After five years of consultations, public meetings and roundtable discussions, the Commodity Futures Trading Commission (CFTC or Commission) has issued final regulatory guidance (Final Guidance) for exchanges, which list financial contracts aimed at decarbonization efforts.
The Commission approved the Final Guidance on September 20, and that document outlines factors that CFTC-registered designated contract markets (DCMs) must consider when listing derivatives contracts that reference voluntary carbon credits (VCCs). The Final Guidance is intended to ensure that DCMs comply with certain Core Principles set forth in the Commodity Exchange Act (CEA) and CFTC regulations when listing VCC derivatives contracts for trading.
The Final Guidance also sets forth factors for DCMs to consider when addressing certain requirements under the CFTC’s Part 40 regulations, which relate to the submission of new derivative contracts, and contract amendments to the CFTC.
DCM Core Principles
Although VCC derivatives are relatively new products, the CEA and CFTC regulations have always required DCMs to comply with certain Core Principles when listing derivatives for trading. Specifically, DCM Core Principle 3 requires DCMs to list only contracts that are not readily susceptible to manipulation and DCM Core Principle 4 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.
In order to comply with these DCM Core Principles, the Final Guidance mandates that DCMs also address the following factors when listing VCC derivatives;
- transparency, additionality, permanence and accounting for the risk of reversal, and robust quantification of emissions reductions or removals, for consideration when addressing quality standards;
- governance, tracking mechanisms, and measures to prevent double counting, for consideration when addressing delivery procedures; and
- third-party validation and verification, for consideration when addressing inspection or certification procedures.
The Commission importantly noted that the Final Guidance is not intended to modify or supersede existing statutory or regulatory requirements, or existing CFTC guidance addressing a DCM’s listing of derivative contracts, including Appendix C to Part 38 of the CFTC’s regulations. The Final Guidance is only intended to list factors for a DCM to consider, which may advance the standardization of VCC derivative contracts in a manner promoting transparency and liquidity.
In his statement accompanying the Commission’s issuance of the Final Guidance, CFTC Chairman Rostin Behnam noted that the Final Guidance reflects diverse insights the CFTC gained from public comment on the proposed guidance, including the insights of agricultural stakeholders, commercial end users, energy market stakeholders, emission-trading focused entities, DCMs and clearinghouses, carbon-credit rating agencies, public interest groups and academics.
Dissenting voices
Not all CFTC commissioners, however voted in support of the Final Guidance. CFTC Commissioner Summer Mersinger dissented to the Commission’s action and criticized the Final Guidance as “a solution in search of a problem.” Commissioner Summer further argued that the CFTC has “no shortage of [other] topics that warrant [the Commission’s] immediate attention.” She suggested that the only reason the Commission is issuing the Final Guidance is to promote a political agenda “best left to voters and elected officials.”
Only time will tell whether the Final Guidance will encourage the trading of VCCs and VCC-linked derivatives.
Carl E Kennedy, partner and co-chair, Financial Markets and Regulation. With a varied background as a former regulator with the US Commodity Futures Trading Commission (CFTC) and as former senior in-house counsel at a large investment bank, clients respect the diverse and highly informed perspective Carl provides, particularly as it relates to the commodities and derivatives markets.
