The role of carbon dioxide (CO2) emissions credit trading to achieve the objectives of the U.N. Framework Convention on Climate Change (UNFCCC) has been debated since the authorization of international emissions trading in the 1997 Kyoto Protocol to the UNFCCC. A longtime advocate, the International Emissions Trading Association (IETA, which is mostly global banks, energy companies and emissions offset standards firms) and a new advocate, the Task Force on Scaling Voluntary Carbon Markets, are major players in the intergovernmental negotiations on the role of markets and public finance to reduce emissions and adapt to climate change. These negotiations may result in agreement at the UNFCCC Conference of Parties in November in Glasgow, Scotland on the terms to legitimate global voluntary emissions offset trading, including in contracts regulated by the U.S. Commodity Futures Trading Commission (CFTC). (Voluntary markets are untethered to mandatory measures, such as emissions caps, as in the European and California emissions compliance markets.)
IETA will lobby for Paris Agreement provisions to support the development of international emissions offset trading that will be consistent with the private sector Task Force proposals for markets and contracts that claim to offset emissions within the contentious terms of the yet to be finalized UNFCCC Article 6.2, referred to as “market mechanisms.” IETA has commissioned a “legal gaps analysis” to ensure that the terms of Article 6.2 provide a safe harbor from legal jeopardy for the carbon market participants, above all global financial institutions and corporations who source most offset credits from offset projects in developing countries, many of which are desperate for climate finance.
The credits, e.g., from a project to avoid creating new emissions by protecting a rainforest from further agribusiness development, are the underlying asset of the offset futures contracts that are expected to be traded by financial speculators and emitting industries. An IETA priority is to ensure that “no share of proceeds” from trading authorized by Article 6.2 be obligated to the “share of proceeds” in Article 6.6 for climate adaptation and emissions reductions projects in the most climate vulnerable countries.
Presenters from the CME (Chicago Mercantile Exchange) Group, the Intercontinental Exchange’s subsidiary in London, and the Nodal Exchange at a June 3 meeting of the CFTC’s Energy and Environmental Markets Advisory Committee (EEMAC) said that there was huge corporate interest in using offset contracts to claim to investors that they were reducing their emissions to meet Net Zero objectives in accord with government commitments in the UNFCCC Paris Agreement. On June 21, the CME Group announced its second product for the voluntary carbon market, the Nature-Based Global Emissions Offset (N-GEO™) futures contract, scheduled to begin trading on August 1, “pending regulatory review” by the CFTC. A subsequent announcement states, “CBL Nature-Based Global Emissions Offset (N-GEO) futures will offer firms a simple way to meet emissions-reduction targets using high-quality, nature-based offsets sourced exclusively from agriculture, forestry, and other land use (AFOLU) projects.” (CBL Markets is the exchange trading platform.)
As we noted about the CME’s Global Emissions Offset (GEO™) futures contract launched in January, the CFTC can allow the CME to self-certify that GEO™ is consistent with CFTC and CME rules, or it can review the contract more carefully in a formal approval process. Since the radically deregulatory Commodity Futures Modernization Act of 2000 authorized self-certification, very few new contracts undergo formal review by the resource deprived CFTC.
The N-GEO™ contract application, however, has not yet been posted on the CFTC website, which may indicate that the staff is analyzing the susceptibility of the contract to market manipulation and excessive speculation. The CME Group has pushed back to September 1 the start date for trading the contract. The staff may be analyzing the controversial history of underlying offset credit assets similar to those of the N-GEO™ contract. Forty-five percent of potential offset future contract buyers surveyed by the Task Force as of October 2020 (slide 50) were concerned about the environmental and accounting integrity of the underlying emissions offset project credits, e.g., regarding emissions reduction fraud and money laundering. The CME describes N-GEO’s™ underlying assets that include agricultural and forestry emissions reduction and avoidance projects verified by two carbon standards organizations to produce tradable offset credits.
What would drive the growth in voluntary emissions offset trading by industries not subject to progressively more stringent and mandatory emissions caps? The major diplomatic driver is the UNFCCC Paris Agreement’s Article 4, according to which Parties agree “to undertake rapid reductions thereafter [after the emissions peak in each Party] in accordance with best available science, so as to achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases [GHG] in the second half of this century, on the basis of equity, and in the context of sustainable development and efforts to eradicate poverty.” (Article 4.1) This 2015 diplomatic objective has been interpreted to authorize both government and corporate “net zero” emissions coalitions to be consistent with the Article 2 objective of limiting the post-industrial global temperature average increase to 1.5⁰ C (Celsius) (2.7⁰ Fahrenheit). Emissions offsets and trading offset credits are claimed to help to achieve the 2050 net-zero objectives.
However, the “best available science” may contradict the Article 4.1 objective of achieving a physical balance between GHG emissions and removals. For example, according to the conclusion of a 2021 study in Nature Climate Change, “Results indicate that a CO2 emission into the atmosphere is more effective at raising atmospheric CO2 than an equivalent CO2 removal is at lowering it, with the asymmetry increasing with the magnitude of the emission/removal. The findings of this study imply that offsetting positive CO2 emissions with negative emissions of the same magnitude could result in a different climate outcome than avoiding the CO2 emissions.” Corollary to this asymmetry is that reducing or avoiding GHG increases by the short-term sequestration of biogenic carbon in agriculture or forestry offset projects cannot offset and is in no way is equivalent to the long-term atmospheric CO2 produced by the production, transport and combustion of fossil fuels.
In July, the MSCI Net-Zero Tracker published the estimated results of emissions reporting by 9,260 companies whose shares are listed for exchange trading, as of May 31, 2021. According to the MSCI analysis, in five years and eight months under current trends, the companies will have emitted a volume of greenhouse gases that will drive the global temperature 1.5⁰ C (2.7⁰ F) above the pre-industrial temperature baseline. In 21 years and five months, the companies’ aggregate emissions will increase the global temperature by 2⁰ C (3.6⁰ F). In 2018, the International Panel on Climate Change delivered to the UNFCCC a Special Report on the physical and sustainable development impacts of a 1.5⁰ C and 2⁰ C worlds. An article summarizing the latter world stated, “At 2˚C, climate change will be devastating for large swathes of the globe.”
We are not yet at 1.5⁰ C, but as reported in a New York Times article titled "'No One Is Safe,'"extreme weather events, such as horrific flooding in Germany and exceptional drought and forest fires in the Western United States, are widely attributed to climate change. Despite the dire state of the climate, it will be a very brave CFTC staff that questions the premise that offset trading will reduce emissions and begin to reverse the momentum towards a 1.5⁰ C world. Such bravery would be more notable because the CFTC might deadlock on any climate related initiative, as there are currently two Democratic members and two Republican members. The staff assists the Commissioners in making policy and rulemaking but does not lead.
The White House has yet to nominate a CFTC Chair, apparently unable to be assured that its preferred candidate will receive at least all Democratic votes in the Senate confirmation process. In tacit recognition of this leadership gap, Better Markets wrote in late June to Acting Chair Rostin Behnam and sponsor of the Market Risk Advisory Committee (MRAC) and Commissioner Dan Berkovitz, sponsor of EEMAC to urge them to update the CFTC’s 2011 report on carbon markets, and to do so with a public notice and comment period, so that an incoming chair would have a climate finance and markets plan to adapt. The recently established Climate Risk Unit would assist them and the advisory committees to update the report and review public comments received.
The CFTC should review the performance history of both the compliance emissions markets that include binding emissions caps for covered industries, as well as the voluntary emissions market without a cap. The CFTC should carry out its public interest duty by examining what, if anything, emission trading has done or could do for the climate. As Carbon Market Watch wrote to the Task Force on Scaling Voluntary Carbon Markets in June: “There has also not been a detailed discussion of why the existence of a secondary [futures] market, as well as financial products such as carbon index funds, would benefit the climate. It is important to not take it for granted that more money (and liquidity) means greater impact in addressing climate change. Exchanging carbon credits between financial speculators does not benefit the climate and can create price volatility which will in fact be detrimental to investments in mitigation action.” (Italics in the original)
The CFTC must ask whether trading emissions futures contracts is the optimal way for market participants to reduce their costs of the physical risks of climate change and the costs and risks of transitioning to business models that will adapt to climate change impacts and absolutely reduce their emissions, rather than merely claim to do so under scientifically flawed net zero accounting schemes. The CFTC’s statutory authority to contribute to emissions mitigation and climate adaptation in the public interest is very general. However, the CFTC’s rule on "Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation” could be applied to deceptive reporting on offset credits, as it is applied to the underlying assets of grain and oilseed futures contracts.
Furthermore, the Biden administration’s May 21 “Executive Order on Climate-Related Financial Risk” gives the CFTC and other financial regulators in the Financial Stability Oversight Council (FSOC) some tasks to complete in a report to be issued by the end of 2021. For example, the report is to discuss “any current approaches to incorporating the consideration of climate-related financial risk into their respective regulatory and supervisory activities and any impediments they faced in adopting those approaches.”(Sec. 3) The CFTC should use its authority to ensure that the offset credits underlying the futures contract are not susceptible to the risks of manipulation, fraud or excessive speculation. If the offset credits that underlie the offset futures contract lack environmental or accounting integrity, they are not a reliable underlying asset for a futures contract. If the CFTC cannot identify the benefits of emissions trading for the climate but can identify the opportunity costs of emissions trading, rather than directly investing in climate change actions, it must reexamine the premises and design of emissions trading, instead of accepting industry claims about purported benefits.