The Commodity Futures Trading Commission (CFTC) recently approved one of its most controversial guidance document to date. Under this new policy, the CFTC will dictate terms for a voluntary carbon-credit (VCC) market beyond its jurisdiction.
The move came in late September when, by a majority vote, the commissioners approved the guidance document titled “Listing Voluntary Carbon Credit Derivative Contracts.” Following the vote of approval, CFTC officials issued the final text on October 15th.
The final guidance enables the CFTC to arbitrarily weigh in on voluntary carbon credit trading across its exchanges; something that no other federal agency has attempted before. And, for good reason: voluntary carbon trading is a separate domain from government regulated cap-and-trade programs.
The CFTC’s guidance ignores this distinction and kicks down the barrier between voluntary and regulated carbon markets. The final guidance institutes an unnecessary set of regulatory constraints on carbon trading across its designated contract markets (DCMs).
Rather than propose a cap-and-trade model, the CFTC has artificially inserted itself into a struggling voluntary market, setting new terms and conditions.
The guidance appears to be a bid to breathe newfound life into pre-existing carbon credit derivatives that aren’t being traded. In its proposal, the Commission expressed concerns on the faltering investor interest in VCCs, stating that “recently, supplies of VCCs are generally considered to be high relative to demand.”
CFTC officials hope that the new guidance will re-energize a voluntary market that too few companies are using.
The Commission inserts arbitrary guideposts for how investors should trade VCCs. It bases these guidelines on fabricated connections to the Commodity Exchange Act (CEA), which does not mention the agency’s authority to regulate such credits.
In February, I submitted a public comment in opposition to the CFTC’s proposed guidance. While the guidance is non-binding like most sub-regulatory edicts, it may carry compliance consequences if CFTC enforcement officials decide to act under their newfound authority.
CFTC lacks the statutory authority to regulate VCCs
The Commission predicates much of its decision to issue guidance for carbon credit derivatives on the CEA and prior regulations. Yet, Congress has not passed legislation that would enable the CFTC to regulate voluntary carbon credit agreements. Nor does the plain language in CEA point to pre-existing authority.
Such environmental agreements are established by the consenting company to de-carbonize its own activities. The CFTC seems to confuse the VCC with the actual regulated commodity that it is attached to.
In its final guidance, the CFTC outlines several of its statutory “Core Principles” governing how DCMs should ensure integrity and transparency for listed contracts in order to “prevent manipulation, price distortion, and disruptions” (Principle 4). While this is understandable, the Commission fails to justify why VCCs or carbon trading is not specifically mentioned as being part of the derivatives market that the Principles apply to.
Given that VCCs represent voluntary agreements between consenting parties about decarbonization and not about the underlying commodities being traded, the CFTC is without statutory authority to dictate any terms for trade.
The first “C” in CFTC does not stand for “carbon”
One of the core issues with the CFTC’s final guidance is that it deviates from its mission to advance an unapproved decarbonization agenda. CFTC is tasked with regulating contracts pertaining to commodities, not the greenhouse gases that may occur from its production.
The Commission is obligated to safeguard the “integrity, resilience, and vibrancy of the US derivatives markets through sound regulation.” This does not extend to ensuring integrity in VCC contracts, as Congress did not deputize the agency to mitigate climate change via its guidance.
Yet, CFTC Chair Rostin Benham said the quiet part out loud when he ensured that the guidance would “foster the allocation of capital towards decarbonization efforts” (see Appendix 2, “statement of support”).
Also worrisome is the CFTC’s false premise that it must intermediate “between financial markets and decarbonization efforts.” Nothing could be further from the truth, as the Commission is expected to operate from a standpoint of neutrality and separation when faced with private matters external to its purview, like carbon reduction.
Even the head of its sister agency, the Securities and Exchange Commission (SEC) at least claimed to be “merit neutral” on climate disclosures, stating the “SEC has no role as to climate risk itself.” By contrast, Chair Behnam fully embraced the agency’s nonexistent role in facilitating private decarbonization to eliminate climate risks.
This final guidance switches the “commodity” in CFTC to “carbon” by reinventing a “financial system that provides effective tools in achieving emission reductions.”
CFTC should not rescue the VCC market from itself
As I argued in my public comment, the CFTC proposes its novel guidance as a means to resuscitate a market in decline. There simply isn’t much of a demand for firms to buy and sell existing carbon credits across DCMs.
In fact, as of last year, “NYMEX is the only US exchange that offers futures contracts on voluntary carbon credits with open interest,” according to a report by Morgan Lewis. Additionally, only 16 percent of these contracts carry some degree of investor interest.
The CFTC finalizes its guidance as a rescue plan for declining interest in VCC trading. Yet, it’s not the place of a regulator to tamper with a voluntary market with rules of the road not designed for this trade. The CFTC cannot simply use its guidance to boost investor demand and trust in carbon credit derivatives.
The CFTC has no role to play in a voluntary carbon credit market. VCCs represent environmental agreements that are external to the CFTC’s regulatory scope.
These private agreements are merely attached to the underlying derivative contracts that the agency should be focused on. The CFTC’s troubling intervention in VCC sets a worrisome precedent for unwarranted government intervention in similar contexts.
Congress should consider adopting a Congressional Review Act resolution of disapproval for the VCC guidance. We must ensure that regulators like the CFTC stay in their regulatory lane and avoid taking on new statutory mandates that were never provided to them.
