CFTC gauging role as carbon markets grow but still face challenges scaling up

Despite growth in regional carbon markets and swelling demand for voluntary carbon offsets, there is a need for standardization to help scale up trading and a role for regulators in ensuring market integrity, participants in a US Commodity Futures Trading Commission advisory panel forum said June 3.

The CFTC's Energy and Environmental Markets Advisory Committee held a daylong session exploring the potential role of carbon markets in the transition to a low-carbon economy. The event featured updates about cap-and-trade programs in the US, EU and UK, and on the current state of exchange-listed carbon derivative products. The commission has stepped up attention to climate, with Acting Chairman Rostin Behnam in March announcing a climate risk unit within the CFTC focused on the role of derivatives markets in pricing and addressing climate risk.

Commissioner Dan Berkovitz, the EEMAC sponsor at the CFTC, outlined three ways the CFTC can support the energy transition: by ensuring integrity of carbon derivatives markets; by working with exchanges and other market participants on development of new products that help companies meet compliance obligations, manage risks and discover prices; and by ensuring appropriate management and disclosure of climate risks. The CFTC also should work with other regulators and stakeholders to optimize effectiveness and integrity of interrelated markets for primary and secondary markets and derivate markets for carbon, he said.

Christian Schneider, managing director for strategy at Nodal Exchange, outlined major trends effecting global carbon market development, including higher greenhouse gas reduction targets, and some geographic expansion of emission trading system markets, as well as expansion of ETS into new sectors beyond power generation. Alongside carbon markets linked to regulation, there has been a complementary rise in voluntary carbon markets, he said.

Exchanges highlighted growth in their carbon markets. Gordon Bennett, Intercontinental Exchange managing director, utility markets, said open interest in ICE's environmental complex is up 14% year-over-year in 2021, at about 2.83 million lots.

Turning to offsets

But there was talk about the difficulties scaling markets up globally, and some participants raised qualms over the quality of carbon offsets or, in other cases, reliability of credits over time.

Suzi Kerr, chief economist at Environmental Defense Fund, described the role of policy and international diplomacy in creating uncertainty in demand and prices in cap and trade and other carbon markets. Rewarding clean investment is a central goal, making managing of policy-driven risk key for the markets, she emphasized.

Sarah Tomalty of BP Energy said the markets being discussed were extremely important for the company to be able to manage its risks. "But given the global nature of the primary markets that underlie the futures products, how do we ensure that quality of the credits that make up those markets and that those credits are not later invalidated?" she asked.

Derek Sammann, senior managing director and global head of commodities and options products at CME Group, updated the commission on the voluntary Global Emissions Offset contract it launched in March. He answered concerns raised about offsets by noting the offset registries upon which the products are based were developed under a United Nations framework with regulatory oversight. Out of eight approved registries, CME selected the three registries which it viewed as most robust, he said.

Touching on that debate, Behnam said it will be important for the CFTC and other government regulators, as the public-private partnership evolves, to "play a good role," because the government has learned lessons related to cryptocurrency markets and Renewable Identification Numbers markets. "Given the ambition and the scale, we have to make sure we get this right because the outcome and the deliverables are really what we're trying to achieve."

Addressing fragmentation

Annette Nazareth, senior counsel at Davis Polk who spoke on behalf of the private sector-led Taskforce for Scaling Voluntary Carbon Markets, emphasized a need for increased standardization of the voluntary carbon markets, in order to meet carbon goals.

"What we have today are markets that don't have the kind of robustness, the integrity of standardization that we think is necessary to build these markets up quickly enough to make a real difference," she said. The task force has circulated a proposal for an umbrella governance body to help build the market and provide oversight for standard-setting organizations.

Sammann, who participated in the task force, noted exchange-cleared emissions contracts, based on mandatory or regulated markets, have clearly defined rules, but the disparity in the various regulatory frameworks around the world results in a lack of transferability or fungibility between different states. Voluntary offset markets, on the other hand, generate offset credits to be located anywhere in the world but have lacked an overall framework to tie in various regions and registered projects to create a standardized price and common set of attributes, he said.

"The decentralized nature of these carbon markets has caused frustration and confusion for both buyers and sellers; meanwhile, the demand for emissions offset credits has soared," said Sammann. The voluntary task force has outlined that the offset market could increase fifteenfold by 2030, with carbon credits worth up to $50 billion by then, he said.

In the US, Frederick Heinle, assistant people's counsel for the District of Columbia, said diversity among state clean energy and decarbonization programs complicates policymaking at a regional and national level.

To further the CFTC's understanding, the Commercial Energy Working Group, comprising energy companies, proposed the creation of a subcommittee within EEMAC to create a report on guiding principles for the design of markets for the independent trading of carbon allowances, focusing on secondary markets and derivative markets.

"It is intended to facilitate fair and orderly trading in carbon markets by promoting uniform consistency in designing the secondary, cash and related derivative markets for carbon allowances and offsets," said Matthew Picardi, vice president of regulatory affairs at Shell Energy.