IATP submitted the following comment to the International Organization of Securities Commissions (IOSCO) on March 3, 2024. 

The Institute for Agriculture and Trade Policy (IATP)¹ appreciates the opportunity to comment on the IOSCO VCM Consultation Report (“Consultation Report” or “CR”). IATP last wrote to IOSCO in February 2023 concerning its Discussion Paper on Voluntary Carbon Markets (“Discussion Paper”).² In that letter we quoted from a CME Group response to the Commodity Futures Trading Commission (“CFTC”) Request for Information (“RFI”) about climate-related financial risk: “[t]he Climate RFI suggests a focus on the regulatory role for the Commission in the voluntary carbon markets. The voluntary carbon markets are still evolving and striving to reach a mature state. An overly proscriptive [sic] approach to the development of the voluntary carbon markets could have the effect of impeding the promise these markets offer to assist the larger community in reaching global emissions reduction targets.”³

The CFTC did not heed all the CME Group’s warnings about proposing regulation of any kind for the “still evolving” voluntary carbon markets. The CFTC adapted the still evolving Integrity Council for the Voluntary Carbon Market’s (“ICVCM”) rulebook to fit its Core Principles regulatory structure in the CFTC’s voluntary guidance for Designated Contract Markets (“DCMs”) to list derivatives contracts with Voluntary Carbon Credits (“VCCs”) as their underlying assets. However, the proposed CFTC guidance also asked whether DCMs, intermediaries and market participants should perform due diligence about VCCs beyond what the ICVCM and other private standards organizations provided.⁴ In the following letter, some of our responses to Consultation Report questions are derived in part from our responses to CFTC guidance questions.⁵

The overlap of financial market and environmental integrity: consequences for the Good Practices

One of the challenges that IOSCO faces in describing Good Practices for VCMs to the regulators of its 131 member governments is to maintain consistently a categorical distinction between financial market integrity and environmental integrity that is advised by the majority of the 52 respondents to the Discussion Paper:

One strong message from the feedback is that IOSCO should clearly define its role with respect to VCMs and should keep any further policy steps limited to that remit, and not address issues of environmental integrity, for example. Subsequent chapters will further discuss how IOSCO is taking forward the Key Considerations directly related to financial market integrity through a proposed set of Good Practices, and how others are being addressed by ongoing public and private sector initiatives whose objective is to raise the environmental integrity in the VCMs by focusing on the climate aspect of carbon credits. (CR, p. 44)

This “strong message” prevents IOSCO from advising on good practices on topics in which the overlap of financial market integrity and environmental integrity is clear. An example of this overlap occurs in a topic that is barely described in the “Consultation Report,” the legal and financial responsibilities and liabilities of crediting programs that maintain buffer accounts of carbon offset credits to compensate for emission reversals of projects whose VCCs have been issued. How will these liabilities affect the financial market integrity of DCMs, intermediaries and market participants who are trading VCC- backed derivatives under conditions of increasingly frequent and severe reversals?

Emissions reversals will almost certainly increase in scope and frequency, at least for nature-based emissions reduction activities, with the imminent arrival of more frequent extreme weather events driven by climate tipping points.⁶ The economic and legal consequences for the crediting programs’ buffer accounts of credits to compensate for such reversals cannot not be forecast with accuracy. However, we know that current reversals, e.g., recent California wildfires, have eliminated any temporary climate benefits from offset projects and are showing the buffer accounts to be vastly underfunded.⁷  

It is very likely that ICVCM will change its rules on emissions reversal and reversal risk management. For example, consider the next iteration of the Assessment Framework, regarding permanence: “The ICVCM will consider longer monitoring and compensation periods (e.g., one hundred years) and shifting the monitoring and compensation oversight to the carbon-crediting program or the jurisdiction aligned with existing and emerging best practice among carbon crediting programs.^”8 The duration of permanence of CO₂ removals in the current ICVCM standard is “at least 40 years.”⁹ A climate science robust duration is much longer: e.g., According to a recent Carbon Market Watch analysis of academic literature, “CO2 can be considered permanently stored only when it is put away as long as the significant percentages of CO2 emissions last in the atmosphere (up to 25%), that is up to 1,000 years. At the very minimum, the bar for storage with significant climate benefits is several centuries."¹⁰

In the event of a ICVCM standard of a 100-year carbon storage permanence and crediting program buffer account failure, it is likely that developing country governments that host VCCs would have to assume the costs of monitoring and maintaining an adequately financed buffer account of high-quality credits to compensate for the reversals. In the event of “several centuries” standards, it is all but certain that developing country governments would have to assume the monitoring and compensation costs and liabilities. When United Nations agencies promote high integrity carbon markets as a reliable source of climate finance and a means to realize Nationally Determined Contributions to mitigation and Sustainable Development Goals,¹¹ the costs of carbon market implementation are seldom mentioned. ICVCM estimates that “90% of all nature-based solutions,” i.e., land-based (and marine?) emissions offset projects, are in developing countries.¹² The possible assumption of buffer account finance by their governments is never mentioned. If IOSCO does not view its remit to advise its member governments, particularly the developing country hosts of emissions reduction projects, of their potential assumption of crediting program buffer account liabilities and compensation, then IOSCO should at least advise its member government regulators of how buffer account failure could affect financial market integrity. 

The legal and economic consequences of adopting a science-based duration for the monitoring of offset reductions and compensation for emissions reversals are staggering, and not just for the crediting programs and the “shift” to governments of the monitoring and emissions reversals responsibilities and liabilities. Most VCC-backed derivatives contracts will have a large percentage of component contracts that are at an increasing risk of reversals. 

For example, the Nodal Exchange’s Global Emissions Reduction (GER) Futures contract description states: “Physically delivered offsets based on a basket of the following carbon offset subcontracts: Base Carbon Contract (BCC), Forestry Carbon Contract (FCC), Prime Carbon Contract (PCC), and Carbon Capture Contract (CCC), where weightings are calculated and determined by the GER Supervisory Committee (GERSC), in accordance with the GER Governance and Methodology Protocol posted at http://www.nodalexchange.com.”¹³ The FCC components account for 39% of the derivatives contract, while the CCC VCCs, the least subject to emissions reversals and buffer account compensation account for 1% of the contract. There is nothing in the GER® Governance and Methodology Protocol¹⁴ that discusses uncompensated reversals, their impact on VCC quality, VCC prices and VCC price volatility. If we assume that reversals will become more frequent and severe as climate tipping points drive more extreme weather events, trading platforms in IOSCO jurisdictions should begin to account for the impact of reversals on VCC estimated deliverable supply and on the possibility of market disruption if uncompensated reversals become widespread. 

Changes to the ICVCM rulebook, such as for emissions reversals, and an analysis of their economic impact should be reported promptly to exchanges, relevant regulators and authorities of IOSCO jurisdictions, under the terms of an information sharing agreement. The exchanges should be obliged to report these changes and their potential economic consequences promptly to intermediaries and market participants.

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