Voluntary Carbon Markets: an Overview of U.s. Regulatory Developments

• Jurisdiction: United States,Federal
• Citation: Vol. 1 No. 3
• Publication year: 2023

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Deborah North and Laura Daugherty ^*

In this article, the authors briefly discuss the voluntary carbon markets before examining related Commodity Futures Trading Commission and Securities and Exchange Commission regulatory developments and the potential impact of the Inflation Reduction Act on these markets in the United States.

As the importance of the voluntary carbon markets to global decarbonization goals grows, so too does U.S. regulatory and legal interest in this area, and the importance to public companies and their boards.

This article briefly explains the voluntary carbon markets before discussing related Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) regulatory developments and the potential impact of the Inflation Reduction Act on these markets in the United States. The development of transparent, sound, and efficient voluntary carbon markets is of vital importance to the growing number of companies using carbon credits to help meet their emissions reduction and net-zero goals and to comply with growing disclosure and related regulatory mandates.

Voluntary Carbon Markets: A Primer

Voluntary carbon markets allow carbon emitters to purchase credits that are awarded to projects that remove or reduce atmospheric carbon. These credits offset their emissions in furtherance of a voluntary commitment to reduce "net" emissions. ¹ These markets can be distinguished from "compliance" carbon markets, which is the term for systems where a government or regulator issues a carbon allowance that participants must not exceed unless they can purchase additional compliance allowances from another participant under the cap-and-trade program. ² Each credit typically

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corresponds to one metric ton of reduced, avoided, or removed carbon dioxide or equivalent greenhouse gas.

The importance of the voluntary carbon markets is growing. According to the Taskforce on Scaling Voluntary Carbon Markets, voluntary carbon markets need to grow by more than 15-fold by 2030 in order to support the investment required to deliver the Paris Agreement's goal of limiting the global average temperature increase to below 1.5°C above pre-industrial levels. ³

CFTC and SEC Interest in the Carbon Markets

The CFTC

The CFTC has shown an increasing interest in carbon. This focus largely began in September 2020 when the CFTC's Climate-Related Market Risk Subcommittee issued a report titled "Managing Climate Risk in the U.S. Financial System." ⁴ The report concludes that climate change poses a major risk to the stability of the U.S. financial system and, in turn, the American economy, and presents 53 recommendations to mitigate the risks that climate change poses to the financial markets. ⁵ In response, in March 2021, then CFTC Acting Chairperson Rostin Behnam established the Climate Risk Unit. The goal of the CFTC's Climate Risk Unit is to "[focus] on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy." ⁶

In June 2022, the CFTC issued a Request for Information (RFI) on Climate-Related Financial Risk. The RFI sought responses on questions specific to data, scenario analysis and stress testing, risk management, disclosure, product innovation, voluntary carbon markets, digital assets, greenwashing, financially vulnerable communities, and public-private partnerships and engagement. The CFTC indicated that it intends to use the responses to promote responsible innovation, ensure the financial integrity of all transactions subject to the Commodity Exchange Act, avoid systemic risk, inform the CFTC's response to the recommendations of the Treasury Department's Financial Stability Oversight Council 2021 "Report on Climate-Related Financial Risk," and inform the ongoing work of its Climate Risk Unit. ⁷

One key issue that has materialized in the comments in response to the RFI is whether the CFTC should establish a broader

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regulatory framework for the voluntary carbon markets, including the spot markets. ⁸ The outcome of this debate is one area to watch as CFTC regulation of the voluntary carbon markets evolves.

The SEC

In March 2022, the SEC proposed sweeping climate risk-related disclosure and reporting rules. ⁹ Although the issuance of the final rules has been delayed given reactions and challenges to the proposal, the proposed rules call for certain disclosures regarding carbon.

One element of the proposed rule calls for mandatory disclosures by any registrant that "maintains an internal carbon price" regarding the price per metric ton of carbon dioxide, the total price and how it is estimated to change over time, the rationale for the internal carbon price, and how it uses the internal carbon price to evaluate and manage climate-related risks. ¹⁰

Another aspect of the...