbon markets.  

The CFTC proposes to further exercise its existing authority by laying out guidance for voluntary carbon credit derivatives contracts to include information based on defined “commodity characteristics.” For voluntary carbon credits, the CFTC proposes those characteristics are (1) transparency; (2) additionality; (3) permanence and risk of reversal; (4) robust quantification; (5) governance; (6) tracking; (7) no double counting; and (8) third-party validation and verification. These characteristics align with carbon credit principles CATF has previously raised in comments to the CFTC. 

Project-level information is essential to derivatives contracts 

To assure voluntary carbon credits provide for the real climate benefits that they are marketed to represent — and that contracts listing derivatives for these credits are not readily susceptible to manipulation — transparency into the project or activity providing the emissions reductions or removals is critical. Credits must represent real emissions reductions or carbon removals that are additional, accurately quantified (including consideration of uncertainty in measurement, activity and market leakage, and the counterfactual business-as-usual scenario), durable, and account for the realistic risk of reversal.  

Unfortunately, many existing crediting protocols are insufficiently prescriptive or transparent to assure consistency in project implementation. Opportunities for project developer discretion abound in the existing design of voluntary carbon market protocols, and therefore the quality of credits certified under a given protocol can be inconsistent.  

CFTC’s guidance offers a method by which transparency is provided, by requiring more detail from credit-issuing entities in the terms and conditions of carbon credit derivatives contracts regarding project-level implementation details and third-party verification.   

CATF’s comments pushed the CFTC to strengthen its guidance by adding additional commodity characteristics and tightening the criteria and factors beyond what is already in the proposal. Specifically, CATF recommends the Commission: 

  • Add (1) durability and (2) vintage to the list of voluntary carbon credit commodity characteristics. Durability associated with every carbon credit, expressed in terms of years for the contracted duration of carbon storage, must be transparent. Within the existing market, durability of credits ranges from 10 years to 100 years, with some types of credits expected to be effectively permanent. Differences in durability imply real differences in quality, price, and suitable use cases for credits. Vintage, which is the year a credit is generated and/or issued, has similar effects on quality, price, and suitable use cases because emissions reductions or removals should ideally be contemporaneous with offsets and in general the robustness of protocols has increased over time. 
  • Require robust baseline analysis for quantifying emissions reductions or removals and determining additionality. Determining additionality — meaning that the emissions reductions or removals would not have taken place absent the financing provided by sale of a credit — is essential. For ecosystem-based credits, the additional carbon stored by a project must be calculated relative to a counter-factual “business as usual” baseline condition. To ensure that credits are high-quality, the baseline should be dynamic over time to reflect current economic, policy, and environmental contexts when credits are issued.  
  • Ensure accounting for or mitigation of the risk of reversal of carbon storage. Storage of carbon in trees and soils is particularly vulnerable to reversal and rerelease to the atmosphere, especially as climate change exacerbates risks associated with wildfire, insect and disease outbreaks, and drought. It is essential that carbon credits provide assurance at the project-level that the risk of reversal is addressed and reflects changes to risk over time using the best available science and spatially explicit data. 
  • Insist on independence of third-party verification and data sources. Validation and verification bodies have an incentive to maintain relationships with project developers, which calls into question their independence. Contract terms and conditions can assure greater independence of these bodies and their methodology, including through direct access to data. 

The CFTC can require that this information be made publicly available and easily accessible in the terms and conditions for voluntary carbon credit derivatives contracts. For example, information can be provided through open-access databases that cover all projects under a given credit-issuing body that are updated regularly and provide machine-readable or digitally searchable information. Including such detailed information will both provide confidence to participants in the voluntary carbon market and prevent price distortion and fraud, which both undermine broader decarbonization goals and ensure robust climate outcomes. 

¿Y ahora qué? 

By finalizing the guidance with CATF’s recommendations, the CFTC has the chance to address quality issues in the voluntary carbon markets. The commission should also build on this guidance by proposing regulations specific to voluntary carbon markets. 

CATF is also developing an assessment of forest carbon credit protocols along with a group of scientific experts. Through a report and article, this work will shine a light on the effectiveness of these protocols and should provide information and support for additional regulatory work by the CFTC.  

The ability of carbon credits to complement emission reductions in the fight against climate change depends on the quality of those credits. They must represent real, additional, durable, and robustly quantified emissions reductions or carbon removals that appropriately account for risk of reversal. CATF is vigilantly working to advocate the adoption of standards that drive out low-quality credits and assure that investments in ecosystem-based climate solutions flow to the most effective projects and activities. 

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