Reed Smith In-depth

Key takeaways

  • CFTC finalized non-binding guidance applicable to futures exchanges and swap execution facilities related to due diligence and oversight of underlying carbon markets.
  • Guidance primarily describes how trading platforms should mitigate manipulation and prevent market disruption in voluntary carbon credit (VCC) derivatives contracts and underlying markets.
  • Guidance is intended to assist in addressing existing obligations given new and evolving nature of the VCC asset class.

Authors: Jonathan T. Ammons Nicholas J. Castriz

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On September 20, 2024, the U.S. Commodity Futures Trading Commission (CFTC) finalized its guidance, originally proposed in December 2023,1 regarding the listing for trading of VCC derivative contracts (the Guidance).2

Currently, there are 29 futures contracts listed on U.S. futures exchanges, or designated contract markets (DCMs). All of these contracts are physically settled (meaning that holding a contract to maturity would result in physical delivery of the VCC), and only three of the listed contracts have open interest.3

The Guidance builds off of certain existing “acceptable practices” and guidance that provide more general information as to how DCMs can comply with certain core principles in connection with listing derivatives in any asset class.4 Specifically, the Guidance sets forth (1) factors to consider when determining that a VCC contract is not readily susceptible to manipulation, as required by Core Principle 3; (2) information as to how exchanges should monitor a VCC contract’s terms and conditions as they relate to the underlying commodity market, as required by Core Principle 4; and (3) procedures for listing VCC contracts.

The Guidance is primarily directed to DCMs listing physically settled derivatives, but the CFTC stated (primarily in footnotes) that the factors included for consideration therein would also be relevant for cash-settled VCC derivatives, including those listed by swap execution facilities (SEFs).5

The CFTC explained that the purpose of the Guidance is to help “advance the standardization of VCC derivative contracts in a manner that fosters transparency and liquidity, accurate pricing, and market integrity.”The CFTC further explained that this step is necessary for a number of reasons, including concerns regarding (1) market participants’ ability to access accurate information to make informed evaluations and comparisons of VCC quality; (2) the ability to accurately price VCCs if methodologies or protocols used to quantify emissions reduction differ from one another and lead to inconsistent results; and (3) incentives to purchase lower quality VCCs that may not accurately reflect the actual greenhouse gas (GHG) emissions reductions associated with a particular project.