Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts; Request for Comment, 89410-89428 [2023-28532]

Download as PDF ddrumheller on DSK120RN23PROD with NOTICES1 89410 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices was accompanied by a Presidential Memorandum titled ‘‘Modernizing United States Spectrum Policy and Establishing a National Spectrum Strategy,’’ which calls for the Secretary of Commerce, acting through NTIA, to publish an Implementation Plan for the Strategy. This will chart the course for federal agency actions, pursuant to the Presidential Memorandum, to further the policy objectives stated in the Strategy. The strategic objectives in the Strategy are grouped under four ‘‘pillars’’ for further action: • Pillar One: A spectrum pipeline to ensure U.S. leadership in advanced and emerging technologies; • Pillar Two: Collaborative long-term planning to support the nation’s evolving spectrum needs; • Pillar Three: Unprecedented spectrum innovation, access, and management through technology development; and • Pillar Four: Expanded spectrum expertise and elevated national awareness. Speakers from the Department of Commerce, the Executive Office of the President, the Federal Communications Commission and Congress have been invited to provide keynote remarks. Panelists are expected to include participants from the FCC, Executive Branch agencies, and the private sector. Prior to the symposium event, NTIA will post detailed program information on its website: www.ntia.gov. The symposium is open to the public and members of the press to attend or to view through a webcast available on the NTIA website. While it is not required, NTIA asks that online attendees provide registration information prior to the event. This information will include names, email addresses, and organizations (optional). Registration information, the agenda, meeting updates, if any, and other relevant documents will be available on NTIA’s website. The event webcast will be closecaptioned. Individuals requiring special accommodations, such as sign language interpretation or other ancillary aids, should notify Mr. Alden at the contact information listed above at least ten (10) business days before the event. Stephanie Weiner, Chief Counsel, National Telecommunications and Information Administration. [FR Doc. 2023–28564 Filed 12–26–23; 8:45 am] BILLING CODE 3510–60–P VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 COMMODITY FUTURES TRADING COMMISSION RIN 3038–AF40 Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts; Request for Comment Commodity Futures Trading Commission ACTION: Proposed guidance; request for comment. AGENCY: The Commodity Futures Trading Commission (the ‘‘Commission’’ or ‘‘CFTC’’) is issuing for public comment this proposed guidance regarding the listing for trading of voluntary carbon credit (‘‘VCC’’) derivative contracts. Specifically, the Commission is proposing to issue guidance to outline factors that designated contract markets (‘‘DCMs’’) should consider when addressing certain provisions of the Commodity Exchange Act (‘‘CEA’’), and CFTC regulations thereunder, that are relevant to the listing for trading of VCC derivative contracts. The Commission recognizes that VCC derivatives are a comparatively new and evolving class of products, and believes that guidance that outlines factors for a DCM to consider in connection with product design and listing may help to advance the standardization of such products in a manner that promotes transparency and liquidity. The Commission requests comment on this proposed guidance and further invites comment on specific questions related to the listing for trading of VCC derivative contracts. DATES: Comments must be received on or before February 16, 2024. ADDRESSES: You may submit comments, identified by ‘‘Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts’’ and RIN 3038–AF40, by any of the following methods: • CFTC Comments Portal: https:// comments.cftc.gov. Select the ‘‘Submit Comments’’ link for this release and follow the instructions on the Public Comment Form. • Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. • Hand Delivery/Courier: Follow the same instructions as for Mail, above. Please submit your comments using only one of these methods. Submissions through the CFTC Comments Portal are encouraged. SUMMARY: PO 00000 Frm 00049 Fmt 4703 Sfmt 4703 All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to https:// comments.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act (‘‘FOIA’’), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission’s regulations.1 The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse, or remove any or all of your submission from https://www.comments.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the guidance will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under FOIA. FOR FURTHER INFORMATION CONTACT: Lillian A. Cardona, Assistant Chief Counsel, (202) 418–5012, lcardona@ cftc.gov; Steven Benton, Industry Economist, (202) 418–5617, sbenton@ cftc.gov; Nora Flood, Chief Counsel, (202) 418–6059, nflood@cftc.gov; Division of Market Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. SUPPLEMENTARY INFORMATION: I. Background A. The Regulatory Framework for DCMs The CFTC’s mission is to promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.2 An independent agency of the U.S. federal government, the CFTC exercises the authorities granted to it under the CEA to promote market integrity, prevent price manipulation and other market disruptions, protect customer funds, and avoid systemic risk, while fostering responsible innovation and fair competition in the derivatives markets.3 DCMs are CFTC-regulated exchanges that provide participants in the derivatives markets with the ability to execute or trade derivative contracts 1 17 CFR 145.9. Mission Statement, available at: https:// www.cftc.gov/About/AboutTheCommission. 3 See CEA section 3(b), 7 U.S.C. 5(b). 2 CFTC E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 with one another.4 In order to obtain and maintain designation with the CFTC, DCMs must comply with statutory ‘‘Core Principles’’ that are set forth in the CEA,5 as well as applicable CFTC rules and regulations.6 The statutory Core Principles for DCMs reflect the important role that these exchanges play in promoting the integrity of derivatives markets. DCMs are self-regulatory organizations, and each DCM has Core Principle obligations to, among other things, establish and enforce rules for trading on the DCM; 7 provide a competitive, open and efficient market for trading; 8 and monitor trading activity.9 For example, DCM Core Principle 4 requires a DCM to have the capacity and responsibility to prevent manipulation, price distortion, and disruptions of the delivery or cash settlement process, through market surveillance, compliance, and enforcement practices and procedures.10 DCM Core Principle 5 4 See CEA section 1a(6), 7 U.S.C. 1a(6). (The term ‘‘board of trade’’ means any organized exchange or other trading facility); CEA section 1a(51)(A), 7 U.S.C. 1a(51)(A) (The term ‘‘trading facility’’ means a person or group of persons that constitutes, maintains, or provides a physical or electronic facility or system in which multiple participants have the ability to execute or trade agreements, contracts, or transactions—(i) by accepting bids or offers made by other participants that are open to multiple participants in the facility or system; or (ii) through the interaction of multiple bids or multiple offers within a system with a pre-determined nondiscretionary automated trade matching or execution algorithm); and CEA section 5(d)(1)(A), 7 U.S.C. 7(d)(1)(A) (To be designated, and maintain a designation, as a contract market, a board of trade shall comply with—(i) any core principle described in this subsection; and (ii) any requirement that the Commission may impose by rule or regulation pursuant to CEA section 8a(5)). 5 See, generally, CEA Section 5(d), 7 U.S.C. 7(d). There are 23 statutory Core Principles for DCMs. 6 CEA section 5(d)(1)(A), 7 U.S.C. 7(d)(1)(A). 7 DCM Core Principle 2 requires, among other things, that a DCM establish, monitor, and enforce compliance with the rules of the DCM, including access requirements, the terms and conditions of any contracts to be traded on the DCM, and rules prohibiting abusive trade practices on the DCM. DCM Core Principle 2 also requires a DCM to have the capacity to detect, investigate, and apply appropriate sanctions to any person that violates any rule of the DCM. CEA section 5(d)(2), 7 U.S.C. 7(d)(2). See also 17 CFR 38.150–160. DCM Core Principle 13 requires that a DCM establish and enforce disciplinary procedures that authorize the DCM to discipline, suspend, or expel members or market participants that violate the DCM’s rules. CEA section 5(d)(13), 7 U.S.C. 7(d)(13). See also 17 CFR 38.700–712. 8 DCM Core Principle 9 requires, among other things, that a DCM provide a competitive, open, and efficient market and mechanism for executing transactions that protects the price discovery process of trading in the centralized market of the DCM. CEA section 5(d)(9), 7 U.S.C. 7(d)(9). See also 17 CFR 38.500. 9 See, e.g., DCM Core Principles 4, 5, and 12, discussed infra. 10 CEA section 5(d)(4) 7 U.S.C. 7(d)(4). See also 17 CFR 38.250–258. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 requires a DCM to adopt for each contract that it lists for trading, as is necessary and appropriate, position limitations or position accountability for speculators, in order to reduce the potential threat of market manipulation or congestion, especially during trading in the delivery month.11 DCM Core Principle 12 requires a DCM to establish and enforce rules to protect markets and market participants from abusive practices, and to promote fair and equitable trading on the DCM.12 Additionally, each DCM has a specific statutory obligation, under DCM Core Principle 3, to only list for trading contracts that are not readily susceptible to manipulation.13 As discussed in greater detail below, a DCM may generally elect to list a new derivative contract for trading either by certifying to the Commission that the contract complies with the CEA and CFTC regulations,14 or by seeking Commission approval of the contract.15 In either case, the DCM must submit the contract’s terms and conditions, and other prescribed information relating to the contract, to the Commission prior to listing.16 For a number of the statutory Core Principles for DCMs, the Commission has adopted rules that establish the manner in which a DCM must comply with the Core Principle.17 These implementing rules are set forth in Part 38 of the Commission’s regulations.18 The Commission has also adopted, in Appendix B to Part 38,19 guidance and acceptable practices for DCMs to take into consideration with respect to certain of the Core Principles.20 11 CEA section 5(d)(5), 7 U.S.C. 7(d)(5). See also 17 CFR 38.300–301. 12 CEA section 5(d)(12), 7 U.S.C. 7(d)(12). See also 17 CFR 38.650–651. 13 CEA section 5(d)(3), 7 U.S.C. 7(d)(3). See also 17 CFR 38.200–201. 14 CEA section 5c(c)(1), 7 U.S.C. 7a–2(c)(1). See also 17 CFR 40.2. 15 CEA sections 5c(c)(4)–(5), 7 U.S.C. 7a–2(c)(4)– (5). See also 17 CFR 40.3. 16 See, generally, 17 CFR 40.2 and 40.3. Amendments to contract terms and conditions also must be submitted to the Commission in accordance with procedures set forth at CEA section 5c(c), 7 U.S.C. 7a–2(c), and Part 40 of the Commission’s regulations. 17 Unless otherwise determined by the Commission by rule or regulation, a DCM has reasonable discretion in establishing the manner in which it complies with a Core Principle. CEA section 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B). 18 17 CFR part 38. 19 17 CFR part 38, Appendix B. 20 Guidance provides contextual information regarding a Core Principle, including important concerns which the Commission believes should be considered in complying with the Core Principle. The guidance for a DCM Core Principle is illustrative only of the types of matters that a DCM may address, and is not intended to be used as a mandatory checklist. Acceptable practices are more PO 00000 Frm 00050 Fmt 4703 Sfmt 4703 89411 With respect to the DCM Core Principle 3 requirement that a DCM only list for trading contracts that are not readily susceptible to manipulation, the Commission has adopted guidance that is set forth in Appendix C to Part 38 of the Commission’s regulations (the ‘‘Appendix C Guidance’’).21 The Appendix C Guidance outlines certain relevant considerations for a DCM when developing derivative contract terms and conditions, and providing supporting documentation and data in connection with the submission of the derivative contract to the Commission.22 The Commission takes these considerations into account when determining whether, with respect to the contract, the DCM is satisfying its Core Principle obligation only to list contracts that are not readily susceptible to manipulation. Among other things, the Appendix C Guidance outlines, for both physicallysettled and cash-settled derivative contracts, certain considerations in connection with the design of the contract’s rules and terms and conditions.23 With respect to physically-settled derivative contracts, the Appendix C Guidance states, among other things, that the contract’s terms and conditions should conform to the most common commercial practices and conditions in the cash market for the underlying commodity.24 The Appendix detailed examples of how a DCM may satisfy particular requirements of a DCM Core Principle. Similar to guidance, acceptable practices are for illustrative purposes only, and do not establish a mandatory means of Core Principle compliance. 17 CFR part 38, Appendix B. 21 17 CFR part 38, Appendix C. Guidance set forth in Appendix B to Part 38 states that a DCM may use the Appendix C Guidance as guidance in meeting DCM Core Principle 3 for both new product listings and existing listed contracts. 17 CFR part 38, Appendix B, Core Principle 3 Guidance. 22 See Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612 at 36632 (June 19, 2012). The Appendix C Guidance is also relevant to swap execution facilities (‘‘SEFs’’), another category of CFTC-regulated exchange that provides eligible contract participants with the ability to execute or trade, with one another, derivative contracts that are swaps. Like DCMs, SEFs are obligated by statute only to permit trading in contracts that are not readily susceptible to manipulation. See CEA section 5h(f)(3), 7 U.S.C 7b– 3(f)(3); 17 CFR 37.301. 23 Physically-settled derivative contracts are contracts that may settle directly into the commodity underlying the contract. If the holder of a position in a physically-settled derivative contract still has an open position at the expiration of trading in the contract, then the position holder must, in accordance with the rules for delivery set forth in the contract, make or take delivery (as applicable) of the underlying commodity. By contrast, cash-settled derivative contracts are, at the expiration of trading in the contract, settled by way of a cash payment instead of physical delivery of the underlying commodity. 24 Appendix C Guidance, paragraph (b)(1). E:\FR\FM\27DEN1.SGM 27DEN1 ddrumheller on DSK120RN23PROD with NOTICES1 89412 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices C Guidance also states that the contract’s terms and conditions should be designed to avoid impediments to the delivery of the underlying commodity, so as to promote convergence between the price of the contract and the cash market value of the underlying commodity at the expiration of trading in the contract.25 The Appendix C Guidance outlines certain criteria that should be addressed in the contract’s terms and conditions, including contract size, the period for making and taking delivery under the contract, delivery points, quality standards for the underlying commodity, and inspection/certification procedures for verifying compliance with those quality standards or any other related delivery requirements under the contract.26 The criteria outlined in the Appendix C Guidance that relate to the quality and other attributes of the underlying commodity that would be delivered under a physically-settled contract upon the expiration of trading, inform the pricing of the contract. Addressing these criteria clearly in the contract’s terms and conditions, in a manner that reflects the individual characteristics of the underlying commodity, helps to ensure that trading in the contract is based on accurate information about the underlying commodity. This, in turn, helps to promote accurate pricing and helps to reduce the susceptibility of the contract to manipulation. Further, when a contract’s terms and conditions help to ensure that, upon delivery, the quality and other attributes of the underlying commodity will be as expected by position holders, this helps to prevent price distortions and fosters confidence in the contract that can incentivize trading and enhance liquidity. With respect to cash-settled derivative contracts, the Appendix C Guidance states that an acceptable specification of the cash settlement price would, among other things, include rules that fully describe the essential economic characteristics of the underlying commodity, as well as how the final settlement price is calculated.27 The Appendix C Guidance states that the utility of a cash-settled contract for risk management and price discovery purposes would be significantly impaired if the cash settlement price is not a reliable or robust indicator of the value of the underlying commodity.28 The Appendix C Guidance states that, accordingly, careful consideration 25 Id. 26 Appendix C Guidance, paragraph (b)(2). C Guidance, paragraph (c)(1). 28 Appendix C Guidance, paragraph (c)(2). 27 Appendix VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 should be given to the potential for manipulation or distortion of the cash settlement price, as well as the reliability of that price as an indicator of cash market values.29 Appropriate consideration also should be given to the commercial acceptability, public availability, and timeliness of the price series that is used to calculate the cash settlement price.30 B. Voluntary Carbon Markets 1. Overview of Voluntary Carbon Markets As discussed further below, this proposed guidance addresses an emerging class of climate-related derivative contracts listed for trading by DCMs, where the underlying commodity is a VCC.31 In addition to direct greenhouse gas (‘‘GHG’’) emissions reduction initiatives, market-based mechanisms, such as carbon markets,32 have developed to support emissions reduction efforts. A carbon market generally refers to an economic mechanism to support the buying and selling of environmental commodities 33 that represent GHG emission reductions or removals from the atmosphere. Carbon markets are intended to harness market forces to incentivize carbon mitigation activities. Carbon markets generally fall into two categories: (i) 29 Id. 30 Id. 31 This proposed guidance uses the term ‘‘voluntary carbon credits’’ rather than ‘‘verified carbon credits,’’ as the proposed guidance is focused on the quality and other attributes of the intangible commodity underlying a derivative contract. The Commission recognizes that market participants in the cash or secondary market for voluntary carbon credits may choose to use a set of standardized terms for the trading and retirement of ‘‘verified carbon credits,’’ as defined by the International Swaps and Derivatives Association (‘‘ISDA’’), in the market participants’ physicallysettled spot, forward or option transactions. See 2022 ISDA Verified Carbon Credit Transactions Definitions (‘‘VCC Definitions’’) Frequently Asked Questions, available at: https://www.isda.org/a/ jBXgE/2022-ISDA-Verified-Carbon-CreditTransactions-Definitions-FAQs-061323.pdf. 32 While the term ‘‘carbon’’ is generally intended to also include other greenhouse gases, such as methane, nitrous oxide, sulfur hexafluoride, hydro fluorocarbons and perfluorocarbons, most emissions trading involves emissions trading of carbon dioxide. 33 An agreement, contract or transaction in an environmental commodity may qualify for the forward exclusion from the ‘‘swap’’ definition set forth in section 1a(47) of the CEA, 7 U.S.C. 1a(47), if the agreement, contract or transaction is intended to be physically settled. For further discussion of the Commission’s interpretation of whether agreements, contracts, or transactions in environmental commodities fall within the forward exclusion from the swap definition, see Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping; Final Rule, 77 FR 48208 (August 13, 2012). PO 00000 Frm 00051 Fmt 4703 Sfmt 4703 mandatory (or compliance) markets, and (ii) voluntary carbon markets. Mandatory markets, such as cap-andtrade programs, emissions trading systems and allowance trading systems, are established and regulated by national, regional, or international governmental bodies.34 Entities subject to the requirements of a mandatory market generally must demonstrate compliance by directly reducing their emissions from their own operations or activities, or by purchasing eligible compliance credits representing emission reductions or removals achieved by others. Voluntary carbon markets are not established by any government body. They enable market participants to purchase, on a voluntary basis, carbon credits that upon retirement represent reductions or removals of GHG emissions. A voluntary carbon credit, or ‘‘VCC,’’ is a tradeable intangible instrument that is issued by a carbon crediting program (‘‘crediting program’’).35 The general industry standard is for a VCC to represent a GHG emissions reduction to, or removal from, the atmosphere equivalent to one metric ton of carbon dioxide.36 A participant in the voluntary carbon markets may purchase a VCC, representing an emissions reduction or removal by another party, to supplement emissions reductions or removals achieved from the participant’s own operations or activities. Liquid and transparent markets in high-integrity VCCs may serve as a tool to facilitate emissions reduction efforts.37 34 See, for example, the United Nation’s Clean Development Mechanism (‘‘CDM’’), the California Compliance Offset Program, the Regional Greenhouse Gas Initiative (‘‘RGGI’’), the Alberta Emission Offset System (‘‘AEOS’’), and the EU Emissions Trading System (‘‘ETS’’). 35 See, e.g., The Integrity Council for the Voluntary Carbon Market Carbon Core Principles, Section 5 Definitions, available at: https:// icvcm.org/wp-content/uploads/2023/07/CCPSection-5-R2-FINAL-26Jul23.pdf. 36 This is calculated as the difference in GHG emission reductions or removals from a baseline scenario, to the emission reductions or removals occurring under the carbon mitigation project or activity, with any adjustments for leakage. See The Integrity Council for the Voluntary Carbon Market Carbon Core Principles, Section 5 Definitions, available at: https://icvcm.org/wp-content/uploads/ 2023/07/CCP-Section-5-R2-FINAL-26Jul23.pdf. 37 The Board of the International Organization of Securities Commissions (‘‘IOSCO’’) published a Voluntary Carbon Markets consultation for public comment. The IOSCO consultation paper sought feedback on a potential approach that regulatory authorities and market participants could take to foster sound and well-functioning voluntary carbon market structure and, as a consequence, scale up these markets to allow them to achieve their environmental objectives. Voluntary Carbon Markets, Discussion Paper, CR/06/22, November E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 The process by which VCCs are issued deserves careful consideration, as that process informs VCC quality and, by extension, the overall integrity and effective functioning of voluntary carbon markets. Generally, parties that play a role in the issuance of a VCC include: (1) the developer of a mitigation project or activity that is intended to reduce or remove GHG emissions from the atmosphere (‘‘project developer’’); (2) a crediting program that, among other things, issues VCCs for mitigation projects or activities that satisfy the crediting program’s standards; 38 and (3) an independent third party that verifies and validates the mitigation project or activity. A project developer must first select the crediting program with which it seeks to certify its mitigation project or activity. The crediting program will certify the project or activity if it satisfies the crediting program’s standards for issuing VCCs. A crediting program generally engages an independent third party to review project or activity documentation, including, among other things, to verify the accuracy of the estimated amount of emission reductions or removals that are expected to be associated with the project or activity, based on the project’s or activity’s baseline scenario 39 and the crediting program’s methodology or protocol for quantifying reduction or removal levels. The estimated emission reductions or removals serve as the basis for the determination of the number of VCCs to be issued for the project or activity. Once the crediting program determines that the mitigation project or activity satisfies the crediting program’s standards for issuing VCCs, the project or activity will be certified. The crediting program typically operates or makes use of a registry, which serves as a central repository for tracking certified mitigation projects or activities and their associated VCCs. Once registered, VCCs associated with a mitigation project or activity may be bought and sold to end users (businesses or individuals) or to intermediaries such as brokers or aggregators that provide liquidity to voluntary carbon market participants.40 2022, available at: https://www.iosco.org/library/ pubdocs/pdf/IOSCOPD718.pdf. 38 Currently, the four largest crediting programs in the voluntary carbon markets are the American Carbon Registry, the Climate Action Reserve, the Gold Standard and the Verified Carbon Standard. 39 A baseline scenario is the predicted or assumed outcome in the absence of the incentives created by carbon credits, holding all other factors constant. 40 Funding by investors for a mitigation project or activity could begin as early as the planning stage. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 2. Initiatives To Promote Transparency, Integrity and Standardization in the Voluntary Carbon Markets As the voluntary carbon markets have continued to develop and mature, private sector and multilateral initiatives have sought to address certain issues—relevant to both the supply side (generation of VCCs from carbon mitigation projects or activities), and the demand side (businesses or individuals purchasing VCCs)— impacting the speed at which transparent, robustly traded markets for high-integrity VCCs are scaled. On the supply side, a key focus has been on the quality of VCCs, particularly, whether they accurately reflect the nature and level of GHG emission reductions or removals that they are intended to represent. Given the current absence of a standardized methodology or protocol to quantify emissions reduction or removal levels, there is a possibility that methodologies or protocols of differing degrees of robustness may calculate different reduction or removal impacts for two projects that are identical in type and size (or even for the same project). This could result in different amounts of carbon credits being issued for each project, despite their actual reduction or removal impact being the same. It may also create incentives for project developers to seek to apply the quantification protocol or methodology, or to seek to certify with the crediting program, that would result in the issuance of the most credits. Among other things, these possibilities create challenges for accurately pricing VCCs. Further, it can be difficult to discern the extent to which the price of any particular VCC reflects the price of one metric ton of carbon dioxide equivalent reduced or removed from the atmosphere, and the extent to which the price reflects understandings or concerns relating to the mitigation project or activity for which the VCC was issued, or other aspects of the process for issuing the VCC.41 Early investors may enter into agreements with a project developer for funding in exchange for discounted VCCs, once issued. 41 Factors that may affect the price of VCCs issued for any particular mitigation project or activity may include the type of the project or activity, the geographic location of the project or activity, and the methodology or protocol used to measure the levels of emissions reductions or removals associated with the project or activity. Types of carbon mitigation projects or activities for which VCCs are issued include renewable energy, industrial gas capture, energy efficiency, forestry initiatives (avoiding deforestation), regenerative agriculture, wind power, and biogas. The location of a mitigation project or activity may, for example, impact the cost of implementing and/or operating PO 00000 Frm 00052 Fmt 4703 Sfmt 4703 89413 Challenges with respect to accurately ascertaining VCC quality, and associated pricing challenges,42 can erode confidence in voluntary carbon markets. Furthermore, opaque or inadequate calculation methodologies or protocols, which can obscure or mischaracterize the carbon impact of a mitigation project or activity, can undermine both the integrity and purpose of those markets. On the demand side, concerns have been raised that, in connection with meeting their carbon mitigation goals, businesses or individuals may be utilizing low integrity VCCs which do not accurately reflect the nature or level of GHG emission reductions or removals that are associated with the mitigation projects or activities for which the VCCs have been issued.43 This can raise questions not only about the business’s or individual’s progress towards their goals, but also about whether any claims related to those goals are misleading.44 Market participants that are purchasing VCCs to help meet their mitigation goals may be focused largely or primarily on price, and also may not have ready access to all of the information that they need to make informed evaluations, and comparisons, of VCC quality. All of this may incentivize, intentionally or not, the purchase of lower quality VCCs. This may be facilitated by the opaque pricing of VCCs, as described above— and by the fact that, recently, supplies of VCCs are generally considered to be high relative to demand.45 the project or activity. Mitigation projects and activities for which VCCs are issued are located in countries worldwide. See Berkeley Voluntary Registry Offsets Database, available at: https:// gspp.berkeley.edu/research-and-impact/centers/ cepp/projects/berkeley-carbon-trading-project/ offsets-database. 42 Observed trading of VCCs is not as readily transparent as for other financial instruments. Spot markets for VCCs are still largely bespoke, with buyers purchasing directly from project developers or via intermediaries. Some exchanges for trading VCCs have been established and are evolving. For example, the AirCarbon Exchange (https://acx.net/ acx-singapore/), located in Singapore; Carbon Trade Exchange (https://ctxglobal.com/), located in the United Kingdom; and Xpansiv CBL (https:// xpansiv.com/cbl/), located in the United States. 43 See, e.g., Forbes, Carbon Neutral Claims Under Investigation In Greenwashing Probe (June 16, 2023), available at: https://www.forbes.com/sites/ amynguyen/2023/06/16/carbon-neutral-claimsunder-investigation-in-greenwashing-probe/ ?sh=2a6170466431. 44 Federal Trade Commission, Guides for the Use of Environmental Marketing Claims, Regulatory Review Notice and Request for Public Comment, 87 FR 77,766 (December 20, 2022) (Federal Trade Commission request for public comment on updating its Green Guides to include claims made regarding carbon offsets). 45 Transcript of Commission’s Second Voluntary Carbon Markets Convening (July 19, 2023), Kyle Harrison, stating, ‘‘Because you have an oversupply, you have a surplus of cheaper credits and E:\FR\FM\27DEN1.SGM Continued 27DEN1 89414 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 Private sector and multilateral efforts have spearheaded the development of various initiatives to address the above challenges, and to promote transparency, integrity and standardization in the voluntary carbon markets. To support and promote VCC quality, these private sector and multilateral initiatives have focused on developing standards for high-integrity VCCs.46 Among other things, these standards are intended to help provide assurance that the VCCs that have been issued for a carbon mitigation project or activity accurately reflect the actual GHG emissions reduction or removal levels associated with that project or activity. These standards also generally highlight the importance of effective crediting program processes, procedures, and governance arrangements, in ensuring that a crediting program is issuing high integrity VCCs. Standards that assist market participants in making informed evaluations, and comparisons, of VCC quality may promote accurate pricing and enhance confidence that the voluntary carbon markets can serve as a tool to assist in emissions reduction efforts. Such standards can thereby play a valuable role in supporting market transparency and liquidity, and the scaling of high-integrity voluntary carbon markets. Such standards may also support initiatives being developed to address concerns about the accuracy of claims made by purchasers of VCCs regarding the role that VCCs play in the purchasers’ progress toward carbon mitigation goals.47 Such standards could serve as a foundation or reference companies can go ahead and use those in many cases as a band-aid solution, as opposed to decarbonizing and reducing their gross emissions,’’ available at: https://www.cftc.gov/sites/default/ files/2023/11/1700165549/SVCMC_ transcript071923.pdf. 46 See, e.g., The Integrity Council for the Voluntary Carbon Market’s Core Carbon Principles (July 2023), available at: https://icvcm.org/wpcontent/uploads/2023/07/CCP-Book-R2-FINAL26Jul23.pdf; the International Civil Aviation Organization’s Carbon Offsetting and Reduction Scheme for International Aviation (‘‘CORSIA’’) (2023), available at: https://www.icao.int/ environmental-protection/CORSIA/Pages/ default.aspx; the G7 Principles of High Integrity Carbon Markets (2023), available at: https:// www.meti.go.jp/information/g7hirosima/energy/ pdf/Annex004.pdf. 47 See, e.g., the World Wildlife Fund (WWF–US), Environmental Defense Fund (EDF) and OekoInstitut’s Carbon Credit Quality Initiative (https:// carboncreditquality.org/); the Tropical Forest Credit Integrity Guide for Companies: Differentiating Tropical Forest Carbon Credit by Impact, Quality, and Scale (https://tfciguide.org/); and the Voluntary Carbon Markets Integrity Initiative’s Claims Code of Practice (https://vcmintegrity.org/vcmi-claims-codeof-practice/). VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 for criteria that purchasers of VCCs could voluntarily adhere to, in order to demonstrate their commitment to using high integrity VCCs to support their mitigation goals, and to being transparent in their progress towards those goals. C. The Commission and Voluntary Carbon Markets 1. Derivative Contracts on Environmental Commodities, Including VCCs Derivative contracts on environmental commodities have been trading on CFTC-regulated exchanges for decades. Derivative contracts on mandatory emissions program instruments have been trading since 2005, with GHG emissions-related instruments first listed in 2007.48 There are currently over 150 derivative contracts on mandatory emissions program instruments listed on DCMs.49 As of November 2023, eighteen futures contracts on voluntary carbon market products have been submitted by DCMs to the Commission for listing.50 Three of 48 The Chicago Climate Futures Exchange (‘‘CCFE’’) listed a Sulfur Financial Instruments Current Vintage Delivery futures contract in 2005. In 2006, the New York Mercantile Exchange (‘‘NYMEX’’) listed a nitrogen oxide (‘‘NOX’’) Emissions Allowance futures contract. In 2007, CCFE listed the first Carbon Financial Instrument futures contract and other emission contracts. In 2008, NYMEX listed the first RGGI futures contract. In 2011, Green Exchange listed its European Union Allowance futures contract. In 2012, NYMEX listed its California Carbon Allowance futures contract. To date, there have been over 1,500 mandatory emissions-related futures and options contracts listed for trading on various DCMs. The vast majority of those contracts are no longer listed for trading. 49 Examples of derivatives contracts on mandatory emissions program instruments, such as renewable energy credits (‘‘RECs’’) and renewable fuel standards (‘‘RFS’’), that currently have open interest include: the ICE Futures U.S. (‘‘ICE U.S.’’) PJM Tri Qualified Renewable Energy Certificate Class I futures contract; the ICE U.S. Texas Compliance Renewable Energy Certificate from CRS Listed Facilities Front Half Specific futures contract; the ICE U.S. New Jersey Compliance Renewable Energy Certificate Class II futures contract; the Chicago Mercantile Exchange (‘‘CME’’) Ethanol T2 FOB Rotterdam Including Duty (Platts) futures contract; the ICE U.S. Biofuel Outright—D4 RINS (OPIS) futures contract; the ICE U.S. RGGI Vintage 2024 futures contract; and the ICE U.S. California Carbon Allowance Current Auction futures contract. 50 For example, NYMEX lists the following physically-settled futures contracts based on voluntary carbon market products: (1) CBL Global Emissions Offset (GEO) futures contract; (2) CBL Nature-Based Global Emissions Offset (N–GEO) futures contract; (3) CBL Core Global Emissions Offset (C–GEO) futures contract; (4) CBL NatureBased Global Emissions Offset Trailing futures contract; and (5) CBL Core Global Emissions Offset Trailing futures contract. Nodal Exchange lists the following physically-settled futures and options contracts based on voluntary carbon market products: (1) Verified Emission Reduction—NatureBased Vintage 2017 futures and options contracts; PO 00000 Frm 00053 Fmt 4703 Sfmt 4703 those contracts currently have open interest.51 Derivative contracts on VCCs base their prices on the spot price of VCCs. For example, NYMEX’s CBL Global Environmental Offset futures contracts, and Nodal Exchange’s Verified Emission Reduction futures and options contracts, are physically-settled contracts. If the holder of a position in the contract still has an open position at the expiration of trading in the contract, then the position holder must, in accordance with the rules for delivery set forth in the contract, make or take delivery (as applicable) of 1,000 VCCs that meet the contract’s rules for delivery eligibility.52 2. Initiatives Relating to Voluntary Carbon Markets First Voluntary Carbon Markets Convening In June 2022, Chairman Behnam held the first-ever Voluntary Carbon Markets Convening to discuss issues related to the supply of and demand for high quality carbon credits, including product standardization and the data necessary to support the integrity of carbon credits’ GHG emissions removal and reduction claims.53 A further goal of this convening was to gather information from a wide variety of (2) Verified Emission Reduction—Nature-Based Vintage 2018 futures and options contracts; (3) Verified Emission Reduction—Nature-Based Vintage 2019 futures and options contracts; (4) Verified Emission Reduction—Nature-Based Vintage 2020 futures and options contracts; (5) Verified Emission Reduction—Nature-Based Vintage 2021 futures and options contracts; (6) Verified Emission Reduction—Nature-Based Vintage 2022 futures and options contracts; (7) Verified Emission Reduction—Nature-Based Vintage 2023 futures contract; (8) Verified Emission Reduction—Nature-Based Vintage 2024 futures contract; (9) Verified Emission Reduction—NatureBased Vintage 2025 futures contract; (10) Verified Emission Reduction—Nature-Based futures and options contracts; (11) Carbon Removal futures contract; (12) Verified Emission Reduction— CORSIA-Eligible futures and options contracts; and 13) Global Emission Reduction futures contract. 51 The NYMEX CBL Global Emissions Offset (GEO) futures contract; the NYMEX CBL NatureBased Global Emissions Offset (N–GEO) futures contract; and the NYMEX CBL Core Global Emission Offset (C–GEO) futures contract are currently the only listed futures contacts with open interest and trading volume. Information is available at: https://www.cmegroup.com/markets/ energy/emissions/cbl-global-emissionsoffset.volume.html. 52 The CME Group CBL contracts permit VCCs to be delivered from the Verified Carbon Standard (‘‘VCS’’) Verra Registry, the American Carbon Registry (‘‘ACR’’), and the Climate Action Reserve (‘‘CAR’’). The Nodal contracts permit VCCs to be delivered from VCS’s Verra Registry and from the Gold Standard Impact Registry, as well as from the American Carbon Registry for certain contracts. 53 For the official announcement of the convening and related materials, See https://www.cftc.gov/ PressRoom/Events/opaeventcftccarbon marketconvene060222. E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices market participants in the voluntary carbon markets to better understand the potential role of the official sector in these markets, particularly in connection with the emergence of CFTC-regulated derivatives referencing VCCs. The convening included participants from carbon credit standard setting bodies, a crediting program, private sector integrity initiatives, spot platforms, DCMs, intermediaries, endusers, public interest groups, and others. Commission Request for Information ddrumheller on DSK120RN23PROD with NOTICES1 In June 2022, the Commission issued for public comment a Request for Information (‘‘RFI’’) 54 in order to better inform the Commission on how, consistent with its statutory authority, to address climate-related financial risk as pertinent to the derivatives markets and underlying commodities markets.55 The responsive comments that the Commission received included feedback on specific questions relating to product innovation and voluntary carbon markets.56 Several commenters expressed support for the Commission to take steps that could support transparency and confidence in the voluntary carbon markets, particularly through recognition or support of private sector and multilateral initiatives to promote standardization and integrity.57 In connection with product innovation, certain commenters expressed the view that the Commission’s current statutory framework and regulations are sufficient to regulate voluntary carbon market derivatives products.58 While there were comments expressing different views on the reach of the Commissions’ jurisdiction to regulate voluntary carbon 54 Request for Information on Climate-Related Financial Risk, 87 FR 34856 (June 8, 2022). 55 In addition to soliciting feedback on all aspects of climate-related financial risk as it may pertain to the derivatives market, the RFI also specifically requested feedback on ten categories of information: 1. Data, 2. Scenario Analysis and Stress Testing, 3. Risk Management, 4. Disclosure, 5. Product Innovation, 6. Voluntary Carbon Markets, 7. Digital Assets, 8. Financially Vulnerable Communities, 9. Public-Private Partnerships/Engagement, and 10. Capacity Coordination. The RFI stated that the Commission may use responsive information to inform potential future actions including, but not limited to, the issuance of new or amended guidance, interpretations, policy statements, or regulations, or other potential Commission action. 56 Twenty-five commenters on the RFI responded to questions regarding product innovation and 44 commenters on the RFI responded to questions regarding the voluntary carbon markets. 57 International Swaps and Derivatives Association (‘‘ISDA’’) at 6; American Petroleum Institute (‘‘API’’) at 4; Center for American Progress at 10; Environmental Defense Fund at 12; Futures Industry Association (‘‘FIA’’) at 9; Intercontinental Exchange, Inc. (‘‘ICE’’) at 4. 58 CME Group at 10, FIA at 3; ISDA at 7. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 markets,59 many commenters supported the Commission utilizing its spot market anti-fraud and anti-manipulation authority in the voluntary carbon market space.60 Second Voluntary Carbon Markets Convening In July 2023, Chairman Behnam held the Second Voluntary Carbon Markets Convening. The purpose of this convening was to discuss recent private sector initiatives for high quality carbon credits; current trends and developments in the cash and derivatives markets for carbon credits; public sector initiatives related to carbon markets; and market participants’ perspectives on how the CFTC can promote integrity for high quality carbon credit derivatives.61 II. Guidance Regarding the Listing of VCC Derivative Contracts The Commission is proposing guidance that outlines factors that DCMs should consider when addressing certain requirements under the CEA and CFTC regulations that are relevant to the listing for trading of VCC derivative contracts. The Commission recognizes that VCC derivatives are a comparatively new and evolving class of 59 Heritage Foundation at 7. e.g., API at 3; ISDA at 6; Verra at 2. With respect to the Commission’s spot market anti-fraud, false-reporting, and anti-manipulation authority, see, e.g., CEA section 6(c)(1), 7 U.S.C. 9(1), which prohibits any person from using or employing, or attempting to use or employ, in connection with a contract for sale of any commodity in interstate commerce, any manipulative or deceptive device or contrivance, in contravention of rules and regulations promulgated by the Commission; CEA section 9(a)(2), 7 U.S.C. 13(a)(2), which among other things makes it a felony for any person to manipulate or attempt to manipulate the price of any commodity in interstate commerce; and implementing Commission rules at Part 180 of the CFTC’s regulations, 17 CFR part 180. In June 2023, the CFTC’s Whistleblower Office issued an alert notifying the public on how to identify and report potential CEA violations connected to fraud or manipulation in the carbon markets. See CFTC Whistleblower Alert, available at: https:// www.whistleblower.gov/sites/whistleblower/files/ 2023-06/06.20.23%20Carbon%20 Markets%20WBO%20Alert.pdf. Also in June 2023, the CFTC’s Division of Enforcement announced the creation of an Environmental Fraud Task Force to combat environmental fraud and misconduct. Specifically, the Task Force’s mission is to address fraud and other misconduct in both the derivatives markets and the relevant spot markets (e.g., voluntary carbon markets) and to examine, among other things, fraud with respect to the purported environmental benefits of purchased carbon credits. See CFTC Release Number 8736–23 (‘‘CFTC Division of Enforcement Creates Two New Task Forces’’) available at: https://www.cftc.gov/ PressRoom/PressReleases/8736-23. 61 For the official announcement of the convening and related materials, see https://www.cftc.gov/ PressRoom/Events/opaeventvoluntarycarbon markets071923. 60 See, PO 00000 Frm 00054 Fmt 4703 Sfmt 4703 89415 products,62 and believes that guidance that outlines factors for a DCM to consider in connection with product design and listing may help to advance the standardization of such products in a manner that promotes transparency and liquidity. This proposed guidance addresses certain Core Principle compliance considerations, as well as certain requirements relating to the submission of new contracts, and contract amendments, to the Commission. This proposed guidance is not intended to modify or supersede existing statutory or regulatory requirements, or existing Commission guidance that addresses the listing of derivative products by CFTCregulated exchanges, including the Appendix C Guidance. Rather, taking into account certain unique attributes of VCC derivatives and voluntary carbon markets, this proposed guidance outlines particular matters that a DCM should consider, to help ensure compliance with existing requirements when listing a VCC derivative contract. Among other things, this proposed guidance addresses how certain aspects of the Appendix C Guidance should be understood to apply in the specific context of VCC derivative contracts. This proposed guidance focuses primarily on the listing by DCMs of physically-settled VCC derivative contracts. In part, this focus reflects the fact that all VCC derivative contracts that are currently listed for trading on DCMs are physically-settled contracts. To date, no DCM has listed for trading a cash-settled VCC derivative contract. In addition, the Commission believes that at this juncture in the evolution of VCC derivatives as a product class, it may be of particular benefit to outline considerations for a DCM, when developing contract terms and conditions, that can help to ensure that, upon delivery, the quality and other attributes of the underlying VCC will be as expected by position holders. This will support accurate pricing, help reduce the susceptibility of the contract to manipulation, and foster confidence in the contract that can enhance liquidity. While this proposed guidance focuses primarily on physically-settled VCC derivative contracts, the Commission continues to believe that, with respect to cash-settled derivative contracts, an acceptable specification of the cash 62 In 2022, ISDA published a whitepaper providing background on the cash and derivatives markets for voluntary carbon credits. See Voluntary Carbon Markets: Analysis of Regulatory Oversight in the US. (2022), available at: https:// www.isda.org/2022/06/02/voluntary-carbonmarkets-analysis-of-regulatory-oversight-in-the-us/. E:\FR\FM\27DEN1.SGM 27DEN1 89416 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices settlement price would include rules that fully describe the essential economic characteristics of the underlying commodity.63 Accordingly, the Commission preliminarily believes that discussions in this proposed guidance of VCC commodity characteristics that a DCM should consider when developing the terms and conditions of a physically-settled VCC derivative contract, should also be considered for cash-settled derivative contracts that settle to the price of a VCC, unless otherwise noted.64 Further, while this proposed guidance focuses on the listing of VCC derivative contracts by DCMs, the Commission preliminarily believes that the proposed guidance also should be considered by any SEF that may seek to permit trading in swap contracts that settle to the price of a VCC, or in physically-settled VCC swap contracts.65 In developing this proposed guidance, the Commission has considered those public comments on the RFI that addressed product innovation and voluntary carbon markets. Taking into account those public comments, the Commission believes that this proposed guidance furthers the agency’s mission and may help to advance the standardization of VCC derivative contracts in a manner that fosters transparency and liquidity, accurate pricing, and market integrity.66 The Commission recognizes that VCCs and voluntary carbon markets are 63 Appendix C Guidance, paragraph (c)(1). noted herein, and for the avoidance of doubt, this proposed guidance is not intended to modify or supersede the Appendix C Guidance, which outlines considerations for both cash-settled and physically-settled derivative contracts— including considerations that are not touched on in this proposed guidance. DCMs are reminded to consult and consider the Appendix C Guidance when developing terms and conditions, and contract submissions to the Commission, for all derivative product types—including VCC derivative products. 65 As noted above, the Appendix C Guidance is also relevant to SEFs, which, like DCMs, are obligated by statute only to permit trading in contracts that are not readily susceptible to manipulation. CEA section 5h(f)(3), 7 U.S.C.3 7b– 3(f)(3). Like DCMs, SEFs also are subject to a statutory obligation to monitor trading in swaps to prevent manipulation, price distortion, and disruptions of the delivery or cash settlement process through surveillance, compliance, and disciplinary practices and procedures. CEA section 5h(f)(4) 7 U.S.C 7b–3(f)(4). See also 17 CFR 37.400– 408. 66 See also, e.g., International Emissions Trading Association comment in response to the Second Voluntary Carbon Markets Convening at 5–6 (stating that the CFTC is in a fortunate position to leverage the evolving work of existing initiatives to support the drive for quality and integrity in the voluntary carbon markets), and BP America, Inc. comment in response to the Second Voluntary Carbon Markets Convening at 3 (supporting guidance for CFTC regulated exchanges.) ddrumheller on DSK120RN23PROD with NOTICES1 64 As VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 evolving and that it may therefore be appropriate for the Commission to revisit this guidance or to issue additional guidance in the future,67 as VCCs and voluntary carbon markets continue to develop and mature.68 A. A DCM Shall Only List Derivative Contracts That Are Not Readily Susceptible to Manipulation As discussed above, DCM Core Principle 3 provides that a DCM shall only list for trading derivative contracts that are not readily susceptible to manipulation.69 With respect to DCM Core Principle 3, the Appendix C Guidance outlines certain relevant considerations for a DCM when developing contract terms and conditions and providing supporting documentation and data in connection with the submission of a contract to the Commission.70 With respect to a physically-settled derivative contract, the Appendix C Guidance states that the terms and conditions of the contract ‘‘should describe or define all of the economically significant characteristics or attributes of the commodity underlying the contract.’’ 71 Among other things, failure to specify the economically significant attributes of the underlying commodity may cause confusion among market participants, who may expect a commodity of different quality, or with other features, to underlie the contract. This may render the precise nature of the commodity that the contract is pricing ambiguous, and make the contract susceptible to manipulation or price distortion. The Appendix C Guidance states that, for any particular contract, the specific attributes of the underlying commodity that should be described or defined in the contract’s terms and conditions 67 For example, the Commission may in the future revisit this guidance, or issue additional guidance, to further address the listing of cash-settled VCC derivatives contracts, including index-based contracts, or to further address the listing of VCC derivative contracts by SEFs. 68 For the avoidance of doubt, this proposed guidance does not address the regulatory treatment of any underlying VCC or associated offset project or activity, including whether any such product, project or activity may qualify as a swap or be eligible for the forward contract exclusion under Commission’s ‘‘swaps’’ definition. See Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping; Final Rule, 77 FR 48208 (August 13, 2012). 69 CEA section 5(d)(3), 7 U.S.C. 7(d)(3). 70 As noted above, the Appendix C Guidance is also relevant to SEFs, which are similarly obligated by statute only to permit trading in contracts that are not readily susceptible to manipulation. CEA section 5h(f)(3); 7 U.S.C. 7b–3(f)(3). 71 Appendix C Guidance, paragraph (b)(2)(i)(A). PO 00000 Frm 00055 Fmt 4703 Sfmt 4703 ‘‘depend upon the individual characteristics of the commodity.’’ 72 Where the underlying commodity is a VCC, the Commission recognizes that standardization and accountability mechanisms for VCCs are currently still developing. The Commission believes that the fact that standardization and accountability mechanisms for VCCs are currently still developing is, itself, an ‘‘individual characteristic of the commodity’’ that should be taken into account by a DCM when designing a VCC derivative contract and addressing the underlying commodity in the contract’s terms and conditions. To that end, the Commission recognizes that, while standardization and accountability mechanisms for VCCs are currently still being developed, there are certain characteristics that have been identified broadly—across both mandatory and voluntary carbon markets—as helping to inform the integrity of carbon credits. The Commission preliminarily believes that a DCM should take these characteristics—referred to in this proposed guidance as ‘‘VCC commodity characteristics,’’ and discussed more fully below—into consideration when designing a VCC derivative contract, and addressing in the contract’s terms and conditions the underlying VCC. The Commission believes that consideration of these VCC commodity characteristics will help the DCM to ensure that it understands, and is clearly specifying in the contract’s terms and conditions, the economically significant attributes of the underlying VCC. As a general matter, the Commission believes that a DCM should consider the VCC commodity characteristics when selecting one or more crediting programs from which eligible VCCs, meeting the derivative contract’s specifications, may be delivered at the contract’s expiration. The Commission believes that this will help the DCM evaluate whether the crediting program is a reliable source of high integrity VCCs. More specifically, the Commission preliminarily believes that, at a minimum, a DCM should consider the VCC commodity characteristics when addressing the following criteria in the design of a VCC derivative contract: • Quality standards, • Delivery points and facilities, and • Inspection provisions. These are among the criteria identified in the Appendix C Guidance as criteria that should be addressed in the terms and conditions of a physically-delivered derivative contract. 72 Id. E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices As discussed above, addressing these criteria clearly in the contract’s terms and conditions helps to ensure that trading in the contract is based on accurate information about the underlying commodity. This, in turn, helps to promote accurate pricing and helps to reduce the susceptibility of the contract to manipulation. ddrumheller on DSK120RN23PROD with NOTICES1 1. Quality Standards The Commission preliminarily believes that a DCM should consider the following VCC commodity characteristics when addressing quality standards in the development of the terms and conditions of a VCC derivative contract: (i) transparency, (ii) additionality, (iii) permanence and risk of reversal, and (iv) robust quantification.73 a. Transparency—Publicly Available Data to Promote Transparency As a threshold matter, the Commission believes that a DCM should provide, in the terms and conditions of a VCC derivative contract, information about the VCCs that are eligible for delivery under the contract. The contract terms and conditions should include information that readily specifies the crediting program or programs—and, as applicable, the specific types of projects or activities— from which VCCs that are eligible for delivery under the contract may be issued. Specifying which crediting programs, and as applicable, which types of projects or activities, are eligible for purposes of delivery will help to provide clarity to market participants regarding the VCCs that can be expected to deliver under the contract, and will thereby help to ensure that the pricing of the contract accurately reflects the intended quality of the underlying VCCs. Where there is ambiguity or confusion about the quality of the VCCs that may be delivered under the contract, this may render the contract susceptible to manipulation or price distortion. The Commission preliminarily believes that, in developing the terms and conditions of a VCC derivative contract, DCMs should also consider whether the crediting program for the underlying VCCs is making detailed information about the crediting program’s policies and procedures and the projects or activities that it credits, 73 As is the case for physically-settled VCC derivative contracts, for cash-settled derivative contracts that settle to the price of a VCC, it is important to clearly specify the VCC quality standards in the contract’s terms and conditions to help ensure that the pricing of the contract reflects the quality of the VCC underlying the contract. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 such as relevant project documentation, publicly available in a searchable and comparable manner. Making such information publicly available would assist market participants in understanding how GHG emission reductions or removals are calculated by the crediting program—including how additionality, which is discussed further below, is assessed—and how GHG emission reductions or removals are quantified. This would assist market participants in making informed evaluations, and comparisons, of the quality of the VCCs that underlie derivative contracts, which would help to support accurate pricing. Accordingly, information regarding the crediting program’s policies and procedures for making program information publicly available may constitute an economically significant attribute of the underlying VCC that should be described or defined in the terms and conditions of the VCC derivative contract. b. Additionality—The Underlying VCC Represents GHG Emission Reductions or Removals That Would Not Have Been Developed and Implemented in the Absence of the Added Monetary Incentive Created by the Revenue From the Sale of Carbon Credits The Commission preliminarily believes that, in developing the terms and conditions of a VCC derivative contract, a DCM should consider whether the underlying VCCs represent GHG emission reductions or removals that are ‘‘additional’’—in other words, whether the VCCs are credited only for projects or activities that result in GHG emission reductions or removals that would not have been developed and implemented in the absence of the added monetary incentive created by the revenue from the sale of carbon credits.74 Additionality is viewed by many as a necessary element of a high quality VCC: if a VCC does not represent emission reductions or removals that would not have occurred in the absence of the added monetary incentive created by the revenue from the sale of carbon credits, then the VCC will not serve a market participant’s goals of contributing to emissions mitigation. Accordingly, as part of its contract design market research, a DCM should consider whether a crediting program can demonstrate that it has procedures in place to assess or test for additionality. A DCM should consider 74 For example, a project or activity may not be considered to be ‘‘additional’’ if the project or activity is already required by law, regulation, or any other legally binding mandate applicable in the project’s or activity’s jurisdiction. PO 00000 Frm 00056 Fmt 4703 Sfmt 4703 89417 whether those procedures are sufficiently rigorous and reliable to provide a reasonable assurance that GHG emission reductions or removals are credited only if they are additional. If holders of positions in a VCC derivative contract understand and intend for VCCs that are eligible for delivery under the contract to be additional, but in fact they may not be, then the pricing of the contract may not accurately reflect the quality of the VCCs that may be delivered under the contract: the cheapest-to-deliver VCC,75 that otherwise meets the contract’s specifications, may not have additionality. Given that additionality is viewed by many as a necessary element of a high quality VCC, information regarding a crediting program’s procedures for assessing or testing for additionality may constitute an economically significant attribute of the underlying VCCs, which should be described or defined in the terms and conditions of a VCC derivative contract. c. Permanence and Accounting for the Risk of Reversal The Commission preliminarily believes that, in developing the terms and conditions of a VCC derivative contract, a DCM should consider whether the crediting program for the underlying VCCs can demonstrate that it has measures in place to address and account for the risk of reversal (i.e., the risk that VCCs issued for a project or activity may have to be recalled or cancelled due to carbon removed by the project or activity being released back into the atmosphere, or due to a reevaluation of the amount of carbon reduced or removed from the atmosphere by the project or activity). Understanding and evaluating the measures that a crediting program has in place to address and account for the risk of reversal may be particularly important where the underlying VCCs are issued for project or activity types with a higher reversal risk. The risk of reversal may impact the risk management needs of VCC derivative market participants. Market participants that are utilizing physically-settled VCC derivative contracts to help meet their carbon mitigation goals have an interest in ensuring that, upon physical settlement, the underlying VCCs will actually reduce or remove the amount of emissions that they were intended to 75 The term ‘‘cheapest-to-deliver’’ refers to the least expensive commodity that can be delivered under the derivative contract that otherwise meets the contract’s specifications. E:\FR\FM\27DEN1.SGM 27DEN1 89418 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 reduce or remove. Accordingly, the risk of reversal—and the manner in which it is accounted for by a crediting program—is tied to the quality of the underlying VCCs and, by extension, to the pricing of the derivative contract. As a result, information regarding a crediting program’s measures for estimating, monitoring, and addressing the risk of reversal may constitute an economically significant attribute of the underlying VCCs that should be described or defined in the terms and conditions of a VCC derivative contract. As part of its contract design market research, the Commission preliminarily believes that a DCM should consider whether the crediting program for a VCC has measures in place that provide reasonable assurance that, in the event of a reversal, the VCC will be replaced by a VCC of comparably high quality that meets the contemplated specifications of the contract. Most crediting programs have established VCC ‘‘buffer reserves’’ to address the risk of credited GHG emission reductions or removals being reversed. Under this approach, VCCs are set aside into a common buffer reserve (or ‘‘pool’’). Reserved VCCs can be drawn upon to compensate for reversals associated with a project or activity. If a reversal occurs, VCCs are drawn upon from the buffer reserve to replace VCCs that are canceled, proportional to the size of the reversal. A DCM should consider whether a crediting program has a buffer reserve or other measures in place that provide reasonable assurance that, in the event of a reversal, the VCCs intended to underlie the derivative contract would be replaced by VCCs of comparable high quality that meets the contemplated specifications of the contract. The DCM could also consider whether the crediting program regularly reviews the methodology by which the size of its buffer pool is calculated in order to address evolving climate risks that may heighten the risk of reversal, and whether there is a mechanism in place to audit the continuing sufficiency of the buffer pool. d. Robust Quantification—GHG Emission Reductions or Removals Should be Conservatively Quantified The Commission preliminarily believes that, as part of its contract design market research, a DCM should consider the methodology or protocol used by a crediting program to calculate the level of GHG emission reductions or removals associated with credited projects or activities. Given the current absence of a standardized methodology or protocol to quantify GHG emission VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 reduction or removal levels 76—not only across crediting programs, but even by a particular crediting program, with respect to different types of projects or activities—the Commission believes that a DCM that lists a VCC derivative contract should consider whether the crediting program for the underlying VCCs can demonstrate that the quantification methodology or protocol that it uses to calculate emission reductions or removals for the underlying VCCs is robust, conservative, and transparent. A robust, conservative, and transparent quantification methodology or protocol helps to ensure that the number of VCCs that are issued for a project or activity accurately reflects the level of GHG emission reductions or removals associated with the project or activity. Accordingly, information about the quantification methodology or protocol used by the crediting program to calculate GHG emission reductions or removals for projects or activities associated with the underlying VCCs may constitute an economically significant attribute of the underlying VCCs that should be described or defined in the terms and conditions of a VCC derivative contract. For the derivative contracts that they list, DCMs are required to adopt, as is necessary and appropriate, exchange-set position limits for speculators.77 To establish exchange-set position limits, a DCM should derive a quantitative estimate of the deliverable supplies of the underlying commodity for the delivery period specified in the contract.78 A DCM’s estimate of a VCC’s deliverable supplies is likely to be informed by understanding how the relevant crediting program determines the amount of VCCs that are issued for credited projects or activities. Where the quantification methodology or protocol used to calculate the amount of VCCs is robust, conservative, and transparent, the DCM should have a more reliable basis from which to form its deliverable supply estimate. That deliverable supply estimate, in turn, can be used as the basis for effectively setting the DCM’s exchange-set speculative 76 Related specifically to the agriculture and forest sector, the U.S. Department of Agriculture’s Office of the Chief Economist has published a Request for Information on the Federal Strategy to Advance Measurement and Monitoring Greenhouse Gas Measurement and Monitoring for the Agriculture and Forest Sectors. This Request for Information was issued on behalf of the Administration’s Greenhouse Gas Monitoring and Measurement Interagency Working Group (‘‘GHG IWG’’). See, 88 FR 44251 (July 12, 2023). 77 CEA section 5(d)(5), 7 U.S.C. 7(d)(5). See also 17 CFR 38.300–301. 78 Guidance on estimating deliverable supply can be found in the Appendix C Guidance. PO 00000 Frm 00057 Fmt 4703 Sfmt 4703 position limits to help reduce the possibility of corners or squeezes that may distort or manipulate the price of the derivative contract.79 2. Delivery Points and Facilities The Appendix C Guidance states that the delivery procedures for a physicallysettled derivative contract should, among other things, seek to minimize or eliminate any impediments to making or taking delivery by both deliverers and takers of delivery, to help ensure convergence of cash and derivative contract prices at the expiration of the derivative contract.80 When addressing delivery procedures for a physicallysettled VCC derivative contract, the Commission preliminarily believes that a DCM should consider the governance framework and tracking mechanisms of the crediting program for the underlying VCCs, as well as the crediting program’s measures to prevent double-counting.81 a. Governance The Commission preliminarily believes that a DCM should consider whether the crediting program for the underlying VCCs can demonstrate that it has a governance framework that effectively supports the crediting program’s independence, transparency and accountability. As a threshold matter, a governance framework that effectively supports transparency and accountability helps to ensure the overall quality of the VCCs issued by a crediting program. Furthermore, it is the Commission’s understanding that a crediting program’s registry may be used as a delivery point to facilitate physical settlement for a VCC derivative contract. As discussed above, a registry is a repository for tracking mitigation projects or activities and associated VCCs. An effective crediting program governance framework can help to ensure that the crediting program operates or makes use of a registry that has appropriate measures in place to 79 For a cash-settled VCC derivative contract, a DCM may similarly consider the deliverable supply of the underlying VCCs when setting exchange-set speculative position limits or historical open interest when establishing non-spot month position accountability levels. See, 17 CFR 150.5 and Appendix F to Part 150, Title 17. 80 Appendix C Guidance, paragraph (b)(2)(i)(B). 81 While cash-settled VCC derivative contracts do not result in the delivery of a VCC, the Commission preliminarily believes that considering the VCC commodity characteristics of governance, tracking and no double-counting when developing the terms and conditions of a cash-settled VCC derivative contract will help to ensure that the contract terms and conditions address essential economic characteristics of the underlying VCC in a manner that promotes accurate pricing and helps to reduce the susceptibility of the contract to manipulation. E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 facilitate the physical settlement of a VCC derivative contract. In reviewing a crediting program’s governance framework, the Commission preliminarily believes that a DCM should consider, among other things, the program’s decision-making procedures, including who is responsible for administration of the program and how the independence of key functions is ensured; reporting and disclosure procedures; public and stakeholder engagement processes; and risk management policies, such as financial resources/reserves, cybersecurity, and anti-money laundering policies. The DCM also should consider whether information regarding these procedures and policies is made publicly available. Given the importance of a crediting program’s governance framework in ensuring the overall quality of the VCCs issued by the program, as well as the potential importance of a crediting program’s registry in facilitating delivery, it may be appropriate for the DCM to include information about the crediting program’s governance framework in the terms and conditions of a physically-settled VCC derivative contract. b. Tracking The Commission preliminarily believes that a DCM should consider whether the crediting program for the underlying VCCs can demonstrate that it has processes and procedures in place to help ensure clarity and certainty with respect to the issuance, transfer, and retirement of VCCs. The DCM should consider whether the crediting program operates or makes use of a registry that has measures in place to effectively track the issuance, transfer, and retirement of VCCs; to identify who owns or retires a VCC; and to make sure that each VCC is uniquely and securely identified and associated with a single emission reduction or removal of one metric ton of carbon dioxide equivalent. In circumstances where the registry will serve as the delivery point for a physically-settled VCC derivative contract, it may be appropriate for the DCM to include as a condition of the contract that the registry have such measures to address tracking in place, as well as effective measures to address double-counting, as discussed below. c. No Double Counting The Commission preliminarily believes that a DCM should consider whether the crediting program for the underlying VCCs can demonstrate that it has effective measures in place that provide reasonable assurance that VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 credited emission reductions or removals are not double counted. That is, that the VCCs representing the credited emission reductions or removals are issued to only one registry and cannot be used after retirement or cancelation. As discussed above in connection with the VCC commodity characteristics of additionality and permanence, market participants that are utilizing physically-settled VCC derivative contracts to help meet carbon mitigation goals have an interest in ensuring that, upon physical settlement, the underlying VCCs will actually reduce or remove the emissions that they were intended to reduce or remove. In order for VCCs to effectively further carbon mitigation goals, it is important for each credited VCC to be uniquely associated with a single emission reduction or removal of one metric ton of carbon dioxide equivalent—and a crediting program should have effective measures in place that provide reasonable assurance of this. If there is not a reasonable assurance that the VCCs underlying a derivative contract are each unique, then, among other things, this could distort or obscure the accuracy of the derivative contract’s pricing. In the context of evolving national and international carbon markets and emissions trading frameworks, effective measures to ensure that emission reductions or removals are not double counted may include, among other things, procedures for conducting crosschecks across multiple carbon credit registries. 3. Inspection Provisions—Third-Party Validation and Verification Consistent with the Appendix C Guidance, the Commission believes that any inspection or certification procedures for verifying compliance with quality requirements or any other related delivery requirements for physically-settled VCC derivatives contracts should be specified in the contract’s terms and conditions.82 The Commission believes that these inspection or certification procedures should be consistent with the latest procedures in the voluntary carbon markets. To that end, the Commission preliminarily believes that the DCM should consider, among other things, 82 Appendix C Guidance, paragraph (b)(2)(i)(G) (To the extent that formal inspection procedures are not used in the cash market, an acceptable specification would contain provisions that assure accuracy in assessing the commodity, that are available at a low cost, that do not pose an obstacle to delivery on the contract and that are performed by reputable, disinterested third-party or by qualified designated contract market employees.). PO 00000 Frm 00058 Fmt 4703 Sfmt 4703 89419 how the crediting program for the underlying VCCs requires validation and verification that credited mitigation projects or activities meet the crediting program’s rules and standards. The Commission preliminarily believes that, when designing a VCC derivative contract, a DCM should consider whether the crediting program has up-to-date, robust and transparent validation and verification procedures, including whether those procedures contemplate validation and verification by a reputable, disinterested party or body. By providing independent confirmation that mitigation projects or activities are achieving the claimed GHG emission reductions or removals, third-party validation and verification can help to ensure that the underlying VCC accurately reflects the quality intended by the DCM and supports voluntary carbon market integrity.83 A DCM should consider whether the crediting program is employing best practices with respect to third-party validation and verification, which may include conducting reviews of the performance of validators, procedures for remediating performance issues, not using the same third party validator to verify every project type or project category, and using a separate third party to conduct ongoing validation and verification from the third party that completed the initial validation and verification process. B. A DCM Shall Monitor a Derivative Contract’s Terms and Conditions as They Relate to the Underlying Commodity Market DCM Core Principle 4 requires a DCM to prevent manipulation, price distortion, and disruptions of the physical delivery or cash-settlement process through market surveillance, compliance, and enforcement practices and procedures.84 For physically-settled derivative contracts, the Commission has recognized DCM Core Principle 4 to include, among other things, an obligation to monitor the contract’s terms and conditions as they relate the underlying commodity market, and to the convergence between the contract price and the price of the underlying commodity, and to monitor the supply of the underlying commodity in light of the contract’s delivery requirements.85 Such monitoring will help a DCM identify circumstances that may cause the contract to become susceptible to price manipulation or distortions, and 83 Id. 84 CEA Section 5(d)(4), 7 U.S.C. 7(d)(4). See also 17 CFR 38.250–258. 85 17 CFR 38.252. E:\FR\FM\27DEN1.SGM 27DEN1 ddrumheller on DSK120RN23PROD with NOTICES1 89420 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices to assess whether the terms and conditions of the contract continue to be appropriate—or whether a change in circumstances should be addressed, for example, through changes to the contract’s terms and conditions.86 Given that VCC derivatives are a comparatively new and evolving class of products, and given that standardization and accountability mechanisms for VCCs are still being developed, the Commission preliminarily believes that the monitoring by a DCM of the terms and conditions of a physically-settled VCC derivative contract should include continual monitoring of the appropriateness of the contract’s terms and conditions that includes, among other things, monitoring to ensure that the delivery instrument—that is, the underlying VCC—conforms or, where appropriate, updates to reflect the latest certification standard(s) applicable for that VCC. For example, where there are changes to either the crediting program or the types of projects or activities associated with the underlying VCC, due for example to new standards or certifications, then the DCM should amend the contract’s terms and conditions to reflect this update. In such circumstances, the DCM should also ensure that it is monitoring the adequacy of the estimated deliverable supply of the underlying VCC to satisfy the contract’s delivery requirements. Finally, the Commission reminds market participants that Commission regulations implementing DCM Core Principle 4 require DCMs to have rules requiring their market participants to keep records of their trading that include records of their activity in the underlying commodity and related derivatives markets.87 A DCM’s rules also must require market participants to make such records available upon request to the DCM.88 As such, DCM market participants are required, upon request, to make records of their trading in underlying VCC cash markets available to the DCM, in order to assist the DCM in fulfilling its market monitoring obligations. These records also are subject to Commission inspection under applicable Commission recordkeeping rules. 86 The Commission has, similarly, recognized that a DCM has a responsibility to monitor the continued appropriateness of the terms and conditions of a cash-settled derivative contract. See, e.g., 17 CFR 38.253(a)(2). 87 17 CFR 38.254(a). 88 Id. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 C. A DCM Must Satisfy the Product Submission Requirements Under Part 40 of the CFTC’s Regulations and CEA Section 5c(c) There are generally two processes by which a DCM may list a new derivative contract for trading.89 The DCM may elect to list the contract for trading by providing the Commission with a written certification—a ‘‘selfcertification’’—that the contract complies with the CEA, including the CFTC’s regulations thereunder.90 Alternatively, the DCM may elect voluntarily to seek prior Commission approval of the contract.91 In each case, the DCM must submit prescribed information to the Commission, including but not limited to the contract’s terms and conditions.92 Amendments to an existing derivative contract also must be submitted to the Commission, along with prescribed information, either by way of selfcertification or for prior Commission approval.93 This proposed guidance highlights three submission requirements in connection with the listing of VCC derivative contracts. These requirements apply regardless of whether a DCM elects to list the contract by way of selfcertification, or with prior Commission approval. These requirements generally apply with respect to the listing by a DCM of a derivative contract, regardless of the underlying asset class. However, the Commission wishes to remind DCMs of the importance of fully complying with these requirements in a submission for a VCC derivative contract. The relevant requirements provide, first, that a contract submission to the Commission must include an explanation and analysis of the contract and its compliance with applicable provisions of the CEA, including core principles and the Commission’s regulations thereunder.94 Second, the 89 SEFs also may generally list new contracts by way of either of these two processes. See, generally, CEA section 5c(c), 7 U.S.C. 7a–2(c). 90 CEA section 5c(c)(1), 7 U.S.C. 7a–2(c)(1). See also 17 CFR 40.2 The Commission must receive the DCM’s self-certified submission at least one business day before the contract’s listing. 17 CFR 40.2(a)(2). 91 CEA sections 5c(c)(4)–(5), 7 U.S.C. 7a–2(c)(4)– (5). See also 17 CFR 40.3. 92 17 CFR 40.2–40.3. 93 17 CFR 40.5–40.6. 94 17 CFR 40.2(a)(3)(v) (for self-certification) and 40.3(a)(4) (for Commission approval). The ‘‘explanation and analysis’’ requirement for selfcertified contracts provides for such explanation and analysis to be ‘‘concise.’’ The ‘‘explanation and analysis’’ requirement for contracts submitted for prior Commission approval does not include the ‘‘concise’’ qualifier. The Commission requires DCMs to provide a more detailed explanation and PO 00000 Frm 00059 Fmt 4703 Sfmt 4703 relevant requirements provide that the explanation and analysis of the contract either be accompanied by the documentation relied upon to establish the basis for compliance with applicable law, or incorporate information contained in such documentation, with appropriate citations to data sources.95 Third, the relevant requirements provide that, if requested by Commission staff, a DCM must provide any additional evidence, information or data that demonstrates that the contract meets, initially or on a continuing basis, the requirements of the CEA or the Commission’s regulations or policies thereunder.96 Since VCC derivatives are a comparatively new and evolving class of products, and since standardization and accountability mechanisms for VCCs are still being developed, the Commission anticipates that in connection with the submission for a VCC derivative contract, a DCM may provide qualitative explanations and analysis to assist in addressing the three above-described requirements. The Commission expects that the information—including supporting documentation, evidence and data—provided by the DCM to describe how the contract mcomplies with the CEA and applicable Commission regulations, will be complete and thorough. Given unique and developing aspects of VCCs and VCC derivative markets, including complete and thorough information in a submission for a VCC derivative contract will assist the Commission and its staff in their understanding of the contract and their analysis of the contact’s compliance with applicable statutory and regulatory requirements, including whether or not the contract is readily susceptible to manipulation. III. Request for Comment The Commission requests comment from the public on all aspects of the Commission’s proposed guidance regarding the listing of VCC derivative contracts, and further invites comments on specific questions related to the listing of such contracts. The Commission encourages all comments including background information, actual market examples, and best practice principles. Specifically, the Commission requests comment on the following questions: analysis of contracts that are submitted for affirmative Commission approval. 95 17 CFR 40.2(a)(3)(v) (for self-certification) and 40.3(a)(4) (for Commission approval). 96 17 CFR 40.2(b) (for self-certification) and 40.3(a)(10) (for Commission approval). E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices General ddrumheller on DSK120RN23PROD with NOTICES1 1. In addition to the VCC commodity characteristics identified in this proposed guidance, are there other characteristics informing the integrity of carbon credits that are relevant to the listing of VCC derivative contracts? Are there VCC commodity characteristics identified in this proposed guidance that are not relevant to the listing of VCC derivative contracts, and if so, why not? 2. Are there standards for VCCs recognized by private sector or multilateral initiatives that a DCM should incorporate into the terms and conditions of a VCC derivative contract, to ensure the underlying VCCs meet or exceed certain attributes expected for a high-integrity carbon credit? 3. In addition to the criteria and factors discussed in this proposed guidance, are there particular criteria or factors that a DCM should consider in connection with monitoring the continual appropriateness of the terms and conditions of a VCC derivative contract? 4. In addition to the criteria and factors discussed in this proposed guidance, are there particular criteria or factors that a DCM should consider, which may inform its analysis of whether or not a VCC derivative contract would be readily susceptible to manipulation? 5. Should the VCC commodity characteristics that are identified in this proposed guidance as being relevant to the listing by a DCM of VCC derivative contracts, also be recognized as being relevant to submissions with respect to VCC derivative contracts made by a registered foreign board of trade under CFTC regulation 48.10? Transparency 6. Is there particular information that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether a crediting program is providing sufficient access to information about the projects or activities that it credits? Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a contract’s terms and conditions, whether there is sufficient transparency about credited projects or activities? Additionality 7. Are there particular criteria or factors that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 whether the procedures that a crediting program has in place to assess or test for additionality provide a reasonable assurance that GHG emission reductions or removals will be credited only if they are additional? 8. In this proposed guidance, the Commission recognizes VCCs as additional where they are credited for projects or activities that would not have been developed and implemented in the absence of the added monetary incentive created by the revenue from carbon credits. Is this the appropriate way to characterize additionality for purposes of this guidance, or would another characterization be more appropriate? For example, should additionality be recognized as the reduction or removal of GHG emissions resulting from projects or activities that are not already required by law, regulation, or any other legally binding mandate applicable in the project’s or activity’s jurisdiction? Risk of Reversal 9. Are there particular criteria or factors that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, a crediting program’s measures to avoid or mitigate the risk of reversal, particularly where the underlying VCC is sourced from nature-based projects or activities such as agriculture, forestry or other land use initiatives? 10. How should DCMs treat contracts where the underlying VCC relates to a project or activity whose underlying GHG emission reductions or removals are subject to reversal? Are there terms, conditions or other rules that a DCM should consider including in a VCC derivative contract in order to account for the risk of reversal? Robust Quantification 11. Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a contract’s terms and conditions, whether a crediting program applies a quantification methodology or protocol for calculating the level of GHG reductions or removals associated with credited projects or activities that is robust, conservative and transparent? Governance 12. In addition to a crediting program’s decision-making, reporting, disclosure, public and stakeholder engagement, and risk management policies, are there other criteria or factors that a DCM should take into account when considering, and/or addressing in a VCC derivative PO 00000 Frm 00060 Fmt 4703 Sfmt 4703 89421 contract’s terms and conditions, whether the crediting program can demonstrate that it has a governance framework that effectively supports the program’s transparency and accountability? Tracking and No Double Counting 13. In addition to the factors identified in this proposed guidance, are there other factors that should be taken into account by a DCM when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether the registry operated or utilized by a crediting program has processes and procedures in place to help ensure clarity and certainty with respect to the issuance, transfer, and retirement of VCCs? 14. Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether it can be demonstrated that the registry operated or utilized by a crediting program has in place measures that provide reasonable assurance that credited emission reductions or removals are not double-counted? Inspection Provisions 15. Should the delivery procedures for a physically-settled VCC derivative contract describe the responsibilities of registries, crediting programs, or any other third-parties required to carry out the delivery process? Sustainable Development Benefits and Safeguards 16. Certain private sector and multilateral initiatives recognize the implementation by a crediting program of measures to help ensure that credited mitigation projects or activities meet or exceed best practices on social and environmental safeguards, as a characteristic that helps to inform the integrity of VCCs issued by the crediting program. When designing a VCC derivative contract, should a DCM consider whether a crediting program has implemented such measures? 17. Certain private sector and multilateral initiatives recognize the implementation by a crediting program of measures to help ensure that credited mitigation projects or activities would avoid locking in levels of GHG emissions, technologies or carbon intensive practices that are incompatible with the objective of achieving net zero GHG emissions by 2050, as a characteristic that helps to inform the integrity of VCCs issued by the crediting program. When designing a VCC derivative contract, should a DCM E:\FR\FM\27DEN1.SGM 27DEN1 89422 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices consider whether a crediting program has implemented such measures? Issued in Washington, DC, on December 21, 2023, by the Commission. Christopher Kirkpatrick, Secretary of the Commission. NOTE: The following appendices will not appear in the Code of Federal Regulations. Appendices to Commission Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts; Request for Comment—Voting Summary and Chairman’s and Commissioners’ Statements ddrumheller on DSK120RN23PROD with NOTICES1 Appendix 1—Voting Summary On this matter, Chairman Behnam and Commissioners Johnson, Goldsmith Romero, and Pham voted in the affirmative. Commissioner Mersinger voted to concur. No Commissioner voted in the negative. Appendix 2—Statement of Support of Chairman Rostin Behnam The CFTC as a market regulator has a significant role to play in the voluntary carbon markets (VCMs). As we have seen the listing of listed futures on voluntary carbon credits (VCCs), the Agency’s relationship and responsibility is real. These markets present an opportunity for the agricultural economy that historically underpins the need for derivatives markets for risk management and price discovery, but they also provide a useful tool throughout the financial markets and the real economy. And today, the Agency takes the most significant step of a financial regulator to promote fundamental standards for high integrity VCCs. Market participants from across all asset classes will increasingly turn to the derivatives markets as they manage the impact of physical and transition risks related to extreme weather events and climate-related financial risk. The CFTC’s role is to ensure that these developing derivatives markets, including those for VCCs, have integrity, adhere to basic market regulatory requirements, and remain resilient as we most certainly will continue to experience extreme and dramatic weather events that will impact pricing and volatility. The Commission’s proposed guidance for designated contract markets (DCMs) that list derivatives contracts with voluntary carbon credits (VCC) as the underlying commodity is an important step in shaping the development of high-integrity voluntary carbon markets. For the first time ever, the CFTC is proposing regulatory guidance for VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 exchanges listing products aimed at providing tools to manage risk, promote price discovery, and help channel capital to support decarbonization. The publication of this proposed guidance and request for public comment marks the culmination of years of work with stakeholders such as farmers, foresters, end users, energy traders and associations, emission-trading focused entities, carbon-credit rating agencies, crediting programs, CFTC-registered exchanges and clearinghouses, and derivatives trade associations. This proposal also represents a whole-ofgovernment approach in coordination with our partners across the federal complex. Each step has been intentional. My sponsorship of the Market Risk Advisory Committee’s Climate-Related Market Risk Subcommittee, which issued a report on Managing Climate Risk in the U.S. Financial System Report in 2020 identified putting a price on carbon as a fundamental element for financial markets to efficiently channel capital to reduce greenhouse gas emissions (GHGs).1 My establishment of the CFTC’s Climate Risk Unit in March 2021 allowed the Commission to build its subject matter expertise regarding the role that climate-related derivatives will have in pricing and managing climaterelated financial risk.2 I hosted two VCM Convenings to gather information from a wide variety of market participants to better understand the potential role of the official sector in these markets, particularly as we began to see the emergence of listed futures products that reference VCC cash markets.3 The CFTC, with the support of my fellow commissioners, issued a Request for Information on ClimateRelated Financial Risk that received 80 comments on ten priority areas of interest including VCMs and product innovation.4 I have also testified before 1 Managing Climate Risk in the U.S. Financial System, Sept. 9, 2020, https://www.cftc.gov/sites/ default/files/2020-09/9-920%20Report%20of%20the%20 Subcommittee%20on%20ClimateRelated%20Market%20Risk%20%20Managing%20Climate%20Risk%20in%20the %20U.S.%20Financial%20 System%20for%20posting.pdf. 2 CFTC Acting Chairman Behnam Establishes New Climate Risk Unit, Mar. 17, 2021, https:// www.cftc.gov/PressRoom/PressReleases/8368-21. 3 CFTC, Event: Commission Meetings, CFTC Announces Voluntary Carbon Markets Convening (Jun. 2, 2022), https://www.cftc.gov/PressRoom/ Events/opaeventcftccarbonmarketconvene060222; and CFTC, Event: Commission Meetings, CFTC Announces Second Voluntary Carbon Markets Convening, (July 19, 2023), https://www.cftc.gov/ PressRoom/Events/opaeventvoluntarycarbon markets071923. 4 Request for Information on Climate-Related Financial Risk, 87 FR 34856 (Jun. 8, 2022), available PO 00000 Frm 00061 Fmt 4703 Sfmt 4703 Congress on several occasions specifically on the role of financial markets in addressing the climate crisis and my views on the CFTC’s role in supporting solutions.5 The primary takeaway from this research and public engagement is clear; the Commission should act, consistent with its statutory authority under the Commodity Exchange Act (CEA), to strengthen market integrity, transparency, and liquidity for derivatives with an underlying VCC that are real, additional, permanent, verifiable, and represent unique metric tons of GHG emissions reduced or removed from the atmosphere. While VCC derivatives are a comparatively new and evolving class of products, DCMs must ensure that any listed derivatives comply with the CEA and Commission regulations. The proposed guidance outlines factors that DCMs should consider when listing products including: DCM Core Principle 3, which requires DCMs to list only contracts that are not readily susceptible to manipulation; DCM Core Principle 4, which requires DCMs to have the capacity and responsibility to prevent manipulation, price distortion, and other market disruptions through market surveillance, compliance, and enforcement practices and procedures; the Commission’s regulations promulgated for these DCM Core Principles; and the product submission provisions set forth in CEA section 5c(c) and Part 40 of the Commission regulations. The proposed guidance is not intended to modify or supersede existing statutory or regulatory requirements, or existing Commission guidance that addresses the DCMs’ listing of derivative contracts, such as Appendix C to Part 38 of the Commission’s regulations. Instead, the proposed guidance outlines particular VCC commodity characteristics that a DCM should consider in the design of a VCC futures contract’s terms and conditions such (i) quality standards, which include transparency, additionality, permanence and accounting for the risk of reversal, and at https://www.cftc.gov/sites/default/files/2022/06/ 2022-12302a.pdf. 5 See, e.g., Rostin Behnam, Chairman, CFTC, Testimony by Chairman Rostin Behnam Before the Subcommittee on Agriculture, Rural Development, Food and Drug Administration and Related Agencies Committee on Appropriations, U.S. House of Representatives (Mar. 28, 2023), https:// www.cftc.gov/PressRoom/SpeechesTestimony/ opabehnam35; Rostin Behnam, CFTC, Testimony of Commissioner Rostin Behnam before the House Select Committee on the Climate Crisis (Oct. 1, 2020), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opabehnam16. E:\FR\FM\27DEN1.SGM 27DEN1 ddrumheller on DSK120RN23PROD with NOTICES1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices robust quantification of emissions reductions or removals; (ii) delivery points and facilities which include effective governance at the carbon crediting program, tracking the issuance, transfer, and retirement of VCCs, and no double counting; and (iii) inspection provisions which includes independent third-party validation and verification. A DCM’s consideration of these factors during the design of a derivative product’s terms and conditions should promote accurate pricing, reduce susceptibility of the contract to manipulation, help prevent price distortions, and foster confidence in the VCC contracts. Consistent with the current statutory and regulatory requirements, DCMs would retain reasonable discretion in establishing the manner in which it complies with a DCM Core Principles and the Commission’s regulations. I believe the proposed guidance outlines well-researched VCC commodity characteristics that build on several private sector and multilateral initiatives that have made great strides to strengthen VCC credit integrity standards. I also believe the proposed guidance supports transparency, liquidity, and market integrity. This effort is the product of a strong publicprivate partnership that I have strived to achieve with the CFTC’s traditional stakeholders as well as those VCM stakeholders that may be newer to the derivatives markets. The Commission is cognizant that the derivatives markets are global markets and has crafted this proposed guidance to be complementary to the important work underway by the International Organization of Securities Commissions (IOSCO) through its Sustainable Finance Task Force’s Carbon Market Workstream, which I co-chair with Verena Ross, the Chair of ESMA. While this proposed Commission guidance focuses on the due diligence that DCMs should undertake when designing and monitoring their proprietary listed VCC derivative contracts, IOSCO’s work over nearly two years is focused on how regulators can promote sound market structure and enhance financial integrity in the VCMs so that highquality carbon credits can be traded in an orderly and transparent way. I invite our stakeholders to also provide comment on IOSCO’s December 2023 publication of its VCM Consultation Report.6 6 International Organization of Securities Commissions (IOSCO), CR06/2023 Voluntary Carbon Markets, Consultation Report (Dec. 2023), https://www.iosco.org/library/pubdocs/pdf/ IOSCOPD749.pdf. VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 The proposed guidance is not intended to suggest that the Commission has a role in creating or mandating compliance with any kind of climate policy. The CFTC’s unique mission focused on risk mitigation and price discovery, however, puts us on the front lines of the now global nexus between financial markets and decarbonization efforts. Leveraging the CFTC’s personnel and expertise demonstrates our commitment to taking thoughtful and deliberate next steps toward building a financial system that provides effective tools in achieving emission reductions. I thank my fellow commissioners for enabling the Commission to publish this proposed guidance for public comment. I greatly appreciate the expertise and all of the hard work done by the staff in my office, the Division of Market Oversight, and the Office of the General Counsel on this proposed guidance. I look forward to reviewing the public comments on all aspects of the guidance as well as on the seventeen specific questions relating to the listing for trading of VCC derivative contracts. Appendix 3—Statement of Commissioner Kristin Johnson Today, the Commodity Futures Trading Commission (Commission or CFTC) adopts proposed Guidance and a Request for Comments regarding the listing of voluntary carbon credit (VCC) derivative contracts on designated contract markets (DCMs)—boards of trade that operate under the regulatory oversight of the CFTC (Proposed Guidance). I support the Proposed Guidance as it advances important transparency and market integrity efforts. However, evidence suggests that environmental commodity markets, specifically the underlying spot markets for carbon credits, are rife with fraud. Consequently, I find the Proposed Guidance to be necessary, but insufficient. I am hopeful that the Proposed Guidance ushers in discussion and the development of a comprehensive regulatory initiative to address the deeply concerning, and nearly indisputable, proliferation of fraud in the carbon credit markets. As I noted, in a recent speech at a joint convening of the Environmental Advisory Council and the Financial Sector Advisory Council of the Dallas Federal Reserve Bank: While the issues and concerns regarding climate risks are endemic, complex, and inherently require multi-lateral solutions effectuated by an international coalition of stakeholders—let’s call it: a coalition of the willing—I strongly believe that financial market regulators and committed market PO 00000 Frm 00062 Fmt 4703 Sfmt 4703 89423 participants may play a pivotal role in developing and implementing some basic, foundational market reforms.1 I anticipate and look forward to the public engagement regarding the Proposed Guidance and responses to the Request for Comments, particularly as relates to the efforts of the Proposed Guidance to address transparency, additionality, risk of reversal, robust quantification, governance, tracking and double counting, inspection provisions, and sustainable development benefits and safeguards. In developing a formal framework to support the VCC markets, I strongly believe that a comprehensive approach that addresses the diversity of environmental derivatives emerging in our markets will improve visibility, enhance integrity, and promote carbon neutrality. The Market for Carbon Credits A VCC is a tradeable intangible instrument that is issued by a carbon crediting program. Once registered, VCCs associated with a mitigation project or activity may be acquired by end users (businesses or individuals) or intermediaries who act as brokers. While the number of VCC exchanges continues to increase, the spot market for such products remains largely bespoke, with buyers purchasing directly from mitigation project developers or via intermediaries. A carbon credit market creates a forum that enables buyers and distributors to engage in the purchase and sale, respectively, of environmental commodities. Each environmental commodity represents the acquisition or distribution of a credit that contributes to the reduction or sequestration (capturing and storage) of greenhouse gas emissions. Carbon markets are either mandatory (compliance) markets or voluntary. VCC markets are not established by any government authority. The VCC market serves as an important tool, among many needed 1 Kristin Johnson, Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of Dallas: All Hat, No Cattle: The Need For Market Structure Reforms in the Voluntary Carbon Markets (Nov. 29, 2023), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opajohnson10. In October, the United Nations Sustainable Stock Exchanges (UN SSE), in collaboration with the International Organization of Securities Commissions (IOSCO), hosted a roundtable on Carbon Markets at the 8th UNCTAD World Investment Forum to engage in dialogue on the future of carbon markets and the role exchanges and securities market regulators can play in making these markets work effectively in combating climate change. Sustainable Stock Exchanges initiative, Carbon markets action framework launched at UNCTAD World Investment Forum (Oct. 18, 2023), https://sseinitiative.org/allnews/carbon-markets-action-framework-launchedat-unctad-world-investment-forum/. E:\FR\FM\27DEN1.SGM 27DEN1 89424 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 tools, designed to address mounting evidence of climate change and the attendant, significant effects on the global economy. Under Chair Behnam’s leadership, in 2020, the Climate-Related Market Risk Subcommittee of the Commission’s Market Risk Advisory Committee (an Advisory Committee that I currently sponsor), released a report identifying actions the Commission could take to address climate change and finding that climate-related financial risks pose a major risk to the stability of the U.S. financial system.2 A report by the U.S. Department of the Treasury released in September explains that ‘‘[t]he impacts of climate change are significant and escalating, including through more frequent and severe weather events, rising sea levels, and higher temperatures.’’ 3 The report details how climate risks are impacting individual household finances, U.S. financial markets, and supply chains. ‘‘In 2022 alone, the cost of climate and weather disasters in the United States totaled more than $176 billion—the third most costly year on record.’’ 4 There are deep and persistent concerns regarding the integrity, credibility, and lack of visibility in the market for carbon credits. Indisputably, challenged efforts to establish universally-adopted and enforceable integrity standards has further stymied attempts to scale carbon credit markets. Just last fall, U.S. Senators Elizabeth Warren, Cory Booker, and Kirsten Gillibrand alongside several other Senators, encouraged the CFTC to use its enforcement jurisdiction aggressively to investigate and prosecute fraud and manipulation in spot and forward environmental commodity markets.5 On June 29, 2023, the Commission announced the Environmental Fraud Task Force, which was created to address misconduct in the regulated derivatives markets and to investigate fraud in the spot market for VCCs, in particular with respect to the purported environmental benefits of purchased carbon credits, and registrants’ misrepresentations regarding purported environmental benefits and 2 Release Number 8234–20, CFTC’s ClimateRelated Risk Subcommittee Releases Report, https://www.cftc.gov/PressRoom/PressReleases/ 8234-20. 3 U.S. Dep’t of the Treasury, The Impact of Climate Change on American Household Finances 1 (2023), https://home.treasury.gov/system/files/ 136/Climate_Change_Household_Finances.pdf. 4 Id. 5 Letter from Cory A. Booker, et al., U.S. Senators, to Rostin Behnam, Chairman, CFTC (Oct. 13, 2022). VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 environmental, social, and governance (ESG) products or strategies.6 These issues have become so much a part of the cultural dialogue that The New Yorker featured an article titled ‘‘The Great Cash-For-Carbon Hustle,’’ which detailed the rise and fall of South Pole, led by its forty-four-year-old CEO Rant Heuberger, and the revelation that it sold carbon credits that were not real. In recent speeches at the Federal Reserve Banks in Atlanta and Dallas and Rice University’s Baker Institute for Public Policy Annual Energy Summit, I outlined the necessity for market structure reforms in the VCC markets as well as derivatives on VCCs.7 As I have previously stated: in order for the carbon offset markets to have any significance (and, arguably, for such markets to avoid extinction), we must ensure the integrity of the market.8 Financial market regulators and committed market participants play a pivotal role in developing and implementing some basic, foundational market reforms.9 Today’s Proposed Guidance marks a step in the right direction. Commission Regulatory Authority The Proposed Guidance applies to the listing of futures with VCCs as the underlying assets. DCMs that list and offer derivatives on VCCs, which are commodities, must be registered with the Commission prior to offering such contracts. Pursuant to the Commodity Exchange Act (CEA), to be designated, and maintain a designation, as a contract market, a board of trade must comply with all core principles and any requirement that the Commission may impose by rule or regulation. 6 Release Number 8736–23, CFTC Division of Enforcement Creates Two New Task Forces, https:// www.cftc.gov/PressRoom/PressReleases/8736-23. 7 Kristin Johnson, Commissioner, CFTC, Keynote Address at Rice University’s Baker Institute for Public Policy Annual Energy Summit: Credibility, Integrity, Visibility: The CFTC’s Role in the Oversight of Carbon Offset Markets (Oct. 5, 2023), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opajohnson7; Kristin Johnson, Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of Atlanta: Policing the (Token) Economy: Introducing Corporate Governance and Market Structure Reforms in Crypto and Environmental Commodities Markets (Nov. 13, 2023), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opajohnson8; Kristin Johnson, Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of Dallas: All Hat, No Cattle: The Need For Market Structure Reforms in Voluntary Carbon Markets (Nov. 29, 2023), https:// www.cftc.gov/PressRoom/SpeechesTestimony/ opajohnson10. 8 Kristin Johnson, Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of Dallas: All Hat, No Cattle: The Need For Market Structure Reforms in Voluntary Carbon Markets (Nov. 29, 2023), https://www.cftc.gov/PressRoom/ SpeechesTestimony/opajohnson10. 9 Id. PO 00000 Frm 00063 Fmt 4703 Sfmt 4703 Core principle 3 requires a DCM to demonstrate that listed contracts are not readily subject to manipulation. Core principle 4 requires a DCM to prevent manipulation, price distortion, and disruptions of the physical delivery or cash-settlement process through market surveillance, compliance, and enforcement practices and procedures.10 Guidance and acceptable practices provide contextual information regarding the core principles and detailed examples of how a DCM must satisfy a core principle. Additionally, DCMs must comply with ‘‘submission requirements . . . prior to listing a product for trading,’’ including by way of self-certification or Commission approval of such products. The Commission reviews the product specifications, including information about the underlying asset, as part of this review process. Futures on VCCs: Great Interest, Limited Volume Over the last several years, the Commission authorized the listing of futures contracts on certain environmental instruments, including mandatory emissions and voluntary carbon program instruments. There are almost two hundred derivative contracts on environmental commodities although at this time only three contracts have open interest. As of November 2023, DCMs submitted eighteen futures contracts on voluntary carbon market products the Commission for listing. Derivative contracts on VCCs base their prices on the spot price of VCCs,11 and therefore the integrity of the underlying spot market is critical to the stability of the derivatives market for those underlying VCC commodities. General Summary of the Proposed Guidance Endemic fraud in the VCC spot market impacts the integrity of environmental derivative contracts that reference spot market projects. While the Commission’s authority to introduce regulation is limited to commodity 10 17 CFR part 38, Appendix B to Part 38 (Guidance on, and Acceptable Practices in, Compliance With Core Principles), and Appendix C to Part 38 (Demonstration of Compliance That a Contract Is Not Readily Susceptible to Manipulation). 11 For example, NYMEX’s CBL Global Environmental Offset futures contracts, and Nodal Exchange’s Verified Emission Reduction futures and options contracts, are physically-settled contracts. If the holder of a position in the contract still has an open position at the expiration of trading in the contract, then the position holder must, in accordance with the rules for delivery set forth in the contract, make or take delivery (as applicable) of 1,000 VCCs that meet the contract’s rules for delivery eligibility. E:\FR\FM\27DEN1.SGM 27DEN1 ddrumheller on DSK120RN23PROD with NOTICES1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices derivatives, the Commission has broad authority to address fraud and market manipulation in the spot market. The Proposed Guidance outlines factors that DCMs should consider when addressing certain requirements under the CEA and CFTC regulations that are relevant to the listing for trading of VCC derivative contracts, as previously mentioned, without providing a qualitative element in terms of identifying how the Commission expects the DCM to weigh those factors to create a certain aspirational goal. Specifically: • When addressing quality standards in the development of the terms and conditions of a VCC derivative contract, the Proposed Guidance states that a DCM should consider transparency, additionality, permanency and risk of reversal, and robust quantification in connection with the underlying VCC. The governance framework and tracking mechanisms of the crediting program for the underlying VCCs and the crediting program’s measures to prevent doublecounting are all additional considerations. Inspection or certification provisions should be specified in the terms and conditions. • DCMs should actively monitor the terms and conditions of VCC derivative contracts to ensure conformity with current standards and should require their market participants to keep records of their trading, including activity in the underlying spot market, and make such records available upon request to the DCM. • As part of the product review process, a DCM is required to submit the contract’s terms and conditions and any contract amendments and must also include an explanation and analysis of the contract and its compliance with applicable CEA provisions. The submitted information—including supporting documentation, evidence and data—provided by the DCM should describe how the contract complies with the CEA and applicable Commission regulations and should be complete and thorough. DMO suggests that the Proposed Guidance should be considered by a swap execution facility (SEF) that proposes to trade swaps with VCCs as underlying commodities. Similar to DCMs, SEFs are directly subject to core principles, guidance, acceptable practices, and product listing requirements.12 The Proposed Guidance may help to improve the integrity of the VCC 12 17 CFR part 37 and Appendix B to Part 37 (Guidance on, and Acceptable Practices in, Compliance with Core Principles). VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 markets. Yet, there are additional and significant issues that the Proposed Guidance does not address. On November 13, 2023, I delivered a keynote speech at the Federal Reserve Bank of Atlanta. During that discussion, I noted: There are certain principles that must guide the development of market structure for [VCC markets] including the introduction of transaction reporting; secondary market regulation including, where relevant, clearing and settlement guidance; accountability standards for intermediaries to ensure integrity and reliability (and in the context of environmental commodities additionality); business conduct standards, including standardized documentation (and requirements for certification of environmental commodities); and appropriate guardrails for any retail market participation.13 On November 29, 2023, I delivered keynote remarks at a joint convening of the Energy Advisory Council and Financial Sector Advisory Council of the Dallas Federal Reserve Bank. There, I outlined additional interventions that may mitigate the proliferation of fraud in VCC markets and foster innovation and competition, while ensuring the integrity of our markets. The Proposed Guidance provides much-needed direction to DCMs (and SEFs) to facilitate their compliance with core principles when they list futures contracts (and swaps contracts) on VCCs. However, the Commission is only addressing one small aspect of the market for derivatives on these underlying assets. There is also a segment of the swaps market that is not traded on a SEF for which VCCs are underliers and an even more significant volume of environmental forwards that are not considered to be swaps. The Proposed Guidance suggests the potential for a broader and more comprehensive framework. Applying the approach adopted in the Proposed Guidance, there may be several interventions that may introduce similar needed clarifications—material risk disclosures, good faith and fair dealing, and clearing. A Comprehensive Approach To Regulating VCC Markets A comprehensive framework enhances the integrity of futures and OTC markets enabling risk transfer, investment, hedging, and price discovery. 13 Kristin Johnson, Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of Atlanta: Policing the (Token) Economy: Introducing Corporate Governance and Market Structure Reforms in Crypto and Environmental Commodities Markets (Nov. 13, 2023), https://www.cftc.gov/ PressRoom/SpeechesTestimony/opajohnson8. PO 00000 Frm 00064 Fmt 4703 Sfmt 4703 89425 Material Risk Disclosures The CEA and CFTC regulations impose material risk disclosure requirements on registered market participants in connection with their communications, solicitations, and negotiations of transactions and material contractual terms. These material risk disclosure requirements reduce information asymmetries and improve transparency. The requirements obligate certain parties to disclose material information sufficient to enable counterparties to make informed decisions about the appropriateness of entering into a transaction. In the swaps market,14 a swap dealer is required to disclose to its non-swap dealer counterparty material information concerning the swap in a manner reasonably designed to allow the counterparty to assess the material risks, material characteristics, material incentives and conflicts of interest that the swap dealer may have in connection with a particular swap.15 In the adopting release for the material risk disclosure requirement, the Commission clarified that the material risk disclosure requirement reaches disclosures regarding the risks associated with the economic terms of the product and risks associated with the underlying asset. The Commission noted that: The Commission believes that for most swaps information about the material risks and characteristics of the swap will relate to the risks and characteristics of the economic terms of the swap. For certain swaps, however, where payments or cash-flows are materially affected by the performance of an underlying asset for which there is not publicly available information (or the information is not otherwise accessible to the counterparty), final § 23.431 would require disclosures about the material risks and characteristics that affect the value of the underlying asset to enable a counterparty to assess the material risks of the swap.16 14 For reference, in futures markets, futures commission merchants are required to provide comprehensive disclosures under CFTC Regulation 1.55 where all materials risks are specifically are addressed. Registered commodity pool operators and commodity trading advisors are also required to provide disclosures on risks of trading futures and swaps. 15 7 CFR 23.431. This provision requires the disclosure of market, credit, liquidity, foreign currency, legal, operational, any other applicable risks; the material economic terms of the swap, the terms relating to the operation of the swap, and the rights and obligations of the parties during the term of the swap; and the price of the swap, the midmarket mark of the swap, and any compensation or other incentive from any source other than the counterparty that the swap dealer may receive in connection with the swap. 16 Business Conduct Standards for Swap Dealers and Major Swap Participants With Counterparties E:\FR\FM\27DEN1.SGM Continued 27DEN1 89426 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 In my view, the concepts of material information, material risks, material characteristics, material incentives and conflicts of interest of a derivative must necessarily include the underlying commodity on which a derivative is priced. In light of the lack of visibility into pricing in the VCC markets and the dearth of publicly available information regarding pricing methodologies, such disclosures are particularly important. Using the risk disclosure requirement as a framework, the Commission should provide guidance that applies to all environmental derivative products. In the context of derivatives on VCCs or other environmental products, where the risk of loss may be magnified because of leverage, the sellers must ensure its counterparty has adequate information to understand how observed volatility and inherent risk in the nascent and evolving VCC market could impact the price of the derivative. For certain forward contracts on VCCs, it is possible that no material risk disclosure requirement applies; however, the CFTC does have enforcement jurisdiction if there is fraud, including where incorrect or misleading information is provided. CFTC regulations do not require parties to make affirmative statements about nonpublic information—but if a party does speak, CFTC Regulation 180.1(b) specifically requires that a materially misleading statement be corrected, including nonpublic information that may be material to the market price, rate, or level of the commodity transaction.17 The Commission may not need to prescribe the precise language of the disclosures. The material risk disclosure rule is principles-based. Instead, the Commission may identify factors that a market participant must consider in a risk disclosure, including all the factors that could lead to significant losses. Information about a carbon credit, including information about the environmental project and market structure, is material because there is a substantial likelihood that a reasonable counterparty would consider it important in making a trading decision. (Business Conduct Standards), 77 FR 9734, 9760 (Feb. 17, 2012). 17 17 CFR 180.1(b) (stating that nothing in that section shall be construed to require any person to disclose to another person nonpublic information that may be material to the market price, rate, or level of the commodity transaction, except as necessary to make any statement made to the other person in or in connection with the transaction not misleading in any material respect). VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 Guidance on Good Faith and Fair Dealing The principles of good faith and fair dealing are well-established in the futures, swaps and securities industries. The National Futures Association’s customer communication rule also imposes a duty to communicate in a fair and balanced manner. In the swaps market, the risk disclosure requirement is closely linked to the swap dealer’s obligation to communicate in a fair and balanced manner. Swap dealers have a duty to communicate with all of their counterparties in a fair and balanced manner based on principles of fair dealing and good faith.18 This duty, the Commission notes, ‘‘is designed to ensure a balanced treatment of potential benefits and risks.’’ 19 In the adopting release for the fair dealing requirement, the Commission noted: In a complex swap, where the risks and characteristics associated with an underlying asset are not readily discoverable by the counterparty upon the exercise of reasonable diligence, the swap dealer or major swap participant is expected, under both the disclosure rule and fair dealing rule, to provide a sound basis for the counterparty to assess the swap by providing information about the risks and characteristics of the underlying asset.20 The Commission should offer guidance as to its expectations of how the fair dealing requirement should be considered in the context of an underlying asset that is a VCC. The fair dealing rule provides an independent basis for enforcement proceedings—for example where the swap dealer makes exaggerated or unwarranted claims, opinions, or forecasts in violation of the fair dealing requirement.21 Such a requirement may not apply to certain forward contracts on VCCs. Yet, the Commission maintains broad enforcement jurisdiction in the event that there is an allegation of fraud, including where incorrect or misleading information is provided. CFTC Regulation 180.1(a)(2) makes unlawful the making of an untrue or misleading statement of a material fact or omitting a material fact necessary to make a statement made not untrue or misleading.22 18 7 CFR 23.433. Conduct Standards, 77 FR at 9769. 20 Id. at 9770. 21 Id. at 9769. 22 17 CFR 180.1(a)(2) (providing that it is unlawful for any person in connection with any contract of sale of any commodity in interstate commerce to intentionally or recklessly make, or attempt to make, any untrue or misleading statement of a material fact or to omit to state a 19 Business PO 00000 Frm 00065 Fmt 4703 Sfmt 4703 Guidance on Product Eligibility for Clearing In the future, should the market evolve and become more standardized, the clearing framework may also provide valuable risk reduction benefits for derivatives on environmental commodities. Clearing, by way of novation, reduces counterparty credit risk because a DCO serves as a seller to every buyer and a buyer to every seller, remaining neutral. DCOs are highly regulated by the Commission, are subject to core principles, and have significant, mutualized financial resources. At settlement, DCOs may facilitate the physical delivery of the actual underlying commodity or cash payments based on the final price of the underlying commodity in connection with the derivatives contract. In the context of environmental derivatives, DCOs would facilitate delivery of the VCC or determine the cash amount based on the price of the VCC in the cash market. For purposes of physical settlement, a well-functioning carbon credit cash market is essential. Core principle C sets out product eligibility requirements. A DCO must have appropriate requirements for determining the eligibility of contracts submitted to the DCO for clearing, taking into account the DCO’s ability to manage the risks associated with such contracts. Some factors the DCO must consider include the availability of reliable prices, the ability of the DCO and clearing members to gain access to the relevant market for purposes of creating, liquidating, transferring, auctioning, and/or allocating positions, and the operational capacity of the DCO and clearing members to address any unique risk characteristics of a product clearing members.23 A DCO should take care not to clear transactions that present an unacceptable level of risk. In the context of the current VCC market, significant questions arise as to whether certain elements of the DCO core principles would be easily established, including whether there are reliable prices for these carbon credits, the access to carbon credit markets, and whether there is material information about the carbon credit. Additional Commission guidance perhaps could facilitate the market, increase volumes and promote sound risk management, reasonably-designed policies and procedures, and robust rules. The development of rules that facilitate the clearing of derivatives material fact necessary in order to make the statements made not untrue or misleading). 23 17 CFR 39.12(b). E:\FR\FM\27DEN1.SGM 27DEN1 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices based on environmental commodities would be greatly advanced by Commission guidance on the application of those principles to the clearing of such products. Forwards on carbon credits are not required to be cleared at a DCO; but clearing and settlement provide critical counterparty credit risk management. Conclusion It is difficult to overstate the significance of today’s announced Proposed Guidance. Once again, the CFTC is demonstrating leadership in the novel carbon credit markets and contemporaneously enhancing the integrity of carbon-credit markets.24 I believe the Commission has taken an important step forward by announcing the Proposed Guidance advanced today. However, I am hopeful that this step is the first on a long journey to introduce effective market structure reforms in VCC markets. Appendix 4—Statement of Commissioner Christy Goldsmith Romero ddrumheller on DSK120RN23PROD with NOTICES1 I am pleased to support today’s proposed guidance regarding the listing of voluntary carbon credit derivatives. I want to recognize Chairman Behnam’s leadership in the voluntary carbon credit space. The proposed guidance follows efforts by the Commission to develop capacity in understanding and regulating voluntary carbon credits.1 The physical effects of climate change are amplifying. 2023 is likely to go down as the warmest year on record.2 The intensifying physical impacts of climate change pose serious risks to commodities derivatives markets and potentially systemic risk to the financial system if not effectively managed. Our mission includes promoting resilience in derivatives markets that can play a critical role in managing climate risk. Many market participants are seeking opportunities in derivatives markets to promote resilience to climate risk, 24 In June 2022, the Commission held the firstever Voluntary Carbon Markets Convening to discuss issues related to the supply and demand for high quality carbon offsets. Then in July 2023, the Commission held the second Voluntary Carbon Markets Convening to discuss recent private sector initiatives for high quality carbon credits, among other topics. 1 The Commission has held two convenings to gather information from a range of carbon market stakeholders and last year conducted a request for information on climate-related risks, which asked several questions about carbon markets. The Commission received significant comments on voluntary carbon credit products and markets. 2 National Oceanic and Atmospheric Administration, Topping the charts: September 2023 was Earth’s warmest September in 174-year record (Oct. 13, 2023). VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 including through voluntary carbon credits. The CFTC oversees voluntary carbon credit derivatives listed and trading on CFTC-registered exchanges. In addition to regulatory authority over derivatives, the CFTC also has antifraud authority in the spot voluntary carbon credit markets given the potential for impact to the derivatives markets. In response to our public consultation, various market participants, public interest groups, and U.S. Senators have asked the CFTC to take a leading role in promoting the integrity of voluntary carbon markets.3 I was pleased to help launch the CFTC’s Environmental Fraud Task Force that will pursue individual cases of fraud related to carbon credits, weeding out bad actors, and promoting market integrity.4 Today’s proposed guidance is the next step in promoting market integrity. I have met with exchanges to discuss their process for listing these emerging products, and found differing approaches to these products and due diligence in the underlying credit. CFTC-registered exchanges have certain requirements under the Commodity Exchange Act including to list only contracts that are not readily susceptible to manipulation, to have the capacity and responsibility to prevent manipulation, price distortion and other market disruptions, and other requirements aimed at market integrity. 3 See Letter from Senators Booker, Warren, Markey, Blumenthal, Sanders, Merkley and Gillibrand (Oct. 13, 2022); see also ISDA Comment Letter on CFTC Request for Information on ClimateRelated Financial Risk (Oct. 7, 2022) (‘‘We believe that the Commission should take a leading role in supporting and enhancing the integrity of voluntary carbon markets.’’); see also Intercontinental Exchange Inc. Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022) (‘‘ICE supports the Commission taking a leadership role in supporting and enhancing the integrity of project-based carbon markets.’’); see also Environmental Defense Fund Comment Letter on CFTC Request for Information on ClimateRelated Financial Risk (Oct. 7, 2022) (‘‘EDF respectfully welcomes CFTC’s interest in identifying the potential for fraud and market manipulation in voluntary carbon markets. Enhanced quality and integrity in voluntary carbon markets can help mobilize carbon finance, help cut emissions and facilitate the achievement of corporate and national greenhouse gas reduction goals.’’); see also bp Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022) (‘‘bp believes the CFTC should focus on simultaneously enhancing its oversight role in derivatives and futures markets while allowing these markets to become deeper and more liquid.’’). 4 Commissioner Christy Goldsmith Romero, Remarks of Commissioner Christy Goldsmith Romero at ISDA’s ESG Forum on Promoting Market Resilience: A Thoughtful Approach to the Daunting Challenge of Climate Financial Risk, (Mar. 7, 2023); See Commissioner Christy Goldsmith Romero, Adjusting the Sails for Cyber and Climate Resilience (Feb. 10, 2023). PO 00000 Frm 00066 Fmt 4703 Sfmt 4703 89427 Commission guidance, like what is proposed today, can help exchanges understand what compliance means in a still rapidly evolving market for voluntary carbon credits, one where there can be concerns about integrity, including for carbon credits listed on some of the largest registries,5 a lack of transparency, and uncertainty related to pricing. These concerns in the spot market could affect the regulated derivatives market. For a market to work well, market participants need to be confident they have credible information about the product, that there are appropriate levels of pricing, and that the market has integrity, so that they do not face legal, reputational and regulatory risks. I continue to believe that bringing more of this market onto regulated exchanges could increase integrity, transparency, and bring greater confidence to the market. I agree with a response to our consultation which said that ‘‘the expansion of exchanges offering products . . . would help grow liquidity and therefore the value of the market for price discovery and risk shifting.’’ 6 CFTC-regulated exchanges have important responsibilities under the Commodity Exchange Act, and stand as the first line of defense to ensure market integrity The market should signal through pricing which carbon credits are high quality compared to credits reflecting projects that do not achieve the requisite level of one ton of greenhouse gases removed or reduced. However, one of the biggest challenges in voluntary carbon markets is fragmentation which different projects, registries, and standards, that can impact derivatives markets and harm market confidence. A lack of transparency through consistent, comparable data can present challenges to proper functioning of markets, including price discovery. There are important and welcome efforts by voluntary bodies like the Integrity Council on Voluntary Carbon Markets (‘‘ICVCM’’) to create voluntary 5 In one relevant example, several press sources reported serious allegations about a project developed by the market’s largest firm, a project that has been among the leading sources of carbon credits globally. Blake, Heidi, The Great Cash-forCarbon Hustle, The New Yorker (Oct. 16, 2023); Ben Elgin, Alastair Marsh, and Max de Haldevang, Faulty Credits Tarnish Billion-Dollar Carbon Offset Seller, Bloomberg (Mar. 24, 2023). The allegations were sufficiently credible that the project’s registry put on hold issuance of credits from the project, pending an investigation. Verra Statement on the New Yorker Article of October 16, 2023, Verra (Oct. 17, 2023). 6 See Ceres Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022). E:\FR\FM\27DEN1.SGM 27DEN1 89428 Federal Register / Vol. 88, No. 247 / Wednesday, December 27, 2023 / Notices ddrumheller on DSK120RN23PROD with NOTICES1 standards to address concerns about credibility and to develop a common understanding of a high-quality credit, efforts that are ongoing. In March, I proposed that the Commission work with regulated exchanges to develop common baseline standards for listing voluntary carbon credit derivatives.7 At a conference held by ISDA, I proposed that the Commission consider requiring exchanges to take certain actions to increase confidence that underlying voluntary carbon credits reliably remove or avoid the amount of carbon claimed of one ton of greenhouse gases per credit. I proposed that such actions could include information sharing agreements with carbon registries and baseline standards for carbon credits that could reference either the ICVCM core carbon principles once they became final or the basic principles on which they are based. I thank the Chairman for working with me on these efforts. Today’s guidance adapts terminology, concepts and standards from the ICVCM’s Core Carbon Principles and its recently issued Assessment Framework. I support the Commission’s recognition of the efforts made by this body that could improve integrity, transparency, and price discovery, and thereby improve confidence in these markets. The Commission’s guidance adapts ICVCM concepts and standards that commenters told us were needed for integrity in voluntary carbon markets. The guidance sets an expectation for exchanges to ensure that underlying VCC’s represent an actual ton of carbon dioxide removed or reduced and that there is no double counting of those reductions or removals.8 It also sets an expectation that underlying VCC’s are subject to a meaningful independent evaluation and verification before issuance.9 Aligning the CFTC’s 7 Commissioner Christy Goldsmith Romero, Remarks of Commissioner Christy Goldsmith Romero at ISDA’s ESG Forum on Promoting Market Resilience: A Thoughtful Approach to the Daunting Challenge of Climate Financial Risk (Mar. 7, 2023). 8 See ISDA Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022) (‘‘In order for these markets to flourish, there can be no room for greenwashing, doublecounting of credits or any other types of fraud and manipulation . . .’’); See also EDF Comment Letter on CFTC Request for Information on ClimateRelated Financial Risk (Oct. 7, 2022) (‘‘One particular concern in carbon markets is that traded reductions might be ‘‘double counted,’’ a situation in which a single GHG emission reduction or removal (i.e. credit) is counted more than once towards achieving mitigation targets or goals.’’). 9 See Ceres Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022) (‘‘The best way to guard against the risk of market disruption because of the lack of the integrity of the underlying credits would be to VerDate Sep<11>2014 19:00 Dec 26, 2023 Jkt 262001 expectations with the ICVCM’s work also recognizes the global nature of this market and of the challenges posed by climate-related financial risk. I am interested in hearing from commenters if the guidance adapts the right parts of the ICVCM standards to encourage integrity and transparency in these markets and if the Commission’s adaptation provides clear, workable expectations. As the ICVCM standards have only been recently released, it will be important to monitor the adoption of these standards. I am also interested in hearing more from commenters about whether market integrity can be improved by exchanges relying on a crediting program’s processes and diligence, as assumed in the proposed guidance, or if there is a benefit to exchanges conducting additional due diligence into specific categories, protocols, or projects. I am interested to hear from commenters, including participants in our previous public consultation if this guidance meets their needs and helps address concerns they have raised. I especially hope to hear from farmers and others in the agricultural community, several of whom encouraged the CFTC to play a role in ensuring integrity in carbon markets in response to last year’s public consultation.10 As derivatives markets evolve, it is important that the Commission remain nimble and aware of changes, and continue to work with exchanges in listing products. I applaud the staff for their hard work on this guidance and I thank them for working with me to incorporate feedback I have heard in meetings with exchanges, market participants and public interest groups over the past 18 months. [FR Doc. 2023–28532 Filed 12–26–23; 8:45 am] BILLING CODE 6351–01–P require all credits underlying derivative instruments be subject to a meaningful evaluation and certification process by an outside, neutral, and expert third party.’’). 10 See Blue Diamond Farming Company Comment Letter on CFTC Request for Information on Climate-Related Financial Risk (Oct. 7, 2022); see also Bryan Agricultural Enterprises Comment Letter on CFTC Request for Information on ClimateRelated Financial Risk (Oct. 7, 2022). PO 00000 Frm 00067 Fmt 4703 Sfmt 4703 DEPARTMENT OF ENERGY [GDO Docket No. EA–463–A] Application for Renewal of Authorization To Export Electric Energy; Boston Energy Trading and Marketing LLC Grid Deployment Office, Department of Energy. ACTION: Notice of application. AGENCY: Boston Energy Trading and Marketing LLC (the Applicant or BETM) has applied for renewed authorization to transmit electric energy from the United States to Canada pursuant to the Federal Power Act. DATES: Comments, protests, or motions to intervene must be submitted on or before January 26, 2024. ADDRESSES: Comments, protests, motions to intervene, or requests for more information should be addressed by electronic mail to Electricity.Exports@hq.doe.gov. FOR FURTHER INFORMATION CONTACT: Christina Gomer, (240) 474–2403, Electricity.Exports@hq.doe.gov. SUPPLEMENTARY INFORMATION: The United States Department of Energy (DOE) regulates electricity exports from the United States to foreign countries in accordance with section 202(e) of the Federal Power Act (FPA) (16 U.S.C. 824a(e)) and regulations thereunder (10 CFR 205.300 et seq.). Sections 301(b) and 402(f) of the DOE Organization Act (42 U.S.C. 7151(b) and 7172(f)) transferred this regulatory authority, previously exercised by the nowdefunct Federal Power Commission, to DOE. Section 202(e) of the FPA provides that an entity which seeks to export electricity must obtain an order from DOE authorizing that export. (16 U.S.C. 824a(e)). On April 10, 2023, the authority to issue such orders was delegated to the DOE’s Grid Deployment Office (GDO) by Delegation Order No. S1–DEL–S3–2023 and Redelegation Order No. S3–DEL–GD1–2023. On December 19, 2018, DOE issued Order No. EA–463 to BETM to transmit electric energy from the United States to Canada as a power marketer for a period of five years. On November 14, 2023, BETM filed an application with DOE (Application or App.) for renewal of their export authority for a five-year term. App. at 8. According to the Application, BETM is a California limited liability company that is a wholly owned subsidiary of Diamond Energy Trading and Marketing, LLC. Id. at 1–2. BETM represents that it is a power marketer SUMMARY: E:\FR\FM\27DEN1.SGM 27DEN1

Agencies

Commodity Futures Trading Commission

[Federal Register Volume 88, Number 247 (Wednesday, December 27, 2023)]
[Notices]
[Pages 89410-89428]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-28532]


=======================================================================
-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

RIN 3038-AF40


Commission Guidance Regarding the Listing of Voluntary Carbon 
Credit Derivative Contracts; Request for Comment

AGENCY: Commodity Futures Trading Commission

ACTION: Proposed guidance; request for comment.

-----------------------------------------------------------------------

SUMMARY: The Commodity Futures Trading Commission (the ``Commission'' 
or ``CFTC'') is issuing for public comment this proposed guidance 
regarding the listing for trading of voluntary carbon credit (``VCC'') 
derivative contracts. Specifically, the Commission is proposing to 
issue guidance to outline factors that designated contract markets 
(``DCMs'') should consider when addressing certain provisions of the 
Commodity Exchange Act (``CEA''), and CFTC regulations thereunder, that 
are relevant to the listing for trading of VCC derivative contracts. 
The Commission recognizes that VCC derivatives are a comparatively new 
and evolving class of products, and believes that guidance that 
outlines factors for a DCM to consider in connection with product 
design and listing may help to advance the standardization of such 
products in a manner that promotes transparency and liquidity. The 
Commission requests comment on this proposed guidance and further 
invites comment on specific questions related to the listing for 
trading of VCC derivative contracts.

DATES: Comments must be received on or before February 16, 2024.

ADDRESSES: You may submit comments, identified by ``Commission Guidance 
Regarding the Listing of Voluntary Carbon Credit Derivative Contracts'' 
and RIN 3038-AF40, by any of the following methods:
     CFTC Comments Portal: https://comments.cftc.gov. Select 
the ``Submit Comments'' link for this release and follow the 
instructions on the Public Comment Form.
     Mail: Send to Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW, Washington, DC 20581.
     Hand Delivery/Courier: Follow the same instructions as for 
Mail, above.
    Please submit your comments using only one of these methods. 
Submissions through the CFTC Comments Portal are encouraged.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://comments.cftc.gov. You should submit only information that you 
wish to make available publicly. If you wish the Commission to consider 
information that you believe is exempt from disclosure under the 
Freedom of Information Act (``FOIA''), a petition for confidential 
treatment of the exempt information may be submitted according to the 
procedures established in Sec.  145.9 of the Commission's 
regulations.\1\
---------------------------------------------------------------------------

    \1\ 17 CFR 145.9.
---------------------------------------------------------------------------

    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse, or remove any or all of 
your submission from https://www.comments.cftc.gov that it may deem to 
be inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the guidance will be retained in the public comment file 
and will be considered as required under the Administrative Procedure 
Act and other applicable laws, and may be accessible under FOIA.

FOR FURTHER INFORMATION CONTACT: Lillian A. Cardona, Assistant Chief 
Counsel, (202) 418-5012, [email protected]; Steven Benton, Industry 
Economist, (202) 418-5617, [email protected]; Nora Flood, Chief Counsel, 
(202) 418-6059, [email protected]; Division of Market Oversight, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. The Regulatory Framework for DCMs

    The CFTC's mission is to promote the integrity, resilience, and 
vibrancy of the U.S. derivatives markets through sound regulation.\2\ 
An independent agency of the U.S. federal government, the CFTC 
exercises the authorities granted to it under the CEA to promote market 
integrity, prevent price manipulation and other market disruptions, 
protect customer funds, and avoid systemic risk, while fostering 
responsible innovation and fair competition in the derivatives 
markets.\3\
---------------------------------------------------------------------------

    \2\ CFTC Mission Statement, available at: https://www.cftc.gov/About/AboutTheCommission.
    \3\ See CEA section 3(b), 7 U.S.C. 5(b).
---------------------------------------------------------------------------

    DCMs are CFTC-regulated exchanges that provide participants in the 
derivatives markets with the ability to execute or trade derivative 
contracts

[[Page 89411]]

with one another.\4\ In order to obtain and maintain designation with 
the CFTC, DCMs must comply with statutory ``Core Principles'' that are 
set forth in the CEA,\5\ as well as applicable CFTC rules and 
regulations.\6\ The statutory Core Principles for DCMs reflect the 
important role that these exchanges play in promoting the integrity of 
derivatives markets. DCMs are self-regulatory organizations, and each 
DCM has Core Principle obligations to, among other things, establish 
and enforce rules for trading on the DCM; \7\ provide a competitive, 
open and efficient market for trading; \8\ and monitor trading 
activity.\9\ For example, DCM Core Principle 4 requires a DCM to have 
the capacity and responsibility to prevent manipulation, price 
distortion, and disruptions of the delivery or cash settlement process, 
through market surveillance, compliance, and enforcement practices and 
procedures.\10\ DCM Core Principle 5 requires a DCM to adopt for each 
contract that it lists for trading, as is necessary and appropriate, 
position limitations or position accountability for speculators, in 
order to reduce the potential threat of market manipulation or 
congestion, especially during trading in the delivery month.\11\ DCM 
Core Principle 12 requires a DCM to establish and enforce rules to 
protect markets and market participants from abusive practices, and to 
promote fair and equitable trading on the DCM.\12\
---------------------------------------------------------------------------

    \4\ See CEA section 1a(6), 7 U.S.C. 1a(6). (The term ``board of 
trade'' means any organized exchange or other trading facility); CEA 
section 1a(51)(A), 7 U.S.C. 1a(51)(A) (The term ``trading facility'' 
means a person or group of persons that constitutes, maintains, or 
provides a physical or electronic facility or system in which 
multiple participants have the ability to execute or trade 
agreements, contracts, or transactions--(i) by accepting bids or 
offers made by other participants that are open to multiple 
participants in the facility or system; or (ii) through the 
interaction of multiple bids or multiple offers within a system with 
a pre-determined non-discretionary automated trade matching or 
execution algorithm); and CEA section 5(d)(1)(A), 7 U.S.C. 
7(d)(1)(A) (To be designated, and maintain a designation, as a 
contract market, a board of trade shall comply with--(i) any core 
principle described in this subsection; and (ii) any requirement 
that the Commission may impose by rule or regulation pursuant to CEA 
section 8a(5)).
    \5\ See, generally, CEA Section 5(d), 7 U.S.C. 7(d). There are 
23 statutory Core Principles for DCMs.
    \6\ CEA section 5(d)(1)(A), 7 U.S.C. 7(d)(1)(A).
    \7\ DCM Core Principle 2 requires, among other things, that a 
DCM establish, monitor, and enforce compliance with the rules of the 
DCM, including access requirements, the terms and conditions of any 
contracts to be traded on the DCM, and rules prohibiting abusive 
trade practices on the DCM. DCM Core Principle 2 also requires a DCM 
to have the capacity to detect, investigate, and apply appropriate 
sanctions to any person that violates any rule of the DCM. CEA 
section 5(d)(2), 7 U.S.C. 7(d)(2). See also 17 CFR 38.150-160. DCM 
Core Principle 13 requires that a DCM establish and enforce 
disciplinary procedures that authorize the DCM to discipline, 
suspend, or expel members or market participants that violate the 
DCM's rules. CEA section 5(d)(13), 7 U.S.C. 7(d)(13). See also 17 
CFR 38.700-712.
    \8\ DCM Core Principle 9 requires, among other things, that a 
DCM provide a competitive, open, and efficient market and mechanism 
for executing transactions that protects the price discovery process 
of trading in the centralized market of the DCM. CEA section 
5(d)(9), 7 U.S.C. 7(d)(9). See also 17 CFR 38.500.
    \9\ See, e.g., DCM Core Principles 4, 5, and 12, discussed 
infra.
    \10\ CEA section 5(d)(4) 7 U.S.C. 7(d)(4). See also 17 CFR 
38.250-258.
    \11\ CEA section 5(d)(5), 7 U.S.C. 7(d)(5). See also 17 CFR 
38.300-301.
    \12\ CEA section 5(d)(12), 7 U.S.C. 7(d)(12). See also 17 CFR 
38.650-651.
---------------------------------------------------------------------------

    Additionally, each DCM has a specific statutory obligation, under 
DCM Core Principle 3, to only list for trading contracts that are not 
readily susceptible to manipulation.\13\ As discussed in greater detail 
below, a DCM may generally elect to list a new derivative contract for 
trading either by certifying to the Commission that the contract 
complies with the CEA and CFTC regulations,\14\ or by seeking 
Commission approval of the contract.\15\ In either case, the DCM must 
submit the contract's terms and conditions, and other prescribed 
information relating to the contract, to the Commission prior to 
listing.\16\
---------------------------------------------------------------------------

    \13\ CEA section 5(d)(3), 7 U.S.C. 7(d)(3). See also 17 CFR 
38.200-201.
    \14\ CEA section 5c(c)(1), 7 U.S.C. 7a-2(c)(1). See also 17 CFR 
40.2.
    \15\ CEA sections 5c(c)(4)-(5), 7 U.S.C. 7a-2(c)(4)-(5). See 
also 17 CFR 40.3.
    \16\ See, generally, 17 CFR 40.2 and 40.3. Amendments to 
contract terms and conditions also must be submitted to the 
Commission in accordance with procedures set forth at CEA section 
5c(c), 7 U.S.C. 7a-2(c), and Part 40 of the Commission's 
regulations.
---------------------------------------------------------------------------

    For a number of the statutory Core Principles for DCMs, the 
Commission has adopted rules that establish the manner in which a DCM 
must comply with the Core Principle.\17\ These implementing rules are 
set forth in Part 38 of the Commission's regulations.\18\ The 
Commission has also adopted, in Appendix B to Part 38,\19\ guidance and 
acceptable practices for DCMs to take into consideration with respect 
to certain of the Core Principles.\20\
---------------------------------------------------------------------------

    \17\ Unless otherwise determined by the Commission by rule or 
regulation, a DCM has reasonable discretion in establishing the 
manner in which it complies with a Core Principle. CEA section 
5(d)(1)(B), 7 U.S.C. 7(d)(1)(B).
    \18\ 17 CFR part 38.
    \19\ 17 CFR part 38, Appendix B.
    \20\ Guidance provides contextual information regarding a Core 
Principle, including important concerns which the Commission 
believes should be considered in complying with the Core Principle. 
The guidance for a DCM Core Principle is illustrative only of the 
types of matters that a DCM may address, and is not intended to be 
used as a mandatory checklist. Acceptable practices are more 
detailed examples of how a DCM may satisfy particular requirements 
of a DCM Core Principle. Similar to guidance, acceptable practices 
are for illustrative purposes only, and do not establish a mandatory 
means of Core Principle compliance. 17 CFR part 38, Appendix B.
---------------------------------------------------------------------------

    With respect to the DCM Core Principle 3 requirement that a DCM 
only list for trading contracts that are not readily susceptible to 
manipulation, the Commission has adopted guidance that is set forth in 
Appendix C to Part 38 of the Commission's regulations (the ``Appendix C 
Guidance'').\21\ The Appendix C Guidance outlines certain relevant 
considerations for a DCM when developing derivative contract terms and 
conditions, and providing supporting documentation and data in 
connection with the submission of the derivative contract to the 
Commission.\22\ The Commission takes these considerations into account 
when determining whether, with respect to the contract, the DCM is 
satisfying its Core Principle obligation only to list contracts that 
are not readily susceptible to manipulation.
---------------------------------------------------------------------------

    \21\ 17 CFR part 38, Appendix C. Guidance set forth in Appendix 
B to Part 38 states that a DCM may use the Appendix C Guidance as 
guidance in meeting DCM Core Principle 3 for both new product 
listings and existing listed contracts. 17 CFR part 38, Appendix B, 
Core Principle 3 Guidance.
    \22\ See Core Principles and Other Requirements for Designated 
Contract Markets, 77 FR 36612 at 36632 (June 19, 2012). The Appendix 
C Guidance is also relevant to swap execution facilities (``SEFs''), 
another category of CFTC-regulated exchange that provides eligible 
contract participants with the ability to execute or trade, with one 
another, derivative contracts that are swaps. Like DCMs, SEFs are 
obligated by statute only to permit trading in contracts that are 
not readily susceptible to manipulation. See CEA section 5h(f)(3), 7 
U.S.C 7b-3(f)(3); 17 CFR 37.301.
---------------------------------------------------------------------------

    Among other things, the Appendix C Guidance outlines, for both 
physically-settled and cash-settled derivative contracts, certain 
considerations in connection with the design of the contract's rules 
and terms and conditions.\23\ With respect to physically-settled 
derivative contracts, the Appendix C Guidance states, among other 
things, that the contract's terms and conditions should conform to the 
most common commercial practices and conditions in the cash market for 
the underlying commodity.\24\ The Appendix

[[Page 89412]]

C Guidance also states that the contract's terms and conditions should 
be designed to avoid impediments to the delivery of the underlying 
commodity, so as to promote convergence between the price of the 
contract and the cash market value of the underlying commodity at the 
expiration of trading in the contract.\25\ The Appendix C Guidance 
outlines certain criteria that should be addressed in the contract's 
terms and conditions, including contract size, the period for making 
and taking delivery under the contract, delivery points, quality 
standards for the underlying commodity, and inspection/certification 
procedures for verifying compliance with those quality standards or any 
other related delivery requirements under the contract.\26\
---------------------------------------------------------------------------

    \23\ Physically-settled derivative contracts are contracts that 
may settle directly into the commodity underlying the contract. If 
the holder of a position in a physically-settled derivative contract 
still has an open position at the expiration of trading in the 
contract, then the position holder must, in accordance with the 
rules for delivery set forth in the contract, make or take delivery 
(as applicable) of the underlying commodity. By contrast, cash-
settled derivative contracts are, at the expiration of trading in 
the contract, settled by way of a cash payment instead of physical 
delivery of the underlying commodity.
    \24\ Appendix C Guidance, paragraph (b)(1).
    \25\ Id.
    \26\ Appendix C Guidance, paragraph (b)(2).
---------------------------------------------------------------------------

    The criteria outlined in the Appendix C Guidance that relate to the 
quality and other attributes of the underlying commodity that would be 
delivered under a physically-settled contract upon the expiration of 
trading, inform the pricing of the contract. Addressing these criteria 
clearly in the contract's terms and conditions, in a manner that 
reflects the individual characteristics of the underlying commodity, 
helps to ensure that trading in the contract is based on accurate 
information about the underlying commodity. This, in turn, helps to 
promote accurate pricing and helps to reduce the susceptibility of the 
contract to manipulation. Further, when a contract's terms and 
conditions help to ensure that, upon delivery, the quality and other 
attributes of the underlying commodity will be as expected by position 
holders, this helps to prevent price distortions and fosters confidence 
in the contract that can incentivize trading and enhance liquidity.
    With respect to cash-settled derivative contracts, the Appendix C 
Guidance states that an acceptable specification of the cash settlement 
price would, among other things, include rules that fully describe the 
essential economic characteristics of the underlying commodity, as well 
as how the final settlement price is calculated.\27\ The Appendix C 
Guidance states that the utility of a cash-settled contract for risk 
management and price discovery purposes would be significantly impaired 
if the cash settlement price is not a reliable or robust indicator of 
the value of the underlying commodity.\28\ The Appendix C Guidance 
states that, accordingly, careful consideration should be given to the 
potential for manipulation or distortion of the cash settlement price, 
as well as the reliability of that price as an indicator of cash market 
values.\29\ Appropriate consideration also should be given to the 
commercial acceptability, public availability, and timeliness of the 
price series that is used to calculate the cash settlement price.\30\
---------------------------------------------------------------------------

    \27\ Appendix C Guidance, paragraph (c)(1).
    \28\ Appendix C Guidance, paragraph (c)(2).
    \29\ Id.
    \30\ Id.
---------------------------------------------------------------------------

B. Voluntary Carbon Markets

1. Overview of Voluntary Carbon Markets
    As discussed further below, this proposed guidance addresses an 
emerging class of climate-related derivative contracts listed for 
trading by DCMs, where the underlying commodity is a VCC.\31\
---------------------------------------------------------------------------

    \31\ This proposed guidance uses the term ``voluntary carbon 
credits'' rather than ``verified carbon credits,'' as the proposed 
guidance is focused on the quality and other attributes of the 
intangible commodity underlying a derivative contract. The 
Commission recognizes that market participants in the cash or 
secondary market for voluntary carbon credits may choose to use a 
set of standardized terms for the trading and retirement of 
``verified carbon credits,'' as defined by the International Swaps 
and Derivatives Association (``ISDA''), in the market participants' 
physically-settled spot, forward or option transactions. See 2022 
ISDA Verified Carbon Credit Transactions Definitions (``VCC 
Definitions'') Frequently Asked Questions, available at: https://www.isda.org/a/jBXgE/2022-ISDA-Verified-Carbon-Credit-Transactions-Definitions-FAQs-061323.pdf.
---------------------------------------------------------------------------

    In addition to direct greenhouse gas (``GHG'') emissions reduction 
initiatives, market-based mechanisms, such as carbon markets,\32\ have 
developed to support emissions reduction efforts. A carbon market 
generally refers to an economic mechanism to support the buying and 
selling of environmental commodities \33\ that represent GHG emission 
reductions or removals from the atmosphere. Carbon markets are intended 
to harness market forces to incentivize carbon mitigation activities. 
Carbon markets generally fall into two categories: (i) mandatory (or 
compliance) markets, and (ii) voluntary carbon markets.
---------------------------------------------------------------------------

    \32\ While the term ``carbon'' is generally intended to also 
include other greenhouse gases, such as methane, nitrous oxide, 
sulfur hexafluoride, hydro fluorocarbons and perfluorocarbons, most 
emissions trading involves emissions trading of carbon dioxide.
    \33\ An agreement, contract or transaction in an environmental 
commodity may qualify for the forward exclusion from the ``swap'' 
definition set forth in section 1a(47) of the CEA, 7 U.S.C. 1a(47), 
if the agreement, contract or transaction is intended to be 
physically settled. For further discussion of the Commission's 
interpretation of whether agreements, contracts, or transactions in 
environmental commodities fall within the forward exclusion from the 
swap definition, see Further Definition of ``Swap,'' ``Security-
Based Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping; Final Rule, 77 FR 48208 
(August 13, 2012).
---------------------------------------------------------------------------

    Mandatory markets, such as cap-and-trade programs, emissions 
trading systems and allowance trading systems, are established and 
regulated by national, regional, or international governmental 
bodies.\34\ Entities subject to the requirements of a mandatory market 
generally must demonstrate compliance by directly reducing their 
emissions from their own operations or activities, or by purchasing 
eligible compliance credits representing emission reductions or 
removals achieved by others.
---------------------------------------------------------------------------

    \34\ See, for example, the United Nation's Clean Development 
Mechanism (``CDM''), the California Compliance Offset Program, the 
Regional Greenhouse Gas Initiative (``RGGI''), the Alberta Emission 
Offset System (``AEOS''), and the EU Emissions Trading System 
(``ETS'').
---------------------------------------------------------------------------

    Voluntary carbon markets are not established by any government 
body. They enable market participants to purchase, on a voluntary 
basis, carbon credits that upon retirement represent reductions or 
removals of GHG emissions. A voluntary carbon credit, or ``VCC,'' is a 
tradeable intangible instrument that is issued by a carbon crediting 
program (``crediting program'').\35\ The general industry standard is 
for a VCC to represent a GHG emissions reduction to, or removal from, 
the atmosphere equivalent to one metric ton of carbon dioxide.\36\
---------------------------------------------------------------------------

    \35\ See, e.g., The Integrity Council for the Voluntary Carbon 
Market Carbon Core Principles, Section 5 Definitions, available at: 
https://icvcm.org/wp-content/uploads/2023/07/CCP-Section-5-R2-FINAL-26Jul23.pdf.
    \36\ This is calculated as the difference in GHG emission 
reductions or removals from a baseline scenario, to the emission 
reductions or removals occurring under the carbon mitigation project 
or activity, with any adjustments for leakage. See The Integrity 
Council for the Voluntary Carbon Market Carbon Core Principles, 
Section 5 Definitions, available at: https://icvcm.org/wp-content/uploads/2023/07/CCP-Section-5-R2-FINAL-26Jul23.pdf.
---------------------------------------------------------------------------

    A participant in the voluntary carbon markets may purchase a VCC, 
representing an emissions reduction or removal by another party, to 
supplement emissions reductions or removals achieved from the 
participant's own operations or activities. Liquid and transparent 
markets in high-integrity VCCs may serve as a tool to facilitate 
emissions reduction efforts.\37\
---------------------------------------------------------------------------

    \37\ The Board of the International Organization of Securities 
Commissions (``IOSCO'') published a Voluntary Carbon Markets 
consultation for public comment. The IOSCO consultation paper sought 
feedback on a potential approach that regulatory authorities and 
market participants could take to foster sound and well-functioning 
voluntary carbon market structure and, as a consequence, scale up 
these markets to allow them to achieve their environmental 
objectives. Voluntary Carbon Markets, Discussion Paper, CR/06/22, 
November 2022, available at: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD718.pdf.

---------------------------------------------------------------------------

[[Page 89413]]

    The process by which VCCs are issued deserves careful 
consideration, as that process informs VCC quality and, by extension, 
the overall integrity and effective functioning of voluntary carbon 
markets. Generally, parties that play a role in the issuance of a VCC 
include: (1) the developer of a mitigation project or activity that is 
intended to reduce or remove GHG emissions from the atmosphere 
(``project developer''); (2) a crediting program that, among other 
things, issues VCCs for mitigation projects or activities that satisfy 
the crediting program's standards; \38\ and (3) an independent third 
party that verifies and validates the mitigation project or activity.
---------------------------------------------------------------------------

    \38\ Currently, the four largest crediting programs in the 
voluntary carbon markets are the American Carbon Registry, the 
Climate Action Reserve, the Gold Standard and the Verified Carbon 
Standard.
---------------------------------------------------------------------------

    A project developer must first select the crediting program with 
which it seeks to certify its mitigation project or activity. The 
crediting program will certify the project or activity if it satisfies 
the crediting program's standards for issuing VCCs. A crediting program 
generally engages an independent third party to review project or 
activity documentation, including, among other things, to verify the 
accuracy of the estimated amount of emission reductions or removals 
that are expected to be associated with the project or activity, based 
on the project's or activity's baseline scenario \39\ and the crediting 
program's methodology or protocol for quantifying reduction or removal 
levels. The estimated emission reductions or removals serve as the 
basis for the determination of the number of VCCs to be issued for the 
project or activity.
---------------------------------------------------------------------------

    \39\ A baseline scenario is the predicted or assumed outcome in 
the absence of the incentives created by carbon credits, holding all 
other factors constant.
---------------------------------------------------------------------------

    Once the crediting program determines that the mitigation project 
or activity satisfies the crediting program's standards for issuing 
VCCs, the project or activity will be certified. The crediting program 
typically operates or makes use of a registry, which serves as a 
central repository for tracking certified mitigation projects or 
activities and their associated VCCs. Once registered, VCCs associated 
with a mitigation project or activity may be bought and sold to end 
users (businesses or individuals) or to intermediaries such as brokers 
or aggregators that provide liquidity to voluntary carbon market 
participants.\40\
---------------------------------------------------------------------------

    \40\ Funding by investors for a mitigation project or activity 
could begin as early as the planning stage. Early investors may 
enter into agreements with a project developer for funding in 
exchange for discounted VCCs, once issued.
---------------------------------------------------------------------------

2. Initiatives To Promote Transparency, Integrity and Standardization 
in the Voluntary Carbon Markets
    As the voluntary carbon markets have continued to develop and 
mature, private sector and multilateral initiatives have sought to 
address certain issues--relevant to both the supply side (generation of 
VCCs from carbon mitigation projects or activities), and the demand 
side (businesses or individuals purchasing VCCs)--impacting the speed 
at which transparent, robustly traded markets for high-integrity VCCs 
are scaled.
    On the supply side, a key focus has been on the quality of VCCs, 
particularly, whether they accurately reflect the nature and level of 
GHG emission reductions or removals that they are intended to 
represent. Given the current absence of a standardized methodology or 
protocol to quantify emissions reduction or removal levels, there is a 
possibility that methodologies or protocols of differing degrees of 
robustness may calculate different reduction or removal impacts for two 
projects that are identical in type and size (or even for the same 
project). This could result in different amounts of carbon credits 
being issued for each project, despite their actual reduction or 
removal impact being the same. It may also create incentives for 
project developers to seek to apply the quantification protocol or 
methodology, or to seek to certify with the crediting program, that 
would result in the issuance of the most credits. Among other things, 
these possibilities create challenges for accurately pricing VCCs. 
Further, it can be difficult to discern the extent to which the price 
of any particular VCC reflects the price of one metric ton of carbon 
dioxide equivalent reduced or removed from the atmosphere, and the 
extent to which the price reflects understandings or concerns relating 
to the mitigation project or activity for which the VCC was issued, or 
other aspects of the process for issuing the VCC.\41\
---------------------------------------------------------------------------

    \41\ Factors that may affect the price of VCCs issued for any 
particular mitigation project or activity may include the type of 
the project or activity, the geographic location of the project or 
activity, and the methodology or protocol used to measure the levels 
of emissions reductions or removals associated with the project or 
activity. Types of carbon mitigation projects or activities for 
which VCCs are issued include renewable energy, industrial gas 
capture, energy efficiency, forestry initiatives (avoiding 
deforestation), regenerative agriculture, wind power, and biogas. 
The location of a mitigation project or activity may, for example, 
impact the cost of implementing and/or operating the project or 
activity. Mitigation projects and activities for which VCCs are 
issued are located in countries worldwide. See Berkeley Voluntary 
Registry Offsets Database, available at: https://gspp.berkeley.edu/research-and-impact/centers/cepp/projects/berkeley-carbon-trading-project/offsets-database.
---------------------------------------------------------------------------

    Challenges with respect to accurately ascertaining VCC quality, and 
associated pricing challenges,\42\ can erode confidence in voluntary 
carbon markets. Furthermore, opaque or inadequate calculation 
methodologies or protocols, which can obscure or mischaracterize the 
carbon impact of a mitigation project or activity, can undermine both 
the integrity and purpose of those markets.
---------------------------------------------------------------------------

    \42\ Observed trading of VCCs is not as readily transparent as 
for other financial instruments. Spot markets for VCCs are still 
largely bespoke, with buyers purchasing directly from project 
developers or via intermediaries. Some exchanges for trading VCCs 
have been established and are evolving. For example, the AirCarbon 
Exchange (https://acx.net/acx-singapore/), located in Singapore; 
Carbon Trade Exchange (https://ctxglobal.com/), located in the 
United Kingdom; and Xpansiv CBL (https://xpansiv.com/cbl/), located 
in the United States.
---------------------------------------------------------------------------

    On the demand side, concerns have been raised that, in connection 
with meeting their carbon mitigation goals, businesses or individuals 
may be utilizing low integrity VCCs which do not accurately reflect the 
nature or level of GHG emission reductions or removals that are 
associated with the mitigation projects or activities for which the 
VCCs have been issued.\43\ This can raise questions not only about the 
business's or individual's progress towards their goals, but also about 
whether any claims related to those goals are misleading.\44\ Market 
participants that are purchasing VCCs to help meet their mitigation 
goals may be focused largely or primarily on price, and also may not 
have ready access to all of the information that they need to make 
informed evaluations, and comparisons, of VCC quality. All of this may 
incentivize, intentionally or not, the purchase of lower quality VCCs. 
This may be facilitated by the opaque pricing of VCCs, as described 
above--and by the fact that, recently, supplies of VCCs are generally 
considered to be high relative to demand.\45\
---------------------------------------------------------------------------

    \43\ See, e.g., Forbes, Carbon Neutral Claims Under 
Investigation In Greenwashing Probe (June 16, 2023), available at: 
https://www.forbes.com/sites/amynguyen/2023/06/16/carbon-neutral-claims-under-investigation-in-greenwashing-probe/?sh=2a6170466431.
    \44\ Federal Trade Commission, Guides for the Use of 
Environmental Marketing Claims, Regulatory Review Notice and Request 
for Public Comment, 87 FR 77,766 (December 20, 2022) (Federal Trade 
Commission request for public comment on updating its Green Guides 
to include claims made regarding carbon offsets).
    \45\ Transcript of Commission's Second Voluntary Carbon Markets 
Convening (July 19, 2023), Kyle Harrison, stating, ``Because you 
have an oversupply, you have a surplus of cheaper credits and 
companies can go ahead and use those in many cases as a band-aid 
solution, as opposed to de-carbonizing and reducing their gross 
emissions,'' available at: https://www.cftc.gov/sites/default/files/2023/11/1700165549/SVCMC_transcript071923.pdf.

---------------------------------------------------------------------------

[[Page 89414]]

    Private sector and multilateral efforts have spearheaded the 
development of various initiatives to address the above challenges, and 
to promote transparency, integrity and standardization in the voluntary 
carbon markets. To support and promote VCC quality, these private 
sector and multilateral initiatives have focused on developing 
standards for high-integrity VCCs.\46\ Among other things, these 
standards are intended to help provide assurance that the VCCs that 
have been issued for a carbon mitigation project or activity accurately 
reflect the actual GHG emissions reduction or removal levels associated 
with that project or activity. These standards also generally highlight 
the importance of effective crediting program processes, procedures, 
and governance arrangements, in ensuring that a crediting program is 
issuing high integrity VCCs.
---------------------------------------------------------------------------

    \46\ See, e.g., The Integrity Council for the Voluntary Carbon 
Market's Core Carbon Principles (July 2023), available at: https://icvcm.org/wp-content/uploads/2023/07/CCP-Book-R2-FINAL-26Jul23.pdf; 
the International Civil Aviation Organization's Carbon Offsetting 
and Reduction Scheme for International Aviation (``CORSIA'') (2023), 
available at: https://www.icao.int/environmental-protection/CORSIA/Pages/default.aspx; the G7 Principles of High Integrity Carbon 
Markets (2023), available at: https://www.meti.go.jp/information/g7hirosima/energy/pdf/Annex004.pdf.
---------------------------------------------------------------------------

    Standards that assist market participants in making informed 
evaluations, and comparisons, of VCC quality may promote accurate 
pricing and enhance confidence that the voluntary carbon markets can 
serve as a tool to assist in emissions reduction efforts. Such 
standards can thereby play a valuable role in supporting market 
transparency and liquidity, and the scaling of high-integrity voluntary 
carbon markets.
    Such standards may also support initiatives being developed to 
address concerns about the accuracy of claims made by purchasers of 
VCCs regarding the role that VCCs play in the purchasers' progress 
toward carbon mitigation goals.\47\ Such standards could serve as a 
foundation or reference for criteria that purchasers of VCCs could 
voluntarily adhere to, in order to demonstrate their commitment to 
using high integrity VCCs to support their mitigation goals, and to 
being transparent in their progress towards those goals.
---------------------------------------------------------------------------

    \47\ See, e.g., the World Wildlife Fund (WWF-US), Environmental 
Defense Fund (EDF) and Oeko-Institut's Carbon Credit Quality 
Initiative (https://carboncreditquality.org/); the Tropical Forest 
Credit Integrity Guide for Companies: Differentiating Tropical 
Forest Carbon Credit by Impact, Quality, and Scale (https://tfciguide.org/); and the Voluntary Carbon Markets Integrity 
Initiative's Claims Code of Practice (https://vcmintegrity.org/vcmi-claims-code-of-practice/).
---------------------------------------------------------------------------

C. The Commission and Voluntary Carbon Markets

1. Derivative Contracts on Environmental Commodities, Including VCCs
    Derivative contracts on environmental commodities have been trading 
on CFTC-regulated exchanges for decades. Derivative contracts on 
mandatory emissions program instruments have been trading since 2005, 
with GHG emissions-related instruments first listed in 2007.\48\ There 
are currently over 150 derivative contracts on mandatory emissions 
program instruments listed on DCMs.\49\ As of November 2023, eighteen 
futures contracts on voluntary carbon market products have been 
submitted by DCMs to the Commission for listing.\50\ Three of those 
contracts currently have open interest.\51\
---------------------------------------------------------------------------

    \48\ The Chicago Climate Futures Exchange (``CCFE'') listed a 
Sulfur Financial Instruments Current Vintage Delivery futures 
contract in 2005. In 2006, the New York Mercantile Exchange 
(``NYMEX'') listed a nitrogen oxide (``NOX'') Emissions 
Allowance futures contract. In 2007, CCFE listed the first Carbon 
Financial Instrument futures contract and other emission contracts. 
In 2008, NYMEX listed the first RGGI futures contract. In 2011, 
Green Exchange listed its European Union Allowance futures contract. 
In 2012, NYMEX listed its California Carbon Allowance futures 
contract. To date, there have been over 1,500 mandatory emissions-
related futures and options contracts listed for trading on various 
DCMs. The vast majority of those contracts are no longer listed for 
trading.
    \49\ Examples of derivatives contracts on mandatory emissions 
program instruments, such as renewable energy credits (``RECs'') and 
renewable fuel standards (``RFS''), that currently have open 
interest include: the ICE Futures U.S. (``ICE U.S.'') PJM Tri 
Qualified Renewable Energy Certificate Class I futures contract; the 
ICE U.S. Texas Compliance Renewable Energy Certificate from CRS 
Listed Facilities Front Half Specific futures contract; the ICE U.S. 
New Jersey Compliance Renewable Energy Certificate Class II futures 
contract; the Chicago Mercantile Exchange (``CME'') Ethanol T2 FOB 
Rotterdam Including Duty (Platts) futures contract; the ICE U.S. 
Biofuel Outright--D4 RINS (OPIS) futures contract; the ICE U.S. RGGI 
Vintage 2024 futures contract; and the ICE U.S. California Carbon 
Allowance Current Auction futures contract.
    \50\ For example, NYMEX lists the following physically-settled 
futures contracts based on voluntary carbon market products: (1) CBL 
Global Emissions Offset (GEO) futures contract; (2) CBL Nature-Based 
Global Emissions Offset (N-GEO) futures contract; (3) CBL Core 
Global Emissions Offset (C-GEO) futures contract; (4) CBL Nature-
Based Global Emissions Offset Trailing futures contract; and (5) CBL 
Core Global Emissions Offset Trailing futures contract. Nodal 
Exchange lists the following physically-settled futures and options 
contracts based on voluntary carbon market products: (1) Verified 
Emission Reduction--Nature-Based Vintage 2017 futures and options 
contracts; (2) Verified Emission Reduction--Nature-Based Vintage 
2018 futures and options contracts; (3) Verified Emission 
Reduction--Nature-Based Vintage 2019 futures and options contracts; 
(4) Verified Emission Reduction--Nature-Based Vintage 2020 futures 
and options contracts; (5) Verified Emission Reduction--Nature-Based 
Vintage 2021 futures and options contracts; (6) Verified Emission 
Reduction--Nature-Based Vintage 2022 futures and options contracts; 
(7) Verified Emission Reduction--Nature-Based Vintage 2023 futures 
contract; (8) Verified Emission Reduction--Nature-Based Vintage 2024 
futures contract; (9) Verified Emission Reduction--Nature-Based 
Vintage 2025 futures contract; (10) Verified Emission Reduction--
Nature-Based futures and options contracts; (11) Carbon Removal 
futures contract; (12) Verified Emission Reduction--CORSIA-Eligible 
futures and options contracts; and 13) Global Emission Reduction 
futures contract.
    \51\ The NYMEX CBL Global Emissions Offset (GEO) futures 
contract; the NYMEX CBL Nature-Based Global Emissions Offset (N-GEO) 
futures contract; and the NYMEX CBL Core Global Emission Offset (C-
GEO) futures contract are currently the only listed futures contacts 
with open interest and trading volume. Information is available at: 
https://www.cmegroup.com/markets/energy/emissions/cbl-global-emissions-offset.volume.html.
---------------------------------------------------------------------------

    Derivative contracts on VCCs base their prices on the spot price of 
VCCs. For example, NYMEX's CBL Global Environmental Offset futures 
contracts, and Nodal Exchange's Verified Emission Reduction futures and 
options contracts, are physically-settled contracts. If the holder of a 
position in the contract still has an open position at the expiration 
of trading in the contract, then the position holder must, in 
accordance with the rules for delivery set forth in the contract, make 
or take delivery (as applicable) of 1,000 VCCs that meet the contract's 
rules for delivery eligibility.\52\
---------------------------------------------------------------------------

    \52\ The CME Group CBL contracts permit VCCs to be delivered 
from the Verified Carbon Standard (``VCS'') Verra Registry, the 
American Carbon Registry (``ACR''), and the Climate Action Reserve 
(``CAR''). The Nodal contracts permit VCCs to be delivered from 
VCS's Verra Registry and from the Gold Standard Impact Registry, as 
well as from the American Carbon Registry for certain contracts.
---------------------------------------------------------------------------

2. Initiatives Relating to Voluntary Carbon Markets
First Voluntary Carbon Markets Convening
    In June 2022, Chairman Behnam held the first-ever Voluntary Carbon 
Markets Convening to discuss issues related to the supply of and demand 
for high quality carbon credits, including product standardization and 
the data necessary to support the integrity of carbon credits' GHG 
emissions removal and reduction claims.\53\ A further goal of this 
convening was to gather information from a wide variety of

[[Page 89415]]

market participants in the voluntary carbon markets to better 
understand the potential role of the official sector in these markets, 
particularly in connection with the emergence of CFTC-regulated 
derivatives referencing VCCs. The convening included participants from 
carbon credit standard setting bodies, a crediting program, private 
sector integrity initiatives, spot platforms, DCMs, intermediaries, 
end-users, public interest groups, and others.
---------------------------------------------------------------------------

    \53\ For the official announcement of the convening and related 
materials, See https://www.cftc.gov/PressRoom/Events/opaeventcftccarbonmarketconvene060222.
---------------------------------------------------------------------------

Commission Request for Information
    In June 2022, the Commission issued for public comment a Request 
for Information (``RFI'') \54\ in order to better inform the Commission 
on how, consistent with its statutory authority, to address climate-
related financial risk as pertinent to the derivatives markets and 
underlying commodities markets.\55\
---------------------------------------------------------------------------

    \54\ Request for Information on Climate-Related Financial Risk, 
87 FR 34856 (June 8, 2022).
    \55\ In addition to soliciting feedback on all aspects of 
climate-related financial risk as it may pertain to the derivatives 
market, the RFI also specifically requested feedback on ten 
categories of information: 1. Data, 2. Scenario Analysis and Stress 
Testing, 3. Risk Management, 4. Disclosure, 5. Product Innovation, 
6. Voluntary Carbon Markets, 7. Digital Assets, 8. Financially 
Vulnerable Communities, 9. Public-Private Partnerships/Engagement, 
and 10. Capacity Coordination. The RFI stated that the Commission 
may use responsive information to inform potential future actions 
including, but not limited to, the issuance of new or amended 
guidance, interpretations, policy statements, or regulations, or 
other potential Commission action.
---------------------------------------------------------------------------

    The responsive comments that the Commission received included 
feedback on specific questions relating to product innovation and 
voluntary carbon markets.\56\ Several commenters expressed support for 
the Commission to take steps that could support transparency and 
confidence in the voluntary carbon markets, particularly through 
recognition or support of private sector and multilateral initiatives 
to promote standardization and integrity.\57\ In connection with 
product innovation, certain commenters expressed the view that the 
Commission's current statutory framework and regulations are sufficient 
to regulate voluntary carbon market derivatives products.\58\ While 
there were comments expressing different views on the reach of the 
Commissions' jurisdiction to regulate voluntary carbon markets,\59\ 
many commenters supported the Commission utilizing its spot market 
anti-fraud and anti-manipulation authority in the voluntary carbon 
market space.\60\
---------------------------------------------------------------------------

    \56\ Twenty-five commenters on the RFI responded to questions 
regarding product innovation and 44 commenters on the RFI responded 
to questions regarding the voluntary carbon markets.
    \57\ International Swaps and Derivatives Association (``ISDA'') 
at 6; American Petroleum Institute (``API'') at 4; Center for 
American Progress at 10; Environmental Defense Fund at 12; Futures 
Industry Association (``FIA'') at 9; Intercontinental Exchange, Inc. 
(``ICE'') at 4.
    \58\ CME Group at 10, FIA at 3; ISDA at 7.
    \59\ Heritage Foundation at 7.
    \60\ See, e.g., API at 3; ISDA at 6; Verra at 2. With respect to 
the Commission's spot market anti-fraud, false-reporting, and anti-
manipulation authority, see, e.g., CEA section 6(c)(1), 7 U.S.C. 
9(1), which prohibits any person from using or employing, or 
attempting to use or employ, in connection with a contract for sale 
of any commodity in interstate commerce, any manipulative or 
deceptive device or contrivance, in contravention of rules and 
regulations promulgated by the Commission; CEA section 9(a)(2), 7 
U.S.C. 13(a)(2), which among other things makes it a felony for any 
person to manipulate or attempt to manipulate the price of any 
commodity in interstate commerce; and implementing Commission rules 
at Part 180 of the CFTC's regulations, 17 CFR part 180. In June 
2023, the CFTC's Whistleblower Office issued an alert notifying the 
public on how to identify and report potential CEA violations 
connected to fraud or manipulation in the carbon markets. See CFTC 
Whistleblower Alert, available at: https://www.whistleblower.gov/sites/whistleblower/files/2023-06/06.20.23%20Carbon%20Markets%20WBO%20Alert.pdf. Also in June 2023, 
the CFTC's Division of Enforcement announced the creation of an 
Environmental Fraud Task Force to combat environmental fraud and 
misconduct. Specifically, the Task Force's mission is to address 
fraud and other misconduct in both the derivatives markets and the 
relevant spot markets (e.g., voluntary carbon markets) and to 
examine, among other things, fraud with respect to the purported 
environmental benefits of purchased carbon credits. See CFTC Release 
Number 8736-23 (``CFTC Division of Enforcement Creates Two New Task 
Forces'') available at: https://www.cftc.gov/PressRoom/PressReleases/8736-23.
---------------------------------------------------------------------------

Second Voluntary Carbon Markets Convening
    In July 2023, Chairman Behnam held the Second Voluntary Carbon 
Markets Convening. The purpose of this convening was to discuss recent 
private sector initiatives for high quality carbon credits; current 
trends and developments in the cash and derivatives markets for carbon 
credits; public sector initiatives related to carbon markets; and 
market participants' perspectives on how the CFTC can promote integrity 
for high quality carbon credit derivatives.\61\
---------------------------------------------------------------------------

    \61\ For the official announcement of the convening and related 
materials, see https://www.cftc.gov/PressRoom/Events/opaeventvoluntarycarbonmarkets071923.
---------------------------------------------------------------------------

II. Guidance Regarding the Listing of VCC Derivative Contracts

    The Commission is proposing guidance that outlines factors that 
DCMs should consider when addressing certain requirements under the CEA 
and CFTC regulations that are relevant to the listing for trading of 
VCC derivative contracts. The Commission recognizes that VCC 
derivatives are a comparatively new and evolving class of products,\62\ 
and believes that guidance that outlines factors for a DCM to consider 
in connection with product design and listing may help to advance the 
standardization of such products in a manner that promotes transparency 
and liquidity.
---------------------------------------------------------------------------

    \62\ In 2022, ISDA published a whitepaper providing background 
on the cash and derivatives markets for voluntary carbon credits. 
See Voluntary Carbon Markets: Analysis of Regulatory Oversight in 
the US. (2022), available at: https://www.isda.org/2022/06/02/voluntary-carbon-markets-analysis-of-regulatory-oversight-in-the-us/.
---------------------------------------------------------------------------

    This proposed guidance addresses certain Core Principle compliance 
considerations, as well as certain requirements relating to the 
submission of new contracts, and contract amendments, to the 
Commission. This proposed guidance is not intended to modify or 
supersede existing statutory or regulatory requirements, or existing 
Commission guidance that addresses the listing of derivative products 
by CFTC-regulated exchanges, including the Appendix C Guidance. Rather, 
taking into account certain unique attributes of VCC derivatives and 
voluntary carbon markets, this proposed guidance outlines particular 
matters that a DCM should consider, to help ensure compliance with 
existing requirements when listing a VCC derivative contract. Among 
other things, this proposed guidance addresses how certain aspects of 
the Appendix C Guidance should be understood to apply in the specific 
context of VCC derivative contracts.
    This proposed guidance focuses primarily on the listing by DCMs of 
physically-settled VCC derivative contracts. In part, this focus 
reflects the fact that all VCC derivative contracts that are currently 
listed for trading on DCMs are physically-settled contracts. To date, 
no DCM has listed for trading a cash-settled VCC derivative contract. 
In addition, the Commission believes that at this juncture in the 
evolution of VCC derivatives as a product class, it may be of 
particular benefit to outline considerations for a DCM, when developing 
contract terms and conditions, that can help to ensure that, upon 
delivery, the quality and other attributes of the underlying VCC will 
be as expected by position holders. This will support accurate pricing, 
help reduce the susceptibility of the contract to manipulation, and 
foster confidence in the contract that can enhance liquidity.
    While this proposed guidance focuses primarily on physically-
settled VCC derivative contracts, the Commission continues to believe 
that, with respect to cash-settled derivative contracts, an acceptable 
specification of the cash

[[Page 89416]]

settlement price would include rules that fully describe the essential 
economic characteristics of the underlying commodity.\63\ Accordingly, 
the Commission preliminarily believes that discussions in this proposed 
guidance of VCC commodity characteristics that a DCM should consider 
when developing the terms and conditions of a physically-settled VCC 
derivative contract, should also be considered for cash-settled 
derivative contracts that settle to the price of a VCC, unless 
otherwise noted.\64\
---------------------------------------------------------------------------

    \63\ Appendix C Guidance, paragraph (c)(1).
    \64\ As noted herein, and for the avoidance of doubt, this 
proposed guidance is not intended to modify or supersede the 
Appendix C Guidance, which outlines considerations for both cash-
settled and physically-settled derivative contracts--including 
considerations that are not touched on in this proposed guidance. 
DCMs are reminded to consult and consider the Appendix C Guidance 
when developing terms and conditions, and contract submissions to 
the Commission, for all derivative product types--including VCC 
derivative products.
---------------------------------------------------------------------------

    Further, while this proposed guidance focuses on the listing of VCC 
derivative contracts by DCMs, the Commission preliminarily believes 
that the proposed guidance also should be considered by any SEF that 
may seek to permit trading in swap contracts that settle to the price 
of a VCC, or in physically-settled VCC swap contracts.\65\
---------------------------------------------------------------------------

    \65\ As noted above, the Appendix C Guidance is also relevant to 
SEFs, which, like DCMs, are obligated by statute only to permit 
trading in contracts that are not readily susceptible to 
manipulation. CEA section 5h(f)(3), 7 U.S.C.3 7b-3(f)(3). Like DCMs, 
SEFs also are subject to a statutory obligation to monitor trading 
in swaps to prevent manipulation, price distortion, and disruptions 
of the delivery or cash settlement process through surveillance, 
compliance, and disciplinary practices and procedures. CEA section 
5h(f)(4) 7 U.S.C 7b-3(f)(4). See also 17 CFR 37.400-408.
---------------------------------------------------------------------------

    In developing this proposed guidance, the Commission has considered 
those public comments on the RFI that addressed product innovation and 
voluntary carbon markets. Taking into account those public comments, 
the Commission believes that this proposed guidance furthers the 
agency's mission and may help to advance the standardization of VCC 
derivative contracts in a manner that fosters transparency and 
liquidity, accurate pricing, and market integrity.\66\
---------------------------------------------------------------------------

    \66\ See also, e.g., International Emissions Trading Association 
comment in response to the Second Voluntary Carbon Markets Convening 
at 5-6 (stating that the CFTC is in a fortunate position to leverage 
the evolving work of existing initiatives to support the drive for 
quality and integrity in the voluntary carbon markets), and BP 
America, Inc. comment in response to the Second Voluntary Carbon 
Markets Convening at 3 (supporting guidance for CFTC regulated 
exchanges.)
---------------------------------------------------------------------------

    The Commission recognizes that VCCs and voluntary carbon markets 
are evolving and that it may therefore be appropriate for the 
Commission to revisit this guidance or to issue additional guidance in 
the future,\67\ as VCCs and voluntary carbon markets continue to 
develop and mature.\68\
---------------------------------------------------------------------------

    \67\ For example, the Commission may in the future revisit this 
guidance, or issue additional guidance, to further address the 
listing of cash-settled VCC derivatives contracts, including index-
based contracts, or to further address the listing of VCC derivative 
contracts by SEFs.
    \68\ For the avoidance of doubt, this proposed guidance does not 
address the regulatory treatment of any underlying VCC or associated 
offset project or activity, including whether any such product, 
project or activity may qualify as a swap or be eligible for the 
forward contract exclusion under Commission's ``swaps'' definition. 
See Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap 
Agreement Recordkeeping; Final Rule, 77 FR 48208 (August 13, 2012).
---------------------------------------------------------------------------

A. A DCM Shall Only List Derivative Contracts That Are Not Readily 
Susceptible to Manipulation

    As discussed above, DCM Core Principle 3 provides that a DCM shall 
only list for trading derivative contracts that are not readily 
susceptible to manipulation.\69\ With respect to DCM Core Principle 3, 
the Appendix C Guidance outlines certain relevant considerations for a 
DCM when developing contract terms and conditions and providing 
supporting documentation and data in connection with the submission of 
a contract to the Commission.\70\
---------------------------------------------------------------------------

    \69\ CEA section 5(d)(3), 7 U.S.C. 7(d)(3).
    \70\ As noted above, the Appendix C Guidance is also relevant to 
SEFs, which are similarly obligated by statute only to permit 
trading in contracts that are not readily susceptible to 
manipulation. CEA section 5h(f)(3); 7 U.S.C. 7b-3(f)(3).
---------------------------------------------------------------------------

    With respect to a physically-settled derivative contract, the 
Appendix C Guidance states that the terms and conditions of the 
contract ``should describe or define all of the economically 
significant characteristics or attributes of the commodity underlying 
the contract.'' \71\ Among other things, failure to specify the 
economically significant attributes of the underlying commodity may 
cause confusion among market participants, who may expect a commodity 
of different quality, or with other features, to underlie the contract. 
This may render the precise nature of the commodity that the contract 
is pricing ambiguous, and make the contract susceptible to manipulation 
or price distortion.
---------------------------------------------------------------------------

    \71\ Appendix C Guidance, paragraph (b)(2)(i)(A).
---------------------------------------------------------------------------

    The Appendix C Guidance states that, for any particular contract, 
the specific attributes of the underlying commodity that should be 
described or defined in the contract's terms and conditions ``depend 
upon the individual characteristics of the commodity.'' \72\ Where the 
underlying commodity is a VCC, the Commission recognizes that 
standardization and accountability mechanisms for VCCs are currently 
still developing. The Commission believes that the fact that 
standardization and accountability mechanisms for VCCs are currently 
still developing is, itself, an ``individual characteristic of the 
commodity'' that should be taken into account by a DCM when designing a 
VCC derivative contract and addressing the underlying commodity in the 
contract's terms and conditions.
---------------------------------------------------------------------------

    \72\ Id.
---------------------------------------------------------------------------

    To that end, the Commission recognizes that, while standardization 
and accountability mechanisms for VCCs are currently still being 
developed, there are certain characteristics that have been identified 
broadly--across both mandatory and voluntary carbon markets--as helping 
to inform the integrity of carbon credits. The Commission preliminarily 
believes that a DCM should take these characteristics--referred to in 
this proposed guidance as ``VCC commodity characteristics,'' and 
discussed more fully below--into consideration when designing a VCC 
derivative contract, and addressing in the contract's terms and 
conditions the underlying VCC. The Commission believes that 
consideration of these VCC commodity characteristics will help the DCM 
to ensure that it understands, and is clearly specifying in the 
contract's terms and conditions, the economically significant 
attributes of the underlying VCC.
    As a general matter, the Commission believes that a DCM should 
consider the VCC commodity characteristics when selecting one or more 
crediting programs from which eligible VCCs, meeting the derivative 
contract's specifications, may be delivered at the contract's 
expiration. The Commission believes that this will help the DCM 
evaluate whether the crediting program is a reliable source of high 
integrity VCCs.
    More specifically, the Commission preliminarily believes that, at a 
minimum, a DCM should consider the VCC commodity characteristics when 
addressing the following criteria in the design of a VCC derivative 
contract:
     Quality standards,
     Delivery points and facilities, and
     Inspection provisions.
    These are among the criteria identified in the Appendix C Guidance 
as criteria that should be addressed in the terms and conditions of a 
physically-delivered derivative contract.

[[Page 89417]]

As discussed above, addressing these criteria clearly in the contract's 
terms and conditions helps to ensure that trading in the contract is 
based on accurate information about the underlying commodity. This, in 
turn, helps to promote accurate pricing and helps to reduce the 
susceptibility of the contract to manipulation.
1. Quality Standards
    The Commission preliminarily believes that a DCM should consider 
the following VCC commodity characteristics when addressing quality 
standards in the development of the terms and conditions of a VCC 
derivative contract: (i) transparency, (ii) additionality, (iii) 
permanence and risk of reversal, and (iv) robust quantification.\73\
---------------------------------------------------------------------------

    \73\ As is the case for physically-settled VCC derivative 
contracts, for cash-settled derivative contracts that settle to the 
price of a VCC, it is important to clearly specify the VCC quality 
standards in the contract's terms and conditions to help ensure that 
the pricing of the contract reflects the quality of the VCC 
underlying the contract.
---------------------------------------------------------------------------

a. Transparency--Publicly Available Data to Promote Transparency
    As a threshold matter, the Commission believes that a DCM should 
provide, in the terms and conditions of a VCC derivative contract, 
information about the VCCs that are eligible for delivery under the 
contract. The contract terms and conditions should include information 
that readily specifies the crediting program or programs--and, as 
applicable, the specific types of projects or activities--from which 
VCCs that are eligible for delivery under the contract may be issued. 
Specifying which crediting programs, and as applicable, which types of 
projects or activities, are eligible for purposes of delivery will help 
to provide clarity to market participants regarding the VCCs that can 
be expected to deliver under the contract, and will thereby help to 
ensure that the pricing of the contract accurately reflects the 
intended quality of the underlying VCCs. Where there is ambiguity or 
confusion about the quality of the VCCs that may be delivered under the 
contract, this may render the contract susceptible to manipulation or 
price distortion.
    The Commission preliminarily believes that, in developing the terms 
and conditions of a VCC derivative contract, DCMs should also consider 
whether the crediting program for the underlying VCCs is making 
detailed information about the crediting program's policies and 
procedures and the projects or activities that it credits, such as 
relevant project documentation, publicly available in a searchable and 
comparable manner. Making such information publicly available would 
assist market participants in understanding how GHG emission reductions 
or removals are calculated by the crediting program--including how 
additionality, which is discussed further below, is assessed--and how 
GHG emission reductions or removals are quantified. This would assist 
market participants in making informed evaluations, and comparisons, of 
the quality of the VCCs that underlie derivative contracts, which would 
help to support accurate pricing. Accordingly, information regarding 
the crediting program's policies and procedures for making program 
information publicly available may constitute an economically 
significant attribute of the underlying VCC that should be described or 
defined in the terms and conditions of the VCC derivative contract.
b. Additionality--The Underlying VCC Represents GHG Emission Reductions 
or Removals That Would Not Have Been Developed and Implemented in the 
Absence of the Added Monetary Incentive Created by the Revenue From the 
Sale of Carbon Credits
    The Commission preliminarily believes that, in developing the terms 
and conditions of a VCC derivative contract, a DCM should consider 
whether the underlying VCCs represent GHG emission reductions or 
removals that are ``additional''--in other words, whether the VCCs are 
credited only for projects or activities that result in GHG emission 
reductions or removals that would not have been developed and 
implemented in the absence of the added monetary incentive created by 
the revenue from the sale of carbon credits.\74\ Additionality is 
viewed by many as a necessary element of a high quality VCC: if a VCC 
does not represent emission reductions or removals that would not have 
occurred in the absence of the added monetary incentive created by the 
revenue from the sale of carbon credits, then the VCC will not serve a 
market participant's goals of contributing to emissions mitigation.
---------------------------------------------------------------------------

    \74\ For example, a project or activity may not be considered to 
be ``additional'' if the project or activity is already required by 
law, regulation, or any other legally binding mandate applicable in 
the project's or activity's jurisdiction.
---------------------------------------------------------------------------

    Accordingly, as part of its contract design market research, a DCM 
should consider whether a crediting program can demonstrate that it has 
procedures in place to assess or test for additionality. A DCM should 
consider whether those procedures are sufficiently rigorous and 
reliable to provide a reasonable assurance that GHG emission reductions 
or removals are credited only if they are additional. If holders of 
positions in a VCC derivative contract understand and intend for VCCs 
that are eligible for delivery under the contract to be additional, but 
in fact they may not be, then the pricing of the contract may not 
accurately reflect the quality of the VCCs that may be delivered under 
the contract: the cheapest-to-deliver VCC,\75\ that otherwise meets the 
contract's specifications, may not have additionality.
---------------------------------------------------------------------------

    \75\ The term ``cheapest-to-deliver'' refers to the least 
expensive commodity that can be delivered under the derivative 
contract that otherwise meets the contract's specifications.
---------------------------------------------------------------------------

    Given that additionality is viewed by many as a necessary element 
of a high quality VCC, information regarding a crediting program's 
procedures for assessing or testing for additionality may constitute an 
economically significant attribute of the underlying VCCs, which should 
be described or defined in the terms and conditions of a VCC derivative 
contract.
c. Permanence and Accounting for the Risk of Reversal
    The Commission preliminarily believes that, in developing the terms 
and conditions of a VCC derivative contract, a DCM should consider 
whether the crediting program for the underlying VCCs can demonstrate 
that it has measures in place to address and account for the risk of 
reversal (i.e., the risk that VCCs issued for a project or activity may 
have to be recalled or cancelled due to carbon removed by the project 
or activity being released back into the atmosphere, or due to a 
reevaluation of the amount of carbon reduced or removed from the 
atmosphere by the project or activity). Understanding and evaluating 
the measures that a crediting program has in place to address and 
account for the risk of reversal may be particularly important where 
the underlying VCCs are issued for project or activity types with a 
higher reversal risk.
    The risk of reversal may impact the risk management needs of VCC 
derivative market participants. Market participants that are utilizing 
physically-settled VCC derivative contracts to help meet their carbon 
mitigation goals have an interest in ensuring that, upon physical 
settlement, the underlying VCCs will actually reduce or remove the 
amount of emissions that they were intended to

[[Page 89418]]

reduce or remove. Accordingly, the risk of reversal--and the manner in 
which it is accounted for by a crediting program--is tied to the 
quality of the underlying VCCs and, by extension, to the pricing of the 
derivative contract. As a result, information regarding a crediting 
program's measures for estimating, monitoring, and addressing the risk 
of reversal may constitute an economically significant attribute of the 
underlying VCCs that should be described or defined in the terms and 
conditions of a VCC derivative contract.
    As part of its contract design market research, the Commission 
preliminarily believes that a DCM should consider whether the crediting 
program for a VCC has measures in place that provide reasonable 
assurance that, in the event of a reversal, the VCC will be replaced by 
a VCC of comparably high quality that meets the contemplated 
specifications of the contract. Most crediting programs have 
established VCC ``buffer reserves'' to address the risk of credited GHG 
emission reductions or removals being reversed. Under this approach, 
VCCs are set aside into a common buffer reserve (or ``pool''). Reserved 
VCCs can be drawn upon to compensate for reversals associated with a 
project or activity. If a reversal occurs, VCCs are drawn upon from the 
buffer reserve to replace VCCs that are canceled, proportional to the 
size of the reversal.
    A DCM should consider whether a crediting program has a buffer 
reserve or other measures in place that provide reasonable assurance 
that, in the event of a reversal, the VCCs intended to underlie the 
derivative contract would be replaced by VCCs of comparable high 
quality that meets the contemplated specifications of the contract. The 
DCM could also consider whether the crediting program regularly reviews 
the methodology by which the size of its buffer pool is calculated in 
order to address evolving climate risks that may heighten the risk of 
reversal, and whether there is a mechanism in place to audit the 
continuing sufficiency of the buffer pool.
d. Robust Quantification--GHG Emission Reductions or Removals Should be 
Conservatively Quantified
    The Commission preliminarily believes that, as part of its contract 
design market research, a DCM should consider the methodology or 
protocol used by a crediting program to calculate the level of GHG 
emission reductions or removals associated with credited projects or 
activities. Given the current absence of a standardized methodology or 
protocol to quantify GHG emission reduction or removal levels \76\--not 
only across crediting programs, but even by a particular crediting 
program, with respect to different types of projects or activities--the 
Commission believes that a DCM that lists a VCC derivative contract 
should consider whether the crediting program for the underlying VCCs 
can demonstrate that the quantification methodology or protocol that it 
uses to calculate emission reductions or removals for the underlying 
VCCs is robust, conservative, and transparent. A robust, conservative, 
and transparent quantification methodology or protocol helps to ensure 
that the number of VCCs that are issued for a project or activity 
accurately reflects the level of GHG emission reductions or removals 
associated with the project or activity. Accordingly, information about 
the quantification methodology or protocol used by the crediting 
program to calculate GHG emission reductions or removals for projects 
or activities associated with the underlying VCCs may constitute an 
economically significant attribute of the underlying VCCs that should 
be described or defined in the terms and conditions of a VCC derivative 
contract.
---------------------------------------------------------------------------

    \76\ Related specifically to the agriculture and forest sector, 
the U.S. Department of Agriculture's Office of the Chief Economist 
has published a Request for Information on the Federal Strategy to 
Advance Measurement and Monitoring Greenhouse Gas Measurement and 
Monitoring for the Agriculture and Forest Sectors. This Request for 
Information was issued on behalf of the Administration's Greenhouse 
Gas Monitoring and Measurement Interagency Working Group (``GHG 
IWG''). See, 88 FR 44251 (July 12, 2023).
---------------------------------------------------------------------------

    For the derivative contracts that they list, DCMs are required to 
adopt, as is necessary and appropriate, exchange-set position limits 
for speculators.\77\ To establish exchange-set position limits, a DCM 
should derive a quantitative estimate of the deliverable supplies of 
the underlying commodity for the delivery period specified in the 
contract.\78\ A DCM's estimate of a VCC's deliverable supplies is 
likely to be informed by understanding how the relevant crediting 
program determines the amount of VCCs that are issued for credited 
projects or activities. Where the quantification methodology or 
protocol used to calculate the amount of VCCs is robust, conservative, 
and transparent, the DCM should have a more reliable basis from which 
to form its deliverable supply estimate. That deliverable supply 
estimate, in turn, can be used as the basis for effectively setting the 
DCM's exchange-set speculative position limits to help reduce the 
possibility of corners or squeezes that may distort or manipulate the 
price of the derivative contract.\79\
---------------------------------------------------------------------------

    \77\ CEA section 5(d)(5), 7 U.S.C. 7(d)(5). See also 17 CFR 
38.300-301.
    \78\ Guidance on estimating deliverable supply can be found in 
the Appendix C Guidance.
    \79\ For a cash-settled VCC derivative contract, a DCM may 
similarly consider the deliverable supply of the underlying VCCs 
when setting exchange-set speculative position limits or historical 
open interest when establishing non-spot month position 
accountability levels. See, 17 CFR 150.5 and Appendix F to Part 150, 
Title 17.
---------------------------------------------------------------------------

2. Delivery Points and Facilities
    The Appendix C Guidance states that the delivery procedures for a 
physically-settled derivative contract should, among other things, seek 
to minimize or eliminate any impediments to making or taking delivery 
by both deliverers and takers of delivery, to help ensure convergence 
of cash and derivative contract prices at the expiration of the 
derivative contract.\80\ When addressing delivery procedures for a 
physically-settled VCC derivative contract, the Commission 
preliminarily believes that a DCM should consider the governance 
framework and tracking mechanisms of the crediting program for the 
underlying VCCs, as well as the crediting program's measures to prevent 
double-counting.\81\
---------------------------------------------------------------------------

    \80\ Appendix C Guidance, paragraph (b)(2)(i)(B).
    \81\ While cash-settled VCC derivative contracts do not result 
in the delivery of a VCC, the Commission preliminarily believes that 
considering the VCC commodity characteristics of governance, 
tracking and no double-counting when developing the terms and 
conditions of a cash-settled VCC derivative contract will help to 
ensure that the contract terms and conditions address essential 
economic characteristics of the underlying VCC in a manner that 
promotes accurate pricing and helps to reduce the susceptibility of 
the contract to manipulation.
---------------------------------------------------------------------------

a. Governance
    The Commission preliminarily believes that a DCM should consider 
whether the crediting program for the underlying VCCs can demonstrate 
that it has a governance framework that effectively supports the 
crediting program's independence, transparency and accountability. As a 
threshold matter, a governance framework that effectively supports 
transparency and accountability helps to ensure the overall quality of 
the VCCs issued by a crediting program. Furthermore, it is the 
Commission's understanding that a crediting program's registry may be 
used as a delivery point to facilitate physical settlement for a VCC 
derivative contract. As discussed above, a registry is a repository for 
tracking mitigation projects or activities and associated VCCs. An 
effective crediting program governance framework can help to ensure 
that the crediting program operates or makes use of a registry that has 
appropriate measures in place to

[[Page 89419]]

facilitate the physical settlement of a VCC derivative contract.
    In reviewing a crediting program's governance framework, the 
Commission preliminarily believes that a DCM should consider, among 
other things, the program's decision-making procedures, including who 
is responsible for administration of the program and how the 
independence of key functions is ensured; reporting and disclosure 
procedures; public and stakeholder engagement processes; and risk 
management policies, such as financial resources/reserves, cyber-
security, and anti-money laundering policies. The DCM also should 
consider whether information regarding these procedures and policies is 
made publicly available.
    Given the importance of a crediting program's governance framework 
in ensuring the overall quality of the VCCs issued by the program, as 
well as the potential importance of a crediting program's registry in 
facilitating delivery, it may be appropriate for the DCM to include 
information about the crediting program's governance framework in the 
terms and conditions of a physically-settled VCC derivative contract.
b. Tracking
    The Commission preliminarily believes that a DCM should consider 
whether the crediting program for the underlying VCCs can demonstrate 
that it has processes and procedures in place to help ensure clarity 
and certainty with respect to the issuance, transfer, and retirement of 
VCCs. The DCM should consider whether the crediting program operates or 
makes use of a registry that has measures in place to effectively track 
the issuance, transfer, and retirement of VCCs; to identify who owns or 
retires a VCC; and to make sure that each VCC is uniquely and securely 
identified and associated with a single emission reduction or removal 
of one metric ton of carbon dioxide equivalent. In circumstances where 
the registry will serve as the delivery point for a physically-settled 
VCC derivative contract, it may be appropriate for the DCM to include 
as a condition of the contract that the registry have such measures to 
address tracking in place, as well as effective measures to address 
double-counting, as discussed below.
c. No Double Counting
    The Commission preliminarily believes that a DCM should consider 
whether the crediting program for the underlying VCCs can demonstrate 
that it has effective measures in place that provide reasonable 
assurance that credited emission reductions or removals are not double 
counted. That is, that the VCCs representing the credited emission 
reductions or removals are issued to only one registry and cannot be 
used after retirement or cancelation. As discussed above in connection 
with the VCC commodity characteristics of additionality and permanence, 
market participants that are utilizing physically-settled VCC 
derivative contracts to help meet carbon mitigation goals have an 
interest in ensuring that, upon physical settlement, the underlying 
VCCs will actually reduce or remove the emissions that they were 
intended to reduce or remove. In order for VCCs to effectively further 
carbon mitigation goals, it is important for each credited VCC to be 
uniquely associated with a single emission reduction or removal of one 
metric ton of carbon dioxide equivalent--and a crediting program should 
have effective measures in place that provide reasonable assurance of 
this. If there is not a reasonable assurance that the VCCs underlying a 
derivative contract are each unique, then, among other things, this 
could distort or obscure the accuracy of the derivative contract's 
pricing.
    In the context of evolving national and international carbon 
markets and emissions trading frameworks, effective measures to ensure 
that emission reductions or removals are not double counted may 
include, among other things, procedures for conducting cross-checks 
across multiple carbon credit registries.
3. Inspection Provisions--Third-Party Validation and Verification
    Consistent with the Appendix C Guidance, the Commission believes 
that any inspection or certification procedures for verifying 
compliance with quality requirements or any other related delivery 
requirements for physically-settled VCC derivatives contracts should be 
specified in the contract's terms and conditions.\82\ The Commission 
believes that these inspection or certification procedures should be 
consistent with the latest procedures in the voluntary carbon markets. 
To that end, the Commission preliminarily believes that the DCM should 
consider, among other things, how the crediting program for the 
underlying VCCs requires validation and verification that credited 
mitigation projects or activities meet the crediting program's rules 
and standards.
---------------------------------------------------------------------------

    \82\ Appendix C Guidance, paragraph (b)(2)(i)(G) (To the extent 
that formal inspection procedures are not used in the cash market, 
an acceptable specification would contain provisions that assure 
accuracy in assessing the commodity, that are available at a low 
cost, that do not pose an obstacle to delivery on the contract and 
that are performed by reputable, disinterested third-party or by 
qualified designated contract market employees.).
---------------------------------------------------------------------------

    The Commission preliminarily believes that, when designing a VCC 
derivative contract, a DCM should consider whether the crediting 
program has up-to-date, robust and transparent validation and 
verification procedures, including whether those procedures contemplate 
validation and verification by a reputable, disinterested party or 
body. By providing independent confirmation that mitigation projects or 
activities are achieving the claimed GHG emission reductions or 
removals, third-party validation and verification can help to ensure 
that the underlying VCC accurately reflects the quality intended by the 
DCM and supports voluntary carbon market integrity.\83\
---------------------------------------------------------------------------

    \83\ Id.
---------------------------------------------------------------------------

    A DCM should consider whether the crediting program is employing 
best practices with respect to third-party validation and verification, 
which may include conducting reviews of the performance of validators, 
procedures for remediating performance issues, not using the same third 
party validator to verify every project type or project category, and 
using a separate third party to conduct ongoing validation and 
verification from the third party that completed the initial validation 
and verification process.

B. A DCM Shall Monitor a Derivative Contract's Terms and Conditions as 
They Relate to the Underlying Commodity Market

    DCM Core Principle 4 requires a DCM to prevent manipulation, price 
distortion, and disruptions of the physical delivery or cash-settlement 
process through market surveillance, compliance, and enforcement 
practices and procedures.\84\ For physically-settled derivative 
contracts, the Commission has recognized DCM Core Principle 4 to 
include, among other things, an obligation to monitor the contract's 
terms and conditions as they relate the underlying commodity market, 
and to the convergence between the contract price and the price of the 
underlying commodity, and to monitor the supply of the underlying 
commodity in light of the contract's delivery requirements.\85\ Such 
monitoring will help a DCM identify circumstances that may cause the 
contract to become susceptible to price manipulation or distortions, 
and

[[Page 89420]]

to assess whether the terms and conditions of the contract continue to 
be appropriate--or whether a change in circumstances should be 
addressed, for example, through changes to the contract's terms and 
conditions.\86\
---------------------------------------------------------------------------

    \84\ CEA Section 5(d)(4), 7 U.S.C. 7(d)(4). See also 17 CFR 
38.250-258.
    \85\ 17 CFR 38.252.
    \86\ The Commission has, similarly, recognized that a DCM has a 
responsibility to monitor the continued appropriateness of the terms 
and conditions of a cash-settled derivative contract. See, e.g., 17 
CFR 38.253(a)(2).
---------------------------------------------------------------------------

    Given that VCC derivatives are a comparatively new and evolving 
class of products, and given that standardization and accountability 
mechanisms for VCCs are still being developed, the Commission 
preliminarily believes that the monitoring by a DCM of the terms and 
conditions of a physically-settled VCC derivative contract should 
include continual monitoring of the appropriateness of the contract's 
terms and conditions that includes, among other things, monitoring to 
ensure that the delivery instrument--that is, the underlying VCC--
conforms or, where appropriate, updates to reflect the latest 
certification standard(s) applicable for that VCC. For example, where 
there are changes to either the crediting program or the types of 
projects or activities associated with the underlying VCC, due for 
example to new standards or certifications, then the DCM should amend 
the contract's terms and conditions to reflect this update. In such 
circumstances, the DCM should also ensure that it is monitoring the 
adequacy of the estimated deliverable supply of the underlying VCC to 
satisfy the contract's delivery requirements.
    Finally, the Commission reminds market participants that Commission 
regulations implementing DCM Core Principle 4 require DCMs to have 
rules requiring their market participants to keep records of their 
trading that include records of their activity in the underlying 
commodity and related derivatives markets.\87\ A DCM's rules also must 
require market participants to make such records available upon request 
to the DCM.\88\ As such, DCM market participants are required, upon 
request, to make records of their trading in underlying VCC cash 
markets available to the DCM, in order to assist the DCM in fulfilling 
its market monitoring obligations. These records also are subject to 
Commission inspection under applicable Commission recordkeeping rules.
---------------------------------------------------------------------------

    \87\ 17 CFR 38.254(a).
    \88\ Id.
---------------------------------------------------------------------------

C. A DCM Must Satisfy the Product Submission Requirements Under Part 40 
of the CFTC's Regulations and CEA Section 5c(c)

    There are generally two processes by which a DCM may list a new 
derivative contract for trading.\89\ The DCM may elect to list the 
contract for trading by providing the Commission with a written 
certification--a ``self-certification''--that the contract complies 
with the CEA, including the CFTC's regulations thereunder.\90\ 
Alternatively, the DCM may elect voluntarily to seek prior Commission 
approval of the contract.\91\ In each case, the DCM must submit 
prescribed information to the Commission, including but not limited to 
the contract's terms and conditions.\92\ Amendments to an existing 
derivative contract also must be submitted to the Commission, along 
with prescribed information, either by way of self-certification or for 
prior Commission approval.\93\
---------------------------------------------------------------------------

    \89\ SEFs also may generally list new contracts by way of either 
of these two processes. See, generally, CEA section 5c(c), 7 U.S.C. 
7a-2(c).
    \90\ CEA section 5c(c)(1), 7 U.S.C. 7a-2(c)(1). See also 17 CFR 
40.2 The Commission must receive the DCM's self-certified submission 
at least one business day before the contract's listing. 17 CFR 
40.2(a)(2).
    \91\ CEA sections 5c(c)(4)-(5), 7 U.S.C. 7a-2(c)(4)-(5). See 
also 17 CFR 40.3.
    \92\ 17 CFR 40.2-40.3.
    \93\ 17 CFR 40.5-40.6.
---------------------------------------------------------------------------

    This proposed guidance highlights three submission requirements in 
connection with the listing of VCC derivative contracts. These 
requirements apply regardless of whether a DCM elects to list the 
contract by way of self-certification, or with prior Commission 
approval. These requirements generally apply with respect to the 
listing by a DCM of a derivative contract, regardless of the underlying 
asset class. However, the Commission wishes to remind DCMs of the 
importance of fully complying with these requirements in a submission 
for a VCC derivative contract.
    The relevant requirements provide, first, that a contract 
submission to the Commission must include an explanation and analysis 
of the contract and its compliance with applicable provisions of the 
CEA, including core principles and the Commission's regulations 
thereunder.\94\ Second, the relevant requirements provide that the 
explanation and analysis of the contract either be accompanied by the 
documentation relied upon to establish the basis for compliance with 
applicable law, or incorporate information contained in such 
documentation, with appropriate citations to data sources.\95\ Third, 
the relevant requirements provide that, if requested by Commission 
staff, a DCM must provide any additional evidence, information or data 
that demonstrates that the contract meets, initially or on a continuing 
basis, the requirements of the CEA or the Commission's regulations or 
policies thereunder.\96\
---------------------------------------------------------------------------

    \94\ 17 CFR 40.2(a)(3)(v) (for self-certification) and 
40.3(a)(4) (for Commission approval). The ``explanation and 
analysis'' requirement for self-certified contracts provides for 
such explanation and analysis to be ``concise.'' The ``explanation 
and analysis'' requirement for contracts submitted for prior 
Commission approval does not include the ``concise'' qualifier. The 
Commission requires DCMs to provide a more detailed explanation and 
analysis of contracts that are submitted for affirmative Commission 
approval.
    \95\ 17 CFR 40.2(a)(3)(v) (for self-certification) and 
40.3(a)(4) (for Commission approval).
    \96\ 17 CFR 40.2(b) (for self-certification) and 40.3(a)(10) 
(for Commission approval).
---------------------------------------------------------------------------

    Since VCC derivatives are a comparatively new and evolving class of 
products, and since standardization and accountability mechanisms for 
VCCs are still being developed, the Commission anticipates that in 
connection with the submission for a VCC derivative contract, a DCM may 
provide qualitative explanations and analysis to assist in addressing 
the three above-described requirements. The Commission expects that the 
information--including supporting documentation, evidence and data--
provided by the DCM to describe how the contract mcomplies with the CEA 
and applicable Commission regulations, will be complete and thorough. 
Given unique and developing aspects of VCCs and VCC derivative markets, 
including complete and thorough information in a submission for a VCC 
derivative contract will assist the Commission and its staff in their 
understanding of the contract and their analysis of the contact's 
compliance with applicable statutory and regulatory requirements, 
including whether or not the contract is readily susceptible to 
manipulation.

III. Request for Comment

    The Commission requests comment from the public on all aspects of 
the Commission's proposed guidance regarding the listing of VCC 
derivative contracts, and further invites comments on specific 
questions related to the listing of such contracts. The Commission 
encourages all comments including background information, actual market 
examples, and best practice principles. Specifically, the Commission 
requests comment on the following questions:

[[Page 89421]]

General

1. In addition to the VCC commodity characteristics identified in this 
proposed guidance, are there other characteristics informing the 
integrity of carbon credits that are relevant to the listing of VCC 
derivative contracts? Are there VCC commodity characteristics 
identified in this proposed guidance that are not relevant to the 
listing of VCC derivative contracts, and if so, why not?

    2. Are there standards for VCCs recognized by private sector or 
multilateral initiatives that a DCM should incorporate into the terms 
and conditions of a VCC derivative contract, to ensure the underlying 
VCCs meet or exceed certain attributes expected for a high-integrity 
carbon credit?
    3. In addition to the criteria and factors discussed in this 
proposed guidance, are there particular criteria or factors that a DCM 
should consider in connection with monitoring the continual 
appropriateness of the terms and conditions of a VCC derivative 
contract?
    4. In addition to the criteria and factors discussed in this 
proposed guidance, are there particular criteria or factors that a DCM 
should consider, which may inform its analysis of whether or not a VCC 
derivative contract would be readily susceptible to manipulation?
    5. Should the VCC commodity characteristics that are identified in 
this proposed guidance as being relevant to the listing by a DCM of VCC 
derivative contracts, also be recognized as being relevant to 
submissions with respect to VCC derivative contracts made by a 
registered foreign board of trade under CFTC regulation 48.10?

Transparency

    6. Is there particular information that DCMs should take into 
account when considering, and/or addressing in a VCC derivative 
contract's terms and conditions, whether a crediting program is 
providing sufficient access to information about the projects or 
activities that it credits? Are there particular criteria or factors 
that a DCM should take into account when considering, and/or addressing 
in a contract's terms and conditions, whether there is sufficient 
transparency about credited projects or activities?

Additionality

    7. Are there particular criteria or factors that DCMs should take 
into account when considering, and/or addressing in a VCC derivative 
contract's terms and conditions, whether the procedures that a 
crediting program has in place to assess or test for additionality 
provide a reasonable assurance that GHG emission reductions or removals 
will be credited only if they are additional?
    8. In this proposed guidance, the Commission recognizes VCCs as 
additional where they are credited for projects or activities that 
would not have been developed and implemented in the absence of the 
added monetary incentive created by the revenue from carbon credits. Is 
this the appropriate way to characterize additionality for purposes of 
this guidance, or would another characterization be more appropriate? 
For example, should additionality be recognized as the reduction or 
removal of GHG emissions resulting from projects or activities that are 
not already required by law, regulation, or any other legally binding 
mandate applicable in the project's or activity's jurisdiction?

Risk of Reversal

    9. Are there particular criteria or factors that DCMs should take 
into account when considering, and/or addressing in a VCC derivative 
contract's terms and conditions, a crediting program's measures to 
avoid or mitigate the risk of reversal, particularly where the 
underlying VCC is sourced from nature-based projects or activities such 
as agriculture, forestry or other land use initiatives?
    10. How should DCMs treat contracts where the underlying VCC 
relates to a project or activity whose underlying GHG emission 
reductions or removals are subject to reversal? Are there terms, 
conditions or other rules that a DCM should consider including in a VCC 
derivative contract in order to account for the risk of reversal?

Robust Quantification

    11. Are there particular criteria or factors that a DCM should take 
into account when considering, and/or addressing in a contract's terms 
and conditions, whether a crediting program applies a quantification 
methodology or protocol for calculating the level of GHG reductions or 
removals associated with credited projects or activities that is 
robust, conservative and transparent?

Governance

    12. In addition to a crediting program's decision-making, 
reporting, disclosure, public and stakeholder engagement, and risk 
management policies, are there other criteria or factors that a DCM 
should take into account when considering, and/or addressing in a VCC 
derivative contract's terms and conditions, whether the crediting 
program can demonstrate that it has a governance framework that 
effectively supports the program's transparency and accountability?

Tracking and No Double Counting

    13. In addition to the factors identified in this proposed 
guidance, are there other factors that should be taken into account by 
a DCM when considering, and/or addressing in a VCC derivative 
contract's terms and conditions, whether the registry operated or 
utilized by a crediting program has processes and procedures in place 
to help ensure clarity and certainty with respect to the issuance, 
transfer, and retirement of VCCs?
    14. Are there particular criteria or factors that a DCM should take 
into account when considering, and/or addressing in a VCC derivative 
contract's terms and conditions, whether it can be demonstrated that 
the registry operated or utilized by a crediting program has in place 
measures that provide reasonable assurance that credited emission 
reductions or removals are not double-counted?

Inspection Provisions

    15. Should the delivery procedures for a physically-settled VCC 
derivative contract describe the responsibilities of registries, 
crediting programs, or any other third-parties required to carry out 
the delivery process?

Sustainable Development Benefits and Safeguards

    16. Certain private sector and multilateral initiatives recognize 
the implementation by a crediting program of measures to help ensure 
that credited mitigation projects or activities meet or exceed best 
practices on social and environmental safeguards, as a characteristic 
that helps to inform the integrity of VCCs issued by the crediting 
program. When designing a VCC derivative contract, should a DCM 
consider whether a crediting program has implemented such measures?
    17. Certain private sector and multilateral initiatives recognize 
the implementation by a crediting program of measures to help ensure 
that credited mitigation projects or activities would avoid locking in 
levels of GHG emissions, technologies or carbon intensive practices 
that are incompatible with the objective of achieving net zero GHG 
emissions by 2050, as a characteristic that helps to inform the 
integrity of VCCs issued by the crediting program. When designing a VCC 
derivative contract, should a DCM

[[Page 89422]]

consider whether a crediting program has implemented such measures?

    Issued in Washington, DC, on December 21, 2023, by the 
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.

    NOTE: The following appendices will not appear in the Code of 
Federal Regulations.

Appendices to Commission Guidance Regarding the Listing of Voluntary 
Carbon Credit Derivative Contracts; Request for Comment--Voting Summary 
and Chairman's and Commissioners' Statements

Appendix 1--Voting Summary

    On this matter, Chairman Behnam and Commissioners Johnson, 
Goldsmith Romero, and Pham voted in the affirmative. Commissioner 
Mersinger voted to concur. No Commissioner voted in the negative.

Appendix 2--Statement of Support of Chairman Rostin Behnam

    The CFTC as a market regulator has a significant role to play in 
the voluntary carbon markets (VCMs). As we have seen the listing of 
listed futures on voluntary carbon credits (VCCs), the Agency's 
relationship and responsibility is real. These markets present an 
opportunity for the agricultural economy that historically underpins 
the need for derivatives markets for risk management and price 
discovery, but they also provide a useful tool throughout the financial 
markets and the real economy. And today, the Agency takes the most 
significant step of a financial regulator to promote fundamental 
standards for high integrity VCCs.
    Market participants from across all asset classes will increasingly 
turn to the derivatives markets as they manage the impact of physical 
and transition risks related to extreme weather events and climate-
related financial risk. The CFTC's role is to ensure that these 
developing derivatives markets, including those for VCCs, have 
integrity, adhere to basic market regulatory requirements, and remain 
resilient as we most certainly will continue to experience extreme and 
dramatic weather events that will impact pricing and volatility.
    The Commission's proposed guidance for designated contract markets 
(DCMs) that list derivatives contracts with voluntary carbon credits 
(VCC) as the underlying commodity is an important step in shaping the 
development of high-integrity voluntary carbon markets. For the first 
time ever, the CFTC is proposing regulatory guidance for exchanges 
listing products aimed at providing tools to manage risk, promote price 
discovery, and help channel capital to support decarbonization. The 
publication of this proposed guidance and request for public comment 
marks the culmination of years of work with stakeholders such as 
farmers, foresters, end users, energy traders and associations, 
emission-trading focused entities, carbon-credit rating agencies, 
crediting programs, CFTC-registered exchanges and clearinghouses, and 
derivatives trade associations. This proposal also represents a whole-
of-government approach in coordination with our partners across the 
federal complex.
    Each step has been intentional. My sponsorship of the Market Risk 
Advisory Committee's Climate-Related Market Risk Subcommittee, which 
issued a report on Managing Climate Risk in the U.S. Financial System 
Report in 2020 identified putting a price on carbon as a fundamental 
element for financial markets to efficiently channel capital to reduce 
greenhouse gas emissions (GHGs).\1\ My establishment of the CFTC's 
Climate Risk Unit in March 2021 allowed the Commission to build its 
subject matter expertise regarding the role that climate-related 
derivatives will have in pricing and managing climate-related financial 
risk.\2\ I hosted two VCM Convenings to gather information from a wide 
variety of market participants to better understand the potential role 
of the official sector in these markets, particularly as we began to 
see the emergence of listed futures products that reference VCC cash 
markets.\3\ The CFTC, with the support of my fellow commissioners, 
issued a Request for Information on Climate-Related Financial Risk that 
received 80 comments on ten priority areas of interest including VCMs 
and product innovation.\4\ I have also testified before Congress on 
several occasions specifically on the role of financial markets in 
addressing the climate crisis and my views on the CFTC's role in 
supporting solutions.\5\
---------------------------------------------------------------------------

    \1\ Managing Climate Risk in the U.S. Financial System, Sept. 9, 
2020, https://www.cftc.gov/sites/default/files/2020-09/9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20Risk%20-%20Managing%20Climate%20Risk%20in%20the%20U.S.%20Financial%20System%20for%20posting.pdf.
    \2\ CFTC Acting Chairman Behnam Establishes New Climate Risk 
Unit, Mar. 17, 2021, https://www.cftc.gov/PressRoom/PressReleases/8368-21.
    \3\ CFTC, Event: Commission Meetings, CFTC Announces Voluntary 
Carbon Markets Convening (Jun. 2, 2022), https://www.cftc.gov/PressRoom/Events/opaeventcftccarbonmarketconvene060222; and CFTC, 
Event: Commission Meetings, CFTC Announces Second Voluntary Carbon 
Markets Convening, (July 19, 2023), https://www.cftc.gov/PressRoom/Events/opaeventvoluntarycarbonmarkets071923.
    \4\ Request for Information on Climate-Related Financial Risk, 
87 FR 34856 (Jun. 8, 2022), available at https://www.cftc.gov/sites/default/files/2022/06/2022-12302a.pdf.
    \5\ See, e.g., Rostin Behnam, Chairman, CFTC, Testimony by 
Chairman Rostin Behnam Before the Subcommittee on Agriculture, Rural 
Development, Food and Drug Administration and Related Agencies 
Committee on Appropriations, U.S. House of Representatives (Mar. 28, 
2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam35; 
Rostin Behnam, CFTC, Testimony of Commissioner Rostin Behnam before 
the House Select Committee on the Climate Crisis (Oct. 1, 2020), 
https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam16.
---------------------------------------------------------------------------

    The primary takeaway from this research and public engagement is 
clear; the Commission should act, consistent with its statutory 
authority under the Commodity Exchange Act (CEA), to strengthen market 
integrity, transparency, and liquidity for derivatives with an 
underlying VCC that are real, additional, permanent, verifiable, and 
represent unique metric tons of GHG emissions reduced or removed from 
the atmosphere.
    While VCC derivatives are a comparatively new and evolving class of 
products, DCMs must ensure that any listed derivatives comply with the 
CEA and Commission regulations. The proposed guidance outlines factors 
that DCMs should consider when listing products including: DCM Core 
Principle 3, which requires DCMs to list only contracts that are not 
readily susceptible to manipulation; DCM Core Principle 4, which 
requires DCMs to have the capacity and responsibility to prevent 
manipulation, price distortion, and other market disruptions through 
market surveillance, compliance, and enforcement practices and 
procedures; the Commission's regulations promulgated for these DCM Core 
Principles; and the product submission provisions set forth in CEA 
section 5c(c) and Part 40 of the Commission regulations.
    The proposed guidance is not intended to modify or supersede 
existing statutory or regulatory requirements, or existing Commission 
guidance that addresses the DCMs' listing of derivative contracts, such 
as Appendix C to Part 38 of the Commission's regulations. Instead, the 
proposed guidance outlines particular VCC commodity characteristics 
that a DCM should consider in the design of a VCC futures contract's 
terms and conditions such (i) quality standards, which include 
transparency, additionality, permanence and accounting for the risk of 
reversal, and

[[Page 89423]]

robust quantification of emissions reductions or removals; (ii) 
delivery points and facilities which include effective governance at 
the carbon crediting program, tracking the issuance, transfer, and 
retirement of VCCs, and no double counting; and (iii) inspection 
provisions which includes independent third-party validation and 
verification. A DCM's consideration of these factors during the design 
of a derivative product's terms and conditions should promote accurate 
pricing, reduce susceptibility of the contract to manipulation, help 
prevent price distortions, and foster confidence in the VCC contracts. 
Consistent with the current statutory and regulatory requirements, DCMs 
would retain reasonable discretion in establishing the manner in which 
it complies with a DCM Core Principles and the Commission's 
regulations.
    I believe the proposed guidance outlines well-researched VCC 
commodity characteristics that build on several private sector and 
multilateral initiatives that have made great strides to strengthen VCC 
credit integrity standards. I also believe the proposed guidance 
supports transparency, liquidity, and market integrity. This effort is 
the product of a strong public-private partnership that I have strived 
to achieve with the CFTC's traditional stakeholders as well as those 
VCM stakeholders that may be newer to the derivatives markets.
    The Commission is cognizant that the derivatives markets are global 
markets and has crafted this proposed guidance to be complementary to 
the important work underway by the International Organization of 
Securities Commissions (IOSCO) through its Sustainable Finance Task 
Force's Carbon Market Workstream, which I co-chair with Verena Ross, 
the Chair of ESMA. While this proposed Commission guidance focuses on 
the due diligence that DCMs should undertake when designing and 
monitoring their proprietary listed VCC derivative contracts, IOSCO's 
work over nearly two years is focused on how regulators can promote 
sound market structure and enhance financial integrity in the VCMs so 
that high-quality carbon credits can be traded in an orderly and 
transparent way. I invite our stakeholders to also provide comment on 
IOSCO's December 2023 publication of its VCM Consultation Report.\6\
---------------------------------------------------------------------------

    \6\ International Organization of Securities Commissions 
(IOSCO), CR06/2023 Voluntary Carbon Markets, Consultation Report 
(Dec. 2023), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD749.pdf.
---------------------------------------------------------------------------

    The proposed guidance is not intended to suggest that the 
Commission has a role in creating or mandating compliance with any kind 
of climate policy. The CFTC's unique mission focused on risk mitigation 
and price discovery, however, puts us on the front lines of the now 
global nexus between financial markets and decarbonization efforts. 
Leveraging the CFTC's personnel and expertise demonstrates our 
commitment to taking thoughtful and deliberate next steps toward 
building a financial system that provides effective tools in achieving 
emission reductions.
    I thank my fellow commissioners for enabling the Commission to 
publish this proposed guidance for public comment. I greatly appreciate 
the expertise and all of the hard work done by the staff in my office, 
the Division of Market Oversight, and the Office of the General Counsel 
on this proposed guidance. I look forward to reviewing the public 
comments on all aspects of the guidance as well as on the seventeen 
specific questions relating to the listing for trading of VCC 
derivative contracts.

Appendix 3--Statement of Commissioner Kristin Johnson

    Today, the Commodity Futures Trading Commission (Commission or 
CFTC) adopts proposed Guidance and a Request for Comments regarding the 
listing of voluntary carbon credit (VCC) derivative contracts on 
designated contract markets (DCMs)--boards of trade that operate under 
the regulatory oversight of the CFTC (Proposed Guidance). I support the 
Proposed Guidance as it advances important transparency and market 
integrity efforts.
    However, evidence suggests that environmental commodity markets, 
specifically the underlying spot markets for carbon credits, are rife 
with fraud. Consequently, I find the Proposed Guidance to be necessary, 
but insufficient. I am hopeful that the Proposed Guidance ushers in 
discussion and the development of a comprehensive regulatory initiative 
to address the deeply concerning, and nearly indisputable, 
proliferation of fraud in the carbon credit markets.
    As I noted, in a recent speech at a joint convening of the 
Environmental Advisory Council and the Financial Sector Advisory 
Council of the Dallas Federal Reserve Bank:

    While the issues and concerns regarding climate risks are 
endemic, complex, and inherently require multi-lateral solutions 
effectuated by an international coalition of stakeholders--let's 
call it: a coalition of the willing--I strongly believe that 
financial market regulators and committed market participants may 
play a pivotal role in developing and implementing some basic, 
foundational market reforms.\1\
---------------------------------------------------------------------------

    \1\ Kristin Johnson, Commissioner, CFTC, Keynote Address at The 
Federal Reserve Bank of Dallas: All Hat, No Cattle: The Need For 
Market Structure Reforms in the Voluntary Carbon Markets (Nov. 29, 
2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson10. In October, the United Nations Sustainable Stock 
Exchanges (UN SSE), in collaboration with the International 
Organization of Securities Commissions (IOSCO), hosted a roundtable 
on Carbon Markets at the 8th UNCTAD World Investment Forum to engage 
in dialogue on the future of carbon markets and the role exchanges 
and securities market regulators can play in making these markets 
work effectively in combating climate change. Sustainable Stock 
Exchanges initiative, Carbon markets action framework launched at 
UNCTAD World Investment Forum (Oct. 18, 2023), https://sseinitiative.org/all-news/carbon-markets-action-framework-launched-at-unctad-world-investment-forum/.

    I anticipate and look forward to the public engagement regarding 
the Proposed Guidance and responses to the Request for Comments, 
particularly as relates to the efforts of the Proposed Guidance to 
address transparency, additionality, risk of reversal, robust 
quantification, governance, tracking and double counting, inspection 
provisions, and sustainable development benefits and safeguards. In 
developing a formal framework to support the VCC markets, I strongly 
believe that a comprehensive approach that addresses the diversity of 
environmental derivatives emerging in our markets will improve 
visibility, enhance integrity, and promote carbon neutrality.

The Market for Carbon Credits

    A VCC is a tradeable intangible instrument that is issued by a 
carbon crediting program. Once registered, VCCs associated with a 
mitigation project or activity may be acquired by end users (businesses 
or individuals) or intermediaries who act as brokers. While the number 
of VCC exchanges continues to increase, the spot market for such 
products remains largely bespoke, with buyers purchasing directly from 
mitigation project developers or via intermediaries. A carbon credit 
market creates a forum that enables buyers and distributors to engage 
in the purchase and sale, respectively, of environmental commodities. 
Each environmental commodity represents the acquisition or distribution 
of a credit that contributes to the reduction or sequestration 
(capturing and storage) of greenhouse gas emissions. Carbon markets are 
either mandatory (compliance) markets or voluntary. VCC markets are not 
established by any government authority.
    The VCC market serves as an important tool, among many needed

[[Page 89424]]

tools, designed to address mounting evidence of climate change and the 
attendant, significant effects on the global economy. Under Chair 
Behnam's leadership, in 2020, the Climate-Related Market Risk 
Subcommittee of the Commission's Market Risk Advisory Committee (an 
Advisory Committee that I currently sponsor), released a report 
identifying actions the Commission could take to address climate change 
and finding that climate-related financial risks pose a major risk to 
the stability of the U.S. financial system.\2\
---------------------------------------------------------------------------

    \2\ Release Number 8234-20, CFTC's Climate-Related Risk 
Subcommittee Releases Report, https://www.cftc.gov/PressRoom/PressReleases/8234-20.
---------------------------------------------------------------------------

    A report by the U.S. Department of the Treasury released in 
September explains that ``[t]he impacts of climate change are 
significant and escalating, including through more frequent and severe 
weather events, rising sea levels, and higher temperatures.'' \3\ The 
report details how climate risks are impacting individual household 
finances, U.S. financial markets, and supply chains. ``In 2022 alone, 
the cost of climate and weather disasters in the United States totaled 
more than $176 billion--the third most costly year on record.'' \4\
---------------------------------------------------------------------------

    \3\ U.S. Dep't of the Treasury, The Impact of Climate Change on 
American Household Finances 1 (2023), https://home.treasury.gov/system/files/136/Climate_Change_Household_Finances.pdf.
    \4\ Id.
---------------------------------------------------------------------------

    There are deep and persistent concerns regarding the integrity, 
credibility, and lack of visibility in the market for carbon credits. 
Indisputably, challenged efforts to establish universally-adopted and 
enforceable integrity standards has further stymied attempts to scale 
carbon credit markets.
    Just last fall, U.S. Senators Elizabeth Warren, Cory Booker, and 
Kirsten Gillibrand alongside several other Senators, encouraged the 
CFTC to use its enforcement jurisdiction aggressively to investigate 
and prosecute fraud and manipulation in spot and forward environmental 
commodity markets.\5\
---------------------------------------------------------------------------

    \5\ Letter from Cory A. Booker, et al., U.S. Senators, to Rostin 
Behnam, Chairman, CFTC (Oct. 13, 2022).
---------------------------------------------------------------------------

    On June 29, 2023, the Commission announced the Environmental Fraud 
Task Force, which was created to address misconduct in the regulated 
derivatives markets and to investigate fraud in the spot market for 
VCCs, in particular with respect to the purported environmental 
benefits of purchased carbon credits, and registrants' 
misrepresentations regarding purported environmental benefits and 
environmental, social, and governance (ESG) products or strategies.\6\
---------------------------------------------------------------------------

    \6\ Release Number 8736-23, CFTC Division of Enforcement Creates 
Two New Task Forces, https://www.cftc.gov/PressRoom/PressReleases/8736-23.
---------------------------------------------------------------------------

    These issues have become so much a part of the cultural dialogue 
that The New Yorker featured an article titled ``The Great Cash-For-
Carbon Hustle,'' which detailed the rise and fall of South Pole, led by 
its forty-four-year-old CEO Rant Heuberger, and the revelation that it 
sold carbon credits that were not real.
    In recent speeches at the Federal Reserve Banks in Atlanta and 
Dallas and Rice University's Baker Institute for Public Policy Annual 
Energy Summit, I outlined the necessity for market structure reforms in 
the VCC markets as well as derivatives on VCCs.\7\ As I have previously 
stated:
---------------------------------------------------------------------------

    \7\ Kristin Johnson, Commissioner, CFTC, Keynote Address at Rice 
University's Baker Institute for Public Policy Annual Energy Summit: 
Credibility, Integrity, Visibility: The CFTC's Role in the Oversight 
of Carbon Offset Markets (Oct. 5, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson7; Kristin Johnson, 
Commissioner, CFTC, Keynote Address at The Federal Reserve Bank of 
Atlanta: Policing the (Token) Economy: Introducing Corporate 
Governance and Market Structure Reforms in Crypto and Environmental 
Commodities Markets (Nov. 13, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson8; Kristin Johnson, Commissioner, CFTC, 
Keynote Address at The Federal Reserve Bank of Dallas: All Hat, No 
Cattle: The Need For Market Structure Reforms in Voluntary Carbon 
Markets (Nov. 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson10.

in order for the carbon offset markets to have any significance 
(and, arguably, for such markets to avoid extinction), we must 
ensure the integrity of the market.\8\ Financial market regulators 
and committed market participants play a pivotal role in developing 
and implementing some basic, foundational market reforms.\9\
---------------------------------------------------------------------------

    \8\ Kristin Johnson, Commissioner, CFTC, Keynote Address at The 
Federal Reserve Bank of Dallas: All Hat, No Cattle: The Need For 
Market Structure Reforms in Voluntary Carbon Markets (Nov. 29, 
2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson10.
    \9\ Id.

    Today's Proposed Guidance marks a step in the right direction.

Commission Regulatory Authority

    The Proposed Guidance applies to the listing of futures with VCCs 
as the underlying assets. DCMs that list and offer derivatives on VCCs, 
which are commodities, must be registered with the Commission prior to 
offering such contracts. Pursuant to the Commodity Exchange Act (CEA), 
to be designated, and maintain a designation, as a contract market, a 
board of trade must comply with all core principles and any requirement 
that the Commission may impose by rule or regulation.
    Core principle 3 requires a DCM to demonstrate that listed 
contracts are not readily subject to manipulation. Core principle 4 
requires a DCM to prevent manipulation, price distortion, and 
disruptions of the physical delivery or cash-settlement process through 
market surveillance, compliance, and enforcement practices and 
procedures.\10\ Guidance and acceptable practices provide contextual 
information regarding the core principles and detailed examples of how 
a DCM must satisfy a core principle. Additionally, DCMs must comply 
with ``submission requirements . . . prior to listing a product for 
trading,'' including by way of self-certification or Commission 
approval of such products.
---------------------------------------------------------------------------

    \10\ 17 CFR part 38, Appendix B to Part 38 (Guidance on, and 
Acceptable Practices in, Compliance With Core Principles), and 
Appendix C to Part 38 (Demonstration of Compliance That a Contract 
Is Not Readily Susceptible to Manipulation).
---------------------------------------------------------------------------

    The Commission reviews the product specifications, including 
information about the underlying asset, as part of this review process.

Futures on VCCs: Great Interest, Limited Volume

    Over the last several years, the Commission authorized the listing 
of futures contracts on certain environmental instruments, including 
mandatory emissions and voluntary carbon program instruments. There are 
almost two hundred derivative contracts on environmental commodities 
although at this time only three contracts have open interest. As of 
November 2023, DCMs submitted eighteen futures contracts on voluntary 
carbon market products the Commission for listing. Derivative contracts 
on VCCs base their prices on the spot price of VCCs,\11\ and therefore 
the integrity of the underlying spot market is critical to the 
stability of the derivatives market for those underlying VCC 
commodities.
---------------------------------------------------------------------------

    \11\ For example, NYMEX's CBL Global Environmental Offset 
futures contracts, and Nodal Exchange's Verified Emission Reduction 
futures and options contracts, are physically-settled contracts. If 
the holder of a position in the contract still has an open position 
at the expiration of trading in the contract, then the position 
holder must, in accordance with the rules for delivery set forth in 
the contract, make or take delivery (as applicable) of 1,000 VCCs 
that meet the contract's rules for delivery eligibility.
---------------------------------------------------------------------------

General Summary of the Proposed Guidance

    Endemic fraud in the VCC spot market impacts the integrity of 
environmental derivative contracts that reference spot market projects. 
While the Commission's authority to introduce regulation is limited to 
commodity

[[Page 89425]]

derivatives, the Commission has broad authority to address fraud and 
market manipulation in the spot market.
    The Proposed Guidance outlines factors that DCMs should consider 
when addressing certain requirements under the CEA and CFTC regulations 
that are relevant to the listing for trading of VCC derivative 
contracts, as previously mentioned, without providing a qualitative 
element in terms of identifying how the Commission expects the DCM to 
weigh those factors to create a certain aspirational goal.
    Specifically:
     When addressing quality standards in the development of 
the terms and conditions of a VCC derivative contract, the Proposed 
Guidance states that a DCM should consider transparency, additionality, 
permanency and risk of reversal, and robust quantification in 
connection with the underlying VCC. The governance framework and 
tracking mechanisms of the crediting program for the underlying VCCs 
and the crediting program's measures to prevent double-counting are all 
additional considerations. Inspection or certification provisions 
should be specified in the terms and conditions.
     DCMs should actively monitor the terms and conditions of 
VCC derivative contracts to ensure conformity with current standards 
and should require their market participants to keep records of their 
trading, including activity in the underlying spot market, and make 
such records available upon request to the DCM.
     As part of the product review process, a DCM is required 
to submit the contract's terms and conditions and any contract 
amendments and must also include an explanation and analysis of the 
contract and its compliance with applicable CEA provisions. The 
submitted information--including supporting documentation, evidence and 
data--provided by the DCM should describe how the contract complies 
with the CEA and applicable Commission regulations and should be 
complete and thorough.
    DMO suggests that the Proposed Guidance should be considered by a 
swap execution facility (SEF) that proposes to trade swaps with VCCs as 
underlying commodities. Similar to DCMs, SEFs are directly subject to 
core principles, guidance, acceptable practices, and product listing 
requirements.\12\
---------------------------------------------------------------------------

    \12\ 17 CFR part 37 and Appendix B to Part 37 (Guidance on, and 
Acceptable Practices in, Compliance with Core Principles).
---------------------------------------------------------------------------

    The Proposed Guidance may help to improve the integrity of the VCC 
markets. Yet, there are additional and significant issues that the 
Proposed Guidance does not address.
    On November 13, 2023, I delivered a keynote speech at the Federal 
Reserve Bank of Atlanta. During that discussion, I noted:

    There are certain principles that must guide the development of 
market structure for [VCC markets] including the introduction of 
transaction reporting; secondary market regulation including, where 
relevant, clearing and settlement guidance; accountability standards 
for intermediaries to ensure integrity and reliability (and in the 
context of environmental commodities additionality); business 
conduct standards, including standardized documentation (and 
requirements for certification of environmental commodities); and 
appropriate guardrails for any retail market participation.\13\
---------------------------------------------------------------------------

    \13\ Kristin Johnson, Commissioner, CFTC, Keynote Address at The 
Federal Reserve Bank of Atlanta: Policing the (Token) Economy: 
Introducing Corporate Governance and Market Structure Reforms in 
Crypto and Environmental Commodities Markets (Nov. 13, 2023), 
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson8.

    On November 29, 2023, I delivered keynote remarks at a joint 
convening of the Energy Advisory Council and Financial Sector Advisory 
Council of the Dallas Federal Reserve Bank. There, I outlined 
additional interventions that may mitigate the proliferation of fraud 
in VCC markets and foster innovation and competition, while ensuring 
the integrity of our markets.
    The Proposed Guidance provides much-needed direction to DCMs (and 
SEFs) to facilitate their compliance with core principles when they 
list futures contracts (and swaps contracts) on VCCs. However, the 
Commission is only addressing one small aspect of the market for 
derivatives on these underlying assets. There is also a segment of the 
swaps market that is not traded on a SEF for which VCCs are underliers 
and an even more significant volume of environmental forwards that are 
not considered to be swaps.
    The Proposed Guidance suggests the potential for a broader and more 
comprehensive framework. Applying the approach adopted in the Proposed 
Guidance, there may be several interventions that may introduce similar 
needed clarifications--material risk disclosures, good faith and fair 
dealing, and clearing.

A Comprehensive Approach To Regulating VCC Markets

    A comprehensive framework enhances the integrity of futures and OTC 
markets enabling risk transfer, investment, hedging, and price 
discovery.
Material Risk Disclosures
    The CEA and CFTC regulations impose material risk disclosure 
requirements on registered market participants in connection with their 
communications, solicitations, and negotiations of transactions and 
material contractual terms.
    These material risk disclosure requirements reduce information 
asymmetries and improve transparency. The requirements obligate certain 
parties to disclose material information sufficient to enable 
counterparties to make informed decisions about the appropriateness of 
entering into a transaction.
    In the swaps market,\14\ a swap dealer is required to disclose to 
its non-swap dealer counterparty material information concerning the 
swap in a manner reasonably designed to allow the counterparty to 
assess the material risks, material characteristics, material 
incentives and conflicts of interest that the swap dealer may have in 
connection with a particular swap.\15\
---------------------------------------------------------------------------

    \14\ For reference, in futures markets, futures commission 
merchants are required to provide comprehensive disclosures under 
CFTC Regulation 1.55 where all materials risks are specifically are 
addressed. Registered commodity pool operators and commodity trading 
advisors are also required to provide disclosures on risks of 
trading futures and swaps.
    \15\ 7 CFR 23.431. This provision requires the disclosure of 
market, credit, liquidity, foreign currency, legal, operational, any 
other applicable risks; the material economic terms of the swap, the 
terms relating to the operation of the swap, and the rights and 
obligations of the parties during the term of the swap; and the 
price of the swap, the mid-market mark of the swap, and any 
compensation or other incentive from any source other than the 
counterparty that the swap dealer may receive in connection with the 
swap.
---------------------------------------------------------------------------

    In the adopting release for the material risk disclosure 
requirement, the Commission clarified that the material risk disclosure 
requirement reaches disclosures regarding the risks associated with the 
economic terms of the product and risks associated with the underlying 
asset. The Commission noted that:

    The Commission believes that for most swaps information about 
the material risks and characteristics of the swap will relate to 
the risks and characteristics of the economic terms of the swap. For 
certain swaps, however, where payments or cash-flows are materially 
affected by the performance of an underlying asset for which there 
is not publicly available information (or the information is not 
otherwise accessible to the counterparty), final Sec.  23.431 would 
require disclosures about the material risks and characteristics 
that affect the value of the underlying asset to enable a 
counterparty to assess the material risks of the swap.\16\
---------------------------------------------------------------------------

    \16\ Business Conduct Standards for Swap Dealers and Major Swap 
Participants With Counterparties (Business Conduct Standards), 77 FR 
9734, 9760 (Feb. 17, 2012).


[[Page 89426]]


---------------------------------------------------------------------------

    In my view, the concepts of material information, material risks, 
material characteristics, material incentives and conflicts of interest 
of a derivative must necessarily include the underlying commodity on 
which a derivative is priced. In light of the lack of visibility into 
pricing in the VCC markets and the dearth of publicly available 
information regarding pricing methodologies, such disclosures are 
particularly important.
    Using the risk disclosure requirement as a framework, the 
Commission should provide guidance that applies to all environmental 
derivative products. In the context of derivatives on VCCs or other 
environmental products, where the risk of loss may be magnified because 
of leverage, the sellers must ensure its counterparty has adequate 
information to understand how observed volatility and inherent risk in 
the nascent and evolving VCC market could impact the price of the 
derivative.
    For certain forward contracts on VCCs, it is possible that no 
material risk disclosure requirement applies; however, the CFTC does 
have enforcement jurisdiction if there is fraud, including where 
incorrect or misleading information is provided. CFTC regulations do 
not require parties to make affirmative statements about nonpublic 
information--but if a party does speak, CFTC Regulation 180.1(b) 
specifically requires that a materially misleading statement be 
corrected, including nonpublic information that may be material to the 
market price, rate, or level of the commodity transaction.\17\
---------------------------------------------------------------------------

    \17\ 17 CFR 180.1(b) (stating that nothing in that section shall 
be construed to require any person to disclose to another person 
nonpublic information that may be material to the market price, 
rate, or level of the commodity transaction, except as necessary to 
make any statement made to the other person in or in connection with 
the transaction not misleading in any material respect).
---------------------------------------------------------------------------

    The Commission may not need to prescribe the precise language of 
the disclosures. The material risk disclosure rule is principles-based. 
Instead, the Commission may identify factors that a market participant 
must consider in a risk disclosure, including all the factors that 
could lead to significant losses. Information about a carbon credit, 
including information about the environmental project and market 
structure, is material because there is a substantial likelihood that a 
reasonable counterparty would consider it important in making a trading 
decision.
Guidance on Good Faith and Fair Dealing
    The principles of good faith and fair dealing are well-established 
in the futures, swaps and securities industries. The National Futures 
Association's customer communication rule also imposes a duty to 
communicate in a fair and balanced manner.
    In the swaps market, the risk disclosure requirement is closely 
linked to the swap dealer's obligation to communicate in a fair and 
balanced manner. Swap dealers have a duty to communicate with all of 
their counterparties in a fair and balanced manner based on principles 
of fair dealing and good faith.\18\ This duty, the Commission notes, 
``is designed to ensure a balanced treatment of potential benefits and 
risks.'' \19\
---------------------------------------------------------------------------

    \18\ 7 CFR 23.433.
    \19\ Business Conduct Standards, 77 FR at 9769.
---------------------------------------------------------------------------

    In the adopting release for the fair dealing requirement, the 
Commission noted:

    In a complex swap, where the risks and characteristics 
associated with an underlying asset are not readily discoverable by 
the counterparty upon the exercise of reasonable diligence, the swap 
dealer or major swap participant is expected, under both the 
disclosure rule and fair dealing rule, to provide a sound basis for 
the counterparty to assess the swap by providing information about 
the risks and characteristics of the underlying asset.\20\
---------------------------------------------------------------------------

    \20\ Id. at 9770.

    The Commission should offer guidance as to its expectations of how 
the fair dealing requirement should be considered in the context of an 
underlying asset that is a VCC. The fair dealing rule provides an 
independent basis for enforcement proceedings--for example where the 
swap dealer makes exaggerated or unwarranted claims, opinions, or 
forecasts in violation of the fair dealing requirement.\21\
---------------------------------------------------------------------------

    \21\ Id. at 9769.
---------------------------------------------------------------------------

    Such a requirement may not apply to certain forward contracts on 
VCCs. Yet, the Commission maintains broad enforcement jurisdiction in 
the event that there is an allegation of fraud, including where 
incorrect or misleading information is provided. CFTC Regulation 
180.1(a)(2) makes unlawful the making of an untrue or misleading 
statement of a material fact or omitting a material fact necessary to 
make a statement made not untrue or misleading.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 180.1(a)(2) (providing that it is unlawful for any 
person in connection with any contract of sale of any commodity in 
interstate commerce to intentionally or recklessly make, or attempt 
to make, any untrue or misleading statement of a material fact or to 
omit to state a material fact necessary in order to make the 
statements made not untrue or misleading).
---------------------------------------------------------------------------

Guidance on Product Eligibility for Clearing
    In the future, should the market evolve and become more 
standardized, the clearing framework may also provide valuable risk 
reduction benefits for derivatives on environmental commodities. 
Clearing, by way of novation, reduces counterparty credit risk because 
a DCO serves as a seller to every buyer and a buyer to every seller, 
remaining neutral. DCOs are highly regulated by the Commission, are 
subject to core principles, and have significant, mutualized financial 
resources. At settlement, DCOs may facilitate the physical delivery of 
the actual underlying commodity or cash payments based on the final 
price of the underlying commodity in connection with the derivatives 
contract.
    In the context of environmental derivatives, DCOs would facilitate 
delivery of the VCC or determine the cash amount based on the price of 
the VCC in the cash market. For purposes of physical settlement, a 
well-functioning carbon credit cash market is essential.
    Core principle C sets out product eligibility requirements. A DCO 
must have appropriate requirements for determining the eligibility of 
contracts submitted to the DCO for clearing, taking into account the 
DCO's ability to manage the risks associated with such contracts.
    Some factors the DCO must consider include the availability of 
reliable prices, the ability of the DCO and clearing members to gain 
access to the relevant market for purposes of creating, liquidating, 
transferring, auctioning, and/or allocating positions, and the 
operational capacity of the DCO and clearing members to address any 
unique risk characteristics of a product clearing members.\23\ A DCO 
should take care not to clear transactions that present an unacceptable 
level of risk.
---------------------------------------------------------------------------

    \23\ 17 CFR 39.12(b).
---------------------------------------------------------------------------

    In the context of the current VCC market, significant questions 
arise as to whether certain elements of the DCO core principles would 
be easily established, including whether there are reliable prices for 
these carbon credits, the access to carbon credit markets, and whether 
there is material information about the carbon credit. Additional 
Commission guidance perhaps could facilitate the market, increase 
volumes and promote sound risk management, reasonably-designed policies 
and procedures, and robust rules.
    The development of rules that facilitate the clearing of 
derivatives

[[Page 89427]]

based on environmental commodities would be greatly advanced by 
Commission guidance on the application of those principles to the 
clearing of such products. Forwards on carbon credits are not required 
to be cleared at a DCO; but clearing and settlement provide critical 
counterparty credit risk management.

Conclusion

    It is difficult to overstate the significance of today's announced 
Proposed Guidance. Once again, the CFTC is demonstrating leadership in 
the novel carbon credit markets and contemporaneously enhancing the 
integrity of carbon-credit markets.\24\
---------------------------------------------------------------------------

    \24\ In June 2022, the Commission held the first-ever Voluntary 
Carbon Markets Convening to discuss issues related to the supply and 
demand for high quality carbon offsets. Then in July 2023, the 
Commission held the second Voluntary Carbon Markets Convening to 
discuss recent private sector initiatives for high quality carbon 
credits, among other topics.
---------------------------------------------------------------------------

    I believe the Commission has taken an important step forward by 
announcing the Proposed Guidance advanced today. However, I am hopeful 
that this step is the first on a long journey to introduce effective 
market structure reforms in VCC markets.

Appendix 4--Statement of Commissioner Christy Goldsmith Romero

    I am pleased to support today's proposed guidance regarding the 
listing of voluntary carbon credit derivatives. I want to recognize 
Chairman Behnam's leadership in the voluntary carbon credit space. The 
proposed guidance follows efforts by the Commission to develop capacity 
in understanding and regulating voluntary carbon credits.\1\
---------------------------------------------------------------------------

    \1\ The Commission has held two convenings to gather information 
from a range of carbon market stakeholders and last year conducted a 
request for information on climate-related risks, which asked 
several questions about carbon markets. The Commission received 
significant comments on voluntary carbon credit products and 
markets.
---------------------------------------------------------------------------

    The physical effects of climate change are amplifying. 2023 is 
likely to go down as the warmest year on record.\2\ The intensifying 
physical impacts of climate change pose serious risks to commodities 
derivatives markets and potentially systemic risk to the financial 
system if not effectively managed. Our mission includes promoting 
resilience in derivatives markets that can play a critical role in 
managing climate risk.
---------------------------------------------------------------------------

    \2\ National Oceanic and Atmospheric Administration, Topping the 
charts: September 2023 was Earth's warmest September in 174-year 
record (Oct. 13, 2023).
---------------------------------------------------------------------------

    Many market participants are seeking opportunities in derivatives 
markets to promote resilience to climate risk, including through 
voluntary carbon credits. The CFTC oversees voluntary carbon credit 
derivatives listed and trading on CFTC-registered exchanges. In 
addition to regulatory authority over derivatives, the CFTC also has 
antifraud authority in the spot voluntary carbon credit markets given 
the potential for impact to the derivatives markets.
    In response to our public consultation, various market 
participants, public interest groups, and U.S. Senators have asked the 
CFTC to take a leading role in promoting the integrity of voluntary 
carbon markets.\3\ I was pleased to help launch the CFTC's 
Environmental Fraud Task Force that will pursue individual cases of 
fraud related to carbon credits, weeding out bad actors, and promoting 
market integrity.\4\ Today's proposed guidance is the next step in 
promoting market integrity.
---------------------------------------------------------------------------

    \3\ See Letter from Senators Booker, Warren, Markey, Blumenthal, 
Sanders, Merkley and Gillibrand (Oct. 13, 2022); see also ISDA 
Comment Letter on CFTC Request for Information on Climate-Related 
Financial Risk (Oct. 7, 2022) (``We believe that the Commission 
should take a leading role in supporting and enhancing the integrity 
of voluntary carbon markets.''); see also Intercontinental Exchange 
Inc. Comment Letter on CFTC Request for Information on Climate-
Related Financial Risk (Oct. 7, 2022) (``ICE supports the Commission 
taking a leadership role in supporting and enhancing the integrity 
of project-based carbon markets.''); see also Environmental Defense 
Fund Comment Letter on CFTC Request for Information on Climate-
Related Financial Risk (Oct. 7, 2022) (``EDF respectfully welcomes 
CFTC's interest in identifying the potential for fraud and market 
manipulation in voluntary carbon markets. Enhanced quality and 
integrity in voluntary carbon markets can help mobilize carbon 
finance, help cut emissions and facilitate the achievement of 
corporate and national greenhouse gas reduction goals.''); see also 
bp Comment Letter on CFTC Request for Information on Climate-Related 
Financial Risk (Oct. 7, 2022) (``bp believes the CFTC should focus 
on simultaneously enhancing its oversight role in derivatives and 
futures markets while allowing these markets to become deeper and 
more liquid.'').
    \4\ Commissioner Christy Goldsmith Romero, Remarks of 
Commissioner Christy Goldsmith Romero at ISDA's ESG Forum on 
Promoting Market Resilience: A Thoughtful Approach to the Daunting 
Challenge of Climate Financial Risk, (Mar. 7, 2023); See 
Commissioner Christy Goldsmith Romero, Adjusting the Sails for Cyber 
and Climate Resilience (Feb. 10, 2023).
---------------------------------------------------------------------------

    I have met with exchanges to discuss their process for listing 
these emerging products, and found differing approaches to these 
products and due diligence in the underlying credit. CFTC-registered 
exchanges have certain requirements under the Commodity Exchange Act 
including to list only contracts that are not readily susceptible to 
manipulation, to have the capacity and responsibility to prevent 
manipulation, price distortion and other market disruptions, and other 
requirements aimed at market integrity.
    Commission guidance, like what is proposed today, can help 
exchanges understand what compliance means in a still rapidly evolving 
market for voluntary carbon credits, one where there can be concerns 
about integrity, including for carbon credits listed on some of the 
largest registries,\5\ a lack of transparency, and uncertainty related 
to pricing. These concerns in the spot market could affect the 
regulated derivatives market. For a market to work well, market 
participants need to be confident they have credible information about 
the product, that there are appropriate levels of pricing, and that the 
market has integrity, so that they do not face legal, reputational and 
regulatory risks.
---------------------------------------------------------------------------

    \5\ In one relevant example, several press sources reported 
serious allegations about a project developed by the market's 
largest firm, a project that has been among the leading sources of 
carbon credits globally. Blake, Heidi, The Great Cash-for-Carbon 
Hustle, The New Yorker (Oct. 16, 2023); Ben Elgin, Alastair Marsh, 
and Max de Haldevang, Faulty Credits Tarnish Billion-Dollar Carbon 
Offset Seller, Bloomberg (Mar. 24, 2023). The allegations were 
sufficiently credible that the project's registry put on hold 
issuance of credits from the project, pending an investigation. 
Verra Statement on the New Yorker Article of October 16, 2023, Verra 
(Oct. 17, 2023).
---------------------------------------------------------------------------

    I continue to believe that bringing more of this market onto 
regulated exchanges could increase integrity, transparency, and bring 
greater confidence to the market. I agree with a response to our 
consultation which said that ``the expansion of exchanges offering 
products . . . would help grow liquidity and therefore the value of the 
market for price discovery and risk shifting.'' \6\ CFTC-regulated 
exchanges have important responsibilities under the Commodity Exchange 
Act, and stand as the first line of defense to ensure market integrity 
The market should signal through pricing which carbon credits are high 
quality compared to credits reflecting projects that do not achieve the 
requisite level of one ton of greenhouse gases removed or reduced.
---------------------------------------------------------------------------

    \6\ See Ceres Comment Letter on CFTC Request for Information on 
Climate-Related Financial Risk (Oct. 7, 2022).
---------------------------------------------------------------------------

    However, one of the biggest challenges in voluntary carbon markets 
is fragmentation which different projects, registries, and standards, 
that can impact derivatives markets and harm market confidence. A lack 
of transparency through consistent, comparable data can present 
challenges to proper functioning of markets, including price discovery. 
There are important and welcome efforts by voluntary bodies like the 
Integrity Council on Voluntary Carbon Markets (``ICVCM'') to create 
voluntary

[[Page 89428]]

standards to address concerns about credibility and to develop a common 
understanding of a high-quality credit, efforts that are ongoing.
    In March, I proposed that the Commission work with regulated 
exchanges to develop common baseline standards for listing voluntary 
carbon credit derivatives.\7\ At a conference held by ISDA, I proposed 
that the Commission consider requiring exchanges to take certain 
actions to increase confidence that underlying voluntary carbon credits 
reliably remove or avoid the amount of carbon claimed of one ton of 
greenhouse gases per credit. I proposed that such actions could include 
information sharing agreements with carbon registries and baseline 
standards for carbon credits that could reference either the ICVCM core 
carbon principles once they became final or the basic principles on 
which they are based. I thank the Chairman for working with me on these 
efforts.
---------------------------------------------------------------------------

    \7\ Commissioner Christy Goldsmith Romero, Remarks of 
Commissioner Christy Goldsmith Romero at ISDA's ESG Forum on 
Promoting Market Resilience: A Thoughtful Approach to the Daunting 
Challenge of Climate Financial Risk (Mar. 7, 2023).
---------------------------------------------------------------------------

    Today's guidance adapts terminology, concepts and standards from 
the ICVCM's Core Carbon Principles and its recently issued Assessment 
Framework. I support the Commission's recognition of the efforts made 
by this body that could improve integrity, transparency, and price 
discovery, and thereby improve confidence in these markets.
    The Commission's guidance adapts ICVCM concepts and standards that 
commenters told us were needed for integrity in voluntary carbon 
markets. The guidance sets an expectation for exchanges to ensure that 
underlying VCC's represent an actual ton of carbon dioxide removed or 
reduced and that there is no double counting of those reductions or 
removals.\8\ It also sets an expectation that underlying VCC's are 
subject to a meaningful independent evaluation and verification before 
issuance.\9\ Aligning the CFTC's expectations with the ICVCM's work 
also recognizes the global nature of this market and of the challenges 
posed by climate-related financial risk.
---------------------------------------------------------------------------

    \8\ See ISDA Comment Letter on CFTC Request for Information on 
Climate-Related Financial Risk (Oct. 7, 2022) (``In order for these 
markets to flourish, there can be no room for greenwashing, double-
counting of credits or any other types of fraud and manipulation . . 
.''); See also EDF Comment Letter on CFTC Request for Information on 
Climate-Related Financial Risk (Oct. 7, 2022) (``One particular 
concern in carbon markets is that traded reductions might be 
``double counted,'' a situation in which a single GHG emission 
reduction or removal (i.e. credit) is counted more than once towards 
achieving mitigation targets or goals.'').
    \9\ See Ceres Comment Letter on CFTC Request for Information on 
Climate-Related Financial Risk (Oct. 7, 2022) (``The best way to 
guard against the risk of market disruption because of the lack of 
the integrity of the underlying credits would be to require all 
credits underlying derivative instruments be subject to a meaningful 
evaluation and certification process by an outside, neutral, and 
expert third party.'').
---------------------------------------------------------------------------

    I am interested in hearing from commenters if the guidance adapts 
the right parts of the ICVCM standards to encourage integrity and 
transparency in these markets and if the Commission's adaptation 
provides clear, workable expectations. As the ICVCM standards have only 
been recently released, it will be important to monitor the adoption of 
these standards.
    I am also interested in hearing more from commenters about whether 
market integrity can be improved by exchanges relying on a crediting 
program's processes and diligence, as assumed in the proposed guidance, 
or if there is a benefit to exchanges conducting additional due 
diligence into specific categories, protocols, or projects.
    I am interested to hear from commenters, including participants in 
our previous public consultation if this guidance meets their needs and 
helps address concerns they have raised. I especially hope to hear from 
farmers and others in the agricultural community, several of whom 
encouraged the CFTC to play a role in ensuring integrity in carbon 
markets in response to last year's public consultation.\10\
---------------------------------------------------------------------------

    \10\ See Blue Diamond Farming Company Comment Letter on CFTC 
Request for Information on Climate-Related Financial Risk (Oct. 7, 
2022); see also Bryan Agricultural Enterprises Comment Letter on 
CFTC Request for Information on Climate-Related Financial Risk (Oct. 
7, 2022).
---------------------------------------------------------------------------

    As derivatives markets evolve, it is important that the Commission 
remain nimble and aware of changes, and continue to work with exchanges 
in listing products. I applaud the staff for their hard work on this 
guidance and I thank them for working with me to incorporate feedback I 
have heard in meetings with exchanges, market participants and public 
interest groups over the past 18 months.

[FR Doc. 2023-28532 Filed 12-26-23; 8:45 am]
BILLING CODE 6351-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.