Many companies buy voluntary carbon credits (VCCs), financial products that purport to represent a standard reduction of greenhouse gas emissions from the atmosphere, in an apparent attempt to offset their greenhouse gas emissions. The carbon credit market, which represented about $2 billion in value in 2022, is currently about $1.4 billion, and over the medium to long term is expected to rebound and grow substantially as global pressure to reduce carbon emissions grows. Largely unregulated by U.S. federal agencies, these markets have proved rife with inaccurate claims, fraud, and abuse.
In 2023, the Commodity Futures Trading Commission (CFTC) proposed guidance for the listing of complex financial products, called derivative contracts, that are based on the value of another asset—in this case, a voluntary carbon credit. The agency’s stated intention was to promote high integrity in the carbon credit markets underlying the derivatives markets.
In February 2024, the Center for American Progress submitted comments on the CFTC’s proposal. While CAP supports efforts to improve the integrity of the broken VCC market, the comment letter pointed out that the CFTC lacks sufficient authority and expertise to effectively oversee the listing and trading of VCC-based derivatives and, worse, that the proposal would provide a sheen of legitimacy to an underlying product that has been proved highly unreliable and could undermine the nation’s climate emission reduction goals.
The CFTC nevertheless finalized the guidance on September 20, 2024. While the Trump administration casts uncertainty over the future of the guidance, the advancement of greenhouse gas emission efforts in dozens of U.S. states and globally suggests that multinational companies may still seek VCC offsets, and the market for derivatives based on those credits may grow.
Background
Voluntary carbon credits
A voluntary carbon credit is an instrument intended to represent the removal or reduction of one metric ton of carbon dioxide or an equivalent amount of other greenhouse gases from the atmosphere. These credits are awarded to a variety of projects, which could include installing carbon capture and storage technology, but also could include simply maintaining forested land or utilizing some other mechanism.
Companies that find it difficult or costly to reach their emissions reduction targets through changes to their own operations may seek to purchase VCCs from either projects that give rise to the credits, such as the tree planting or clean technology companies, or, more typically, from a firm that facilitates trading in VCCs to ostensibly offset their own emissions. Companies may then claim that these offsets enable them to meet their carbon emission reduction commitments. A multibillion-dollar industry has formed that facilitates the trading of VCCs—and profits from the fees generated.
Unfortunately, the VCC market is fraught with failed projects and outright fraud. Independent studies of the projects giving rise to VCCs have found widespread problems, with most failing to deliver on promised reductions or removals. These problems suggest that most carbon credits fail to result in verifiable, unique, additional, and permanent emissions reductions. Research conducted by the Science Based Targets initiative (SBTi), a private organization that is trying to establish science-based audits for companies seeking to meet climate emission reduction targets, confirms this assertion.
In November 2024, countries attending the 29th annual United Nations Climate Change Conference agreed on rules for a global market to buy and sell carbon credits; however, most of the details of such a market have yet to be worked out. Thus, there still is no global system or registry for VCCs to ensure that credits are not double-counted. Nor is there a global consensus on how to identify, monitor, and retire carbon credits to ensure that they are reliable and standard, and that they result in permanent reductions or removals of carbon dioxide or other greenhouse gases. Therefore, the VCC markets remain privately operated.
Due to the well-documented uncertainty around VCCs and the projects that give rise to them, most governing entities developing or implementing greenhouse gas emissions disclosure laws do not allow companies to use VCCs to offset or net against the emissions they report. Most of these governing entities, including the European Union, California, the U.S. Securities and Exchange Commission, and the International Sustainability Standards Board, have called for separate disclosure of information relating to VCCs that a company purchases to achieve emission targets.
Private market researchers have estimated that the VCC market could grow to $21.7 billion through 2032. But such growth estimates would likely only be achieved if companies were allowed to use VCCs to meet government-mandated emission reduction targets.
VCC derivatives
Despite these extensive problems with the validity of VCCs, the VCC industry is seeking to enhance VCC trading by creating derivative contract products based on existing VCCs. For example, counterparties to such a derivative contract would bet on the price of the VCC at a future point in time, enabling hedging of and speculation on VCC trading. Derivative exchanges have sought to approve such products for trading.
The CFTC guidance
The CFTC, which oversees derivative exchanges, proposed in December 2023 to provide guidance to the exchanges regarding their consideration of VCC-based derivative contracts for trading. It sought comments from the public on the proposal—and CAP responded—and later finalized the guidance.
CAP response
In its comments on the proposed guidance, CAP argued that, unlike other commodity derivatives traded under the agency’s jurisdiction, the way that the underlying VCCs are created is not certain and verifiable and thus not fungible enough to ensure that the trading of those contracts would be consistent with the core principles that the agency must follow. CAP also argued that derivatives based on VCCs are likely beyond the agency’s legal authority and especially its expertise.
CAP further explained that derivatives based on VCCs are fraught with misguided incentives and conflicts of interest, particularly given that no parties to the derivative transaction have an incentive to ensure that the emission reductions are real, permanent, and not double-counted—unlike end users of other commodity derivatives contracts.
Finally, CAP explained that the agency’s proposal is inconsistent with the urgency of the global goal, expressed in the 2015 Paris Agreement, of limiting global temperatures to well below 2 degrees Celsius above preindustrial levels in order to avoid dangerous climate impacts. Since then, the Intergovernmental Panel on Climate Change has found that impacts above 1.5 degrees of warming are more serious than previously estimated, and climate disasters have increased in number and severity. Policymakers and scientific experts serious about preventing the worst impacts of climate change are now prioritizing absolute reductions in emissions. Purchase of VCCs by companies to offset rather than reduce their own emissions, CAP argues, is not consistent with these goals.
The CFTC released its final guidance on September 20, 2024. Although the final guidance contains more detailed considerations that designated contract markets should look for in VCC-based derivative contracts and places greater emphasis than the proposal on the need for standardization of VCCs, the final guidance remains seriously flawed and fails to address the concerns raised in CAP’s comments.
Click here to read CAP’s comment letter.