Carbon Market Regulation: Where is the Oversight?
As the environmental asset markets grapple with two key questions — 1) where is the carbon market oversight, and 2) who is the overseer, it is evident that the carbon sales and trading market stands on the cusp of transformative change within the next 6–18 months. The heightened consciousness of consumers towards environmental impact and the ever-increasing focus of investors on Environmental, Social, and Governance (ESG) concerns has rendered carbon markets a vital tool for corporations to reduce their ecological footprint. Yet, unlike traditional equity and debt markets, these environmental asset markets have proliferated relatively untouched by regulatory scrutiny since they have been treated as asset transactions and not as commodities or securities. Carbon registries and marketplaces, designed to mitigate greenhouse gas emissions (GHG) by facilitating the trading of emission units or carbon offsets, also offer a means to finance the projects that generate these offsets. Despite this innovative approach to tackling a global challenge, concerns persist over transparency and the absence of robust regulatory oversight.
Currently, an array of transaction types exist within carbon markets that elude the purview of traditional regulation. Nevertheless, these transactions bear semblance to established commodities and securities, indicating a potential case for regulation under bodies like the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) in the United States. Given the escalating trend of corporations and fund managers leveraging ESG claims to lure investors and in the wake of recent controversies surrounding the validity of certain carbon offset classes, the advent of stricter regulatory scrutiny seems inevitable.
Corporations typically purchase carbon offsets — representing reductions, removals, or avoidances of greenhouse gas emissions — to balance their own emissions. Although their intangible nature might classify them as securities, they do not pass the Howey Test, the conventional criterion for a security, defined as an investment of money in a common enterprise with a reasonable expectation of profit derived from the efforts of others. Buying a carbon offset confers no ownership rights to the offset-generating business and the demand for offsets is propelled not by profit expectations, but by the intention of consuming or “retiring” the offset. However, given their similarities to traditional commodities and the inapplicability of the Howey Test, it’s plausible that the CFTC, the primary overseer of US commodity markets, may soon expand its regulatory ambit to include these transactions.
Structured financing and carbon derivative transactions constitute a notable proportion of the carbon markets. Given that these instruments often involve intricate financial contracts and potentially high-risk derivatives resembling traditional securities transactions, they may soon attract the attention of the SEC, the entity responsible for securities market regulation in the US.
For instance, structured financing in carbon markets typically involves the creation of special purpose vehicles (SPVs) that issue debt or equity securities. These securities, backed by future carbon credit sales revenue streams, bear a strong resemblance to conventional securities. Likewise, carbon derivatives, contracts that are valued based on carbon credit prices, mirror derivative securities and should hence fall within the SEC’s jurisdiction.
It’s critical to understand that regulatory oversight in this context isn’t about impeding market growth or adding bureaucratic hurdles. Instead, it’s about promoting transparency, fairness, and efficiency, which, in turn, bolsters the effectiveness of these markets in curbing global greenhouse gas emissions.
To summarize, as carbon markets continue their ascent and evolution, they necessitate a regulatory framework that parallels that of traditional financial markets. Regulatory supervision by institutions like the CFTC and SEC can inject much-needed transparency, prevent fraudulent activities, and safeguard market participants. Considering the growing significance of environmental issues to both investors and consumers, and the recent scandals shaking up the carbon markets, robust regulation is not only indispensable — it should be wholeheartedly embraced.
Capturiant is leading the way to ensure regulatory compliance in carbon market transactions. Led by a team of FINRA-licensed professionals with both commodities and securities experience, Capturiant is establishing the trust and transparency carbon product sellers, buyers, and investors increasingly demand. Whatever the future holds for carbon market regulation, Capturiant is positioned to ensure a safe, reliable, and compliant platform for all market participants.
This article was written by Sam Stokes and Catalina Row.
This article does not constitute legal or investment advice.
