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John Kostyack, Principal, Kostyack Strategies and Steering Committee Member, Climate Risk
Disclosure Lab of Duke Law’s Global Financial Markets Center
Lee Reiners, Executive Director, Global Financial Markets Center, and Steering Committee
Member, Climate Risk Disclosure Lab
Dr. Steve Suppan, Senior Policy Analyst, Institute for Agriculture and Trade Policy

We thank the Commodity Futures Trading Commission (CFTC, or Commission) for the invitation to comment on the proposal by the Commercial Energy Working Group to form an EEMAC carbon markets subcommittee.1 The proposed stakeholder group would produce a report on principles for designing the derivatives and underlying cash markets for the carbon allowances and offsets that are used to manage the greenhouse gas (GHG) emissions of carbon market participants.

Before commenting, we would like to extend our thanks to Commissioner Dan Berkovitz, the EEMAC sponsor, for his great public service, both as Commissioner and earlier as General Counsel to the Commission, as he prepares to depart the Commission on October 15.


We urge the Commision to undertake its own study of carbon markets and to provide opportunities for public comment, as recommended by Better Markets in its recent letter.2 In the event that the Commission elects to carry out a study using a stakeholder advisory subcommittee as proposed, we support Public Citizen’s recommendations that “the subcommittee’s membership should feature robust representation of public interest stakeholders, including environmental justice perspectives” and that members be required to disclose their economic interests.3

It has been 10 years since the CFTC led an interagency study of carbon markets; since then, they have expanded dramatically and are expected to continue expanding as increasing numbers of companies make pledges to achieve “net-zero” GHG emissions using offsets. We provide recommendations below on how to ensure that this study effectively addresses the significant integrity issues in these markets, which threaten global financial stability as well as achievement of Paris Agreement climate targets.

For purposes of these comments, we use the term “carbon markets” to cover the full range of cash, secondary and derivatives markets that have been established, both voluntarily and for compliance purposes, to capture the financial value to emitters of GHG emissions reductions.

Overview of Financial Risks from Carbon Markets

As President Biden recognized in his May 20, 2021, Executive Order, climate change poses a significant risk to the stability of the global financial system. The primary drivers of this risk are the same as the drivers of climate-change-related damage already underway around the planet:  production and combustion of fossil fuels. Heading off a climate-related financial crisis in the future, and protecting people and communities today, requires managing the wind-down of fossil fuel production and reducing GHG emissions at the pace needed to achieve the 1.5℃ target in the Paris Climate Agreement.

Carbon markets provide an important vehicle for companies and other entities with difficult-to-abate GHG emissions to mitigate these emissions by financing abatement actions by others. However, given the rapid growth of these markets, the evidence of emissions offset integrity problems, and the lack of carbon market-focused oversight by financial regulators, these markets are likely exacerbating climate-related financial risk. Allocating capital to offset credits, futures and swaps markets, rather than prioritizing investments to directly reduce corporate Scope 1, 2 and 3 GHG emissions, is likely to increase financial risk to individual companies as well as the financial system. Shocks to the financial system due to failures in these markets will become increasingly likely over time in the absence of action by the CFTC and other regulators.

An updated carbon market study should evaluate whether risk to the financial system is growing in both voluntary and compliance markets. Pledges by major corporations and others to voluntarily achieve net-zero GHG emissions by mid-century have been proliferating in recent years. Many of these appear to contemplate business-as-usual GHG emissions by the entity making the pledge and propose to offset those emissions through trades of offset contracts and/or reliance on unproven carbon-removal technologies.4 Market participants surveyed by the Task Force on Scaling Voluntary Carbon Markets have expressed numerous concerns about offsets’ credibility and integrity.5 Due to questionable environmental performance and a host of other uncertainties, the financial value of offsets and offsets derivatives - key legal instruments purporting to demonstrate avoided emissions, reduced emissions or carbon removals - is highly volatile. Sustained volatility frustrates price discovery for emitters that rely on a carbon price signal to justify  investments in low-carbon technologies. Moreover, without price discovery, there is no hedging. Without hedging, financial actors enter the derivatives market for no purpose other than speculation, leading to wild price gyrations and financial instability.

Specifically, the growing participation in markets for offset derivatives by banks and other major financial actors jeopardizes financial stability in at least two ways:

  • Offset and offset derivatives valuations can suddenly and unpredictably deflate, devastating the balance sheets of companies reliant on these offsets. This failure by companies to adequately prepare for the transition to a low-carbon economy, known as transition risk, affects far more than those companies holding the instruments revealed to be overvalued. Other firms with offsets, and numerous other firms with business models tied to carbon markets and/or sensitive to new carbon regulation, could likewise be damaged, with cascading effects throughout the global economy.
  • If GHG emissions turn out to be worse than anticipated due to heavy reliance on offset programs that prove to be poorly designed, extreme weather events and other climate change impacts could cause sudden and unanticipated asset deflation. The consequences of failure to prepare for this damage, known as physical risk, likewise could reverberate across the global economy.

Offsets are also widely used in compliance markets, i.e., by governments seeking to achieve emission reductions with market incentives as a substitute for, or complement to, direct mandates. Some of these programs have also had significant integrity problems, such as in California, where a recent study found that forestry offsets under the state’s cap and trade program were virtually worthless, failing to reduce emissions and causing the state to fail to meet its emissions targets.6 In response to this finding, Washington state recently enacted a cap and trade program with a very limited role for offsets, virtually ensuring that offsets could not jeopardize the state’s achievement of its targets.7

Below we provide our recommendations on issues to be addressed in the updated carbon market report and, if an advisory subcommittee is created, on selecting the subcommittee and ensuring its transparency.

To continue reading, please download a PDF of the letter

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