FEATURE: CFTC approves final guidance on VCM-based derivatives contracts

Quantum Commodity Intelligence – The US Commodity Futures Trading Commission (CFTC) has approved its final guidance regarding the listing for trading of voluntary carbon credit derivative contracts, in a move it hopes will aid the standardisation of such contracts.

The guidance applies to designated contract markets (DCMs), which are CFTC-regulated derivatives exchanges, that list derivatives on voluntary carbon credits (VCCs) as the underlying commodity, the US markets regulator said on September 20.

"For the first time ever, a US financial regulator is issuing regulatory guidance for contract markets that list financial contracts aimed at providing tools to manage risk, promote price discovery, and foster the allocation of capital towards decarbonisation efforts," CFTC Chairman Rostin Behnam said in a statement of support.

The guidance outlines factors for DCMs to consider when addressing certain Core Principle requirements in the US Commodity Exchange Act (CEA) and CFTC regulations that are relevant to the listing for trading of voluntary carbon credit derivative contracts.

Principles

These Core Principles include:

Core Principle 3, which requires DCMs to list only contracts that are not readily susceptible to manipulation; and

Core Principle 4, which 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.

The guidance also outlines factors for consideration when addressing certain requirements under the CFTC's Part 40 Regulations that relate to the submission of new derivative contracts, and contract amendments to the CFTC, the regulator added.

"The guidance is the result of over five years of research, public engagement and consultation with market participants"

The guidance is the result of more than five years of research, public engagement and consultation with market participants, Behnam said.

The primary takeaway of that process, he said, was that the CFTC should act "to strengthen market integrity, transparency, and liquidity for derivatives with underlying voluntary carbon credits that are real, additional, permanent, verifiable, and each represent a unique metric ton of GHG emissions reduced or removed from the atmosphere".

The CFTC released its proposed guidance during the COP28 climate talks late last year in Dubai, a day after the International Organization of Securities Commissions (Iosco),  a global group of market watchdogs, released its own set of guidelines. However, the CFTC's final guidance "is not intended to modify or supersede existing statutory or regulatory requirements", Behnam said.

It should also complement the work underway by Iosco through its Sustainable Finance Task Force's Carbon Market Workstream, the next deliverable of which is expected later this year, he added.

Dissent

CFTC approval of the guidance was not unanimous, however, with Republican Commissioner Summer Mersinger issuing a dissenting statement arguing that the regulator's "outsized focus" on VCC derivative products and the underlying VCC markets "looks a lot more like promotion of ideology than simply offering guidance".

The guidance, on an emerging class of products "that have very little open interest and comprise a miniscule percentage of trading activity on CFTC-regulated DCMs", does "very little" to provide clarity, and "nothing to foster transparency", Mersinger said.

She specifically highlighted sections of the guidance focussing on social and environmental safeguards and net zero objectives.

"Focusing on ESG and net zero in evaluating derivatives contracts is a backdoor attempt to inject and memorialise certain political ideologies into CFTC regulatory decisions," Mersinger stated.