Energy Transition – An evolving journey

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The voluntary carbon market (VCM) has been in operation since the 2000s, alongside mandatory/regulated carbon market schemes such as the EU Emissions Trading System and the U.S. Regional Greenhouse Gas Initiative. The two largest VCM programs, Verra’s Verified Carbon Standard (VCS) and Gold Standard, have been around since 2006 and 2003 respectively. In that sense, VCM trading is nothing new. However, the VCM has only really taken off in the last few years, with the growth of the market being rapidly accelerated by the adoption of the Paris Agreement in 2016 and, in the shadows of that, the Glasgow Climate Pact in 2021 and the proliferation of governments and corporates making “net-zero” carbon reduction commitments.

The rapid growth of the VCM in recent years has made VCM trading much more mainstream. Nonetheless, because the VCM is largely unregulated, in contrast to the more established mandatory carbon markets, some commentators and participants still see it as the “wild west” of the carbon trading sector.

In this piece, we examine a few of the key issues and opportunities currently faced by the VCM.

The legal nature of voluntary carbon credits

As with any asset or legal instrument, understanding the legal nature of voluntary carbon credits (VCCs) is critical to assessing and documenting how they can be traded and what risks there are to the transacting parties, including what property interest can be claimed over them and what form of security can be taken over them. Their legal nature also impacts their regulatory treatment and what tax implications there are in trading and holding them.

Yet there remains a large degree of uncertainty over the precise legal nature of VCCs, and the VCM program providers largely skirt around this question in their rules and standards. Since a VCC is a creature of contractual law (i.e., the construct of the VCM program it is issued under) and is not an instrument that is created via any legislative or international treaty framework, its nature is determined by the law applicable to its creation, holding and transfer. It is therefore determined by national law(s), having regard to the law applicable to the contractual framework under which the relevant VCM program operates and, potentially, the governing law of any trading documentation. This will differ between VCM programs and transactions, so there is no consistent answer to the question as to the legal nature of VCCs.

Applying an English law analysis to the question, the nature of a VCC would essentially be one of either (i) a property right (in rem) or (ii) a personal right (in personam). Personal rights are generally considered nontransferable as they are so closely tied to the relationship between the obligor and the oblige, that a third party cannot require the obligor to be indebted to the third party in place of the obligee. In contrast, a property right may be enforced against the obligor by a third party if the legal processes for the transfer of the obligee’s rights have been duly completed.

English law governed trading documentation generally proceeds on the basis that VCCs are a form of intangible property (although this has not been authoritatively determined by the English courts), which means legal title can be held and transferred to another party. However, as intangible property, this gives rise to complexities around what security can be taken over them. This is compounded by the need to take into account the national law applying to the VCCs and the registry account in which they are held, e.g., in the case of VCCs issued under the VCS, the law of the District of Columbia.

Industry efforts are underway to address the lack of consistency as to the legal nature of VCCs. However, until they come to fruition, it is important when trading and creating security over VCCs to assess the impact of the contractual governing law and the law applicable to the VCCs or registry account.

Key takeaways
  • No single global legal position determines the nature of voluntary carbon credits, including what title can be claimed in them and what security can be taken over them
  • The lack of market standard trading documentation for voluntary carbon credits is both a hindrance to the growth of the market and an opportunity
  • A two-tier voluntary carbon market labeling/pricing structure may develop: one for credits that comply with the new Paris Agreement Article 6 corresponding adjustments rules, and one for credits that do not
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