CFTC Issues Proposed Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts

The U.S. Commodity Futures Trading Commission (CFTC) has announced an upcoming consultation on a proposed Guidance on Listing VCC-Derivative Contracts. The guidance outlines specific issues that Designated Contract Markets (DCMs) should consider when contemplating the listing of Voluntary Carbon Credit (VCC) derivative contracts on their platforms. The noted issues are aimed at ensuring that VCC contracts align with regulatory standards, are less susceptible to manipulation, and maintain market integrity. Furthermore, the CFTC hopes to promote the standardization of these products, foster transparency, and enhance their liquidity in the market.
Among the proposed factors for consideration are the following:
(1) A DCM shall only list derivative contracts that are not readily susceptible to manipulation: In this context, the CFTC notes that any VCC contract listed by a DCM should meet the following criteria or satisfy the following noted requirements, among others:
– The terms and conditions of VCC-derivative contracts should specify the responsible carbon crediting program for eligible VCCs. DCMs should assess if these programs offer enough information for market participants to evaluate the VCC quality.
– DCMs should evaluate the policies and procedures of carbon crediting programs in relation to the withdrawal of VCCs, e.g. if they do not reach their envisioned emission targets, and should ensure that equivalent VCCs are issued once such withdrawal takes place.
– DCMs should ensure that carbon crediting programs have a transparent and robust methodology for quantifying emission reductions associated with the „underlying“ projects.
– DCMs should establish adequate position limits for such contracts.
– DCMs should ensure that carbon crediting programs have processes in place for clear issuance, transfer, and retirement of VCCs.
– DCMs should ascertain that carbon crediting programs have policies and procedures to support a program’s „independence, transparency, and accountability.”
(2) A DCM shall monitor a derivative contract’s terms and conditions as they relate to the underlying commodity market: Current CFTC rules mandate that DCMs must safeguard against manipulation, price distortion, and disruptions in both physical delivery and cash-settlement processes. This involves active monitoring using market surveillance, compliance measures, and enforcement protocols. Specifically, DCMs must track the contract’s terms in relation to the underlying commodity market, ensuring the contract price aligns with the actual commodity price. Additionally, they need to oversee the availability of the underlying commodity concerning the contract’s delivery requirements. For physically settled VCC derivatives, the guidance would specify that DCMs need to consistently assess and ensure that the contract’s terms remain appropriate. This includes confirming that the underlying VCC complies with or updates to the latest relevant certification standards.
(3) A DCM must satisfy the product submission requirements under corresponding CFTC rules and regulations: Generally speaking, DCMs can get approval to list a derivative contract from the CFTC in two ways: either by certifying that the contract meets the necessary rules (self-certification) or by asking for preapproval before listing. The new guidance wouldn’t add additional rules in the context of VCC contracts, but would emphasize that
– when asking for approval or self-certifying a VCC derivatives contract, the DCM needs to explain how the contract complies with the rules of the Commodity Exchange Act (CEA), including its core principles and the regulations set by the Commission;
– DCMs should be prepared to provide relevant facts and materials to substantiate their claims about contract compliance; and
– DCMs should be ready to provide additional information to the Commission during the review process, if so needed.