A group of seven U.S. senators have written a letter to the Commodity Futures Trading Commission ("CFTC"), expressing concerns with the integrity of the carbon credit markets and urging the CFTC to investigate and regulate voluntary carbon offsets markets.

On October 13, 2022, Senators Cory Booker, Elizabeth Warren, Edward Markey, Richard Blumenthal, Bernard Sanders, Jeffrey Merkley, and Kirsten Gillibrand sent a letter to CFTC Chairman Rostin Behnam requesting that the CFTC establish "rules governing the carbon market." While carbon credits are designed to provide offsets for carbon emissions based on other actions that have reduced or removed carbon dioxide from the atmosphere, the senators cited "[s]everal studies … highlight[ing] that carbon offset projects are frequently illegitimate[]." Even "those that do contribute to meaningful emissions reductions," they added, can "often [be] representative of broader 'pay to pollute' schemes. …"

Currently, carbon credits are traded in a number of voluntary markets, which means that those markets are not currently subject to a comprehensive scheme of federal regulation like those that govern derivatives and securities markets. The senators' letter makes their displeasure with voluntary compliance plain. To address their concerns, the senators recommended that the CFTC:

  • "Investigate the integrity of currently approved derivatives and their underlying carbon offsets";
  • "[D]evelop … standards for carbon offsets that effectively reduce … emissions and can serve as underlying commodities for approved derivatives …";
  • "Create a registration framework for offsets, offset brokers, and offset registries";
  • "Pursue cases of individual project fraud"; and
  • "Develop a working group to study both the risk to investors associated with carbon offsets and derivatives (legal, reputational, and regulatory) and the systemic climate financial risk created by their availability and usage."

Carbon credits can and do underlie CFTC-regulated derivatives. However, the CFTC only has antifraud and anti-manipulation authority over carbon credit markets. (The same is true for other "cash" or "spot" markets in other commodities.) The Commodity Exchange Act does not provide a basis for imposing a registration and oversight structure on cash or spot markets. As a result, many of the senators' requests for action go far beyond the CFTC's current statutory authority. Congress, then, will have to act.

In the meantime, we fully expect that the CFTC will continue its efforts to review the carbon credit markets for potential fraud and manipulation. Firms that market carbon credits or that provide or host trading markets are also likely to receive significant scrutiny, as may investment funds and other major investors in carbon credits. The agency is also likely to continue its general fact-finding and may publish—whether directly or under the auspices of an advisory committee—best practices or other guidance for participants in carbon credit markets and the market themselves. The CFTC's focus on carbon credits and climate risk is unquestionable, as is clear from the formation of the Climate Risk Unit, its recent Voluntary Carbon Market Convening, and its just-concluded request for information on climate risk in the financial system. Ultimately, however, it can only go so far with its existing powers.