Can US regulators save the voluntary carbon market from self-inflicted wounds?

The voluntary carbon market is facing an existential crisis. 

It promises to deliver tens of billions of dollars in private finance every year to projects that curb climate pollution. In return, corporations use the resulting carbon credits to offset their emissions, allowing them to market themselves as carbon neutral to climate-conscious consumers.

Despite that semblance of a win-win, though, the voluntary carbon market is suffering from fake credits, over-inflated corporate claims of carbon neutrality, and weak protocols issued by carbon credit registries. These self-inflicted wounds could be lethal — unless government regulators step up and provide stronger market oversight. 

Deploying the technologies needed to decarbonize large sectors of our economy will take decades. While there is value in reducing climate pollution today, many near-term opportunities such as reforestation or smaller scale clean energy projects lack upfront capital. Some market estimates project the voluntary carbon market could grow to $1.1 trillion in 2050 with higher quality standards. But that trajectory has so far been hampered by a series of missteps.

The latest market debacle comes via a new report from the Science-based Targets Initiative — or SBTi, a self-appointed authority on net-zero standards. Published in July, it signals another flip-flop in the organization's position on the types of emissions companies can offset with carbon credits. Specifically, they suggest that companies should not use carbon credits to offset their Scope 3 emissions, which are less directly connected to the company than Scope 1 or Scope 2 and come from the goods and materials in their value chains.

This position goes back on a previous reversal issued last April. Not surprisingly, the report has been met with a flurry of criticism, and has sown even more confusion about the future of the voluntary carbon market. 

Amid this controversy, both the U.S. Securities and Exchange Commission and the state of California have delayed the implementation of corporate climate disclosure requirements that would increase transparency into the use of carbon offsets. Simultaneously, some companies are choosing to leave SBTi entirely.

This comes as large tech companies such as Google walk back ambitious carbon neutrality targets, casting even more doubt on the role of carbon credits in corporate decarbonization efforts.

Of course, certain market actors have made efforts for reform. For example, the Integrity Council for the Voluntary Carbon Market defined benchmarks for high-integrity carbon credits, which have been embraced by registries like the American Carbon Registry, the Climate Action Reserve, and Gold Standard. But so far, these well-meaning attempts at self-governance have failed to stabilize the market and fix the weaknesses of the existing system. 

The growing gulf between opportunity and reality — both in the United States and internationally — underscores the need for additional government oversight of the voluntary carbon market to protect investors, prevent manipulation, and ensure the market delivers the intended climate benefits. This is particularly urgent because later this fall, countries will gather at the Conference of Parties in Azerbaijan to determine rules for country-level use of carbon credits to meet climate targets under the Paris Agreement.

The potential for federal action

The White House has signaled support for voluntary carbon markets and their potential role in driving down emissions. 

But individual federal agencies have a critical role to play in creating robust regulations to protect the credibility and liquidity of those markets. This includes the Department of Agriculture establishing stringent standards for crediting protocols recommended to landowners, the SEC enforcing comprehensive corporate disclosure requirements, and the Commodity Futures Trading Commission setting strong standards for carbon credits sold on regulated exchanges.

The next opportunity for enhanced government oversight is the forthcoming guidance from the CFTC on listing voluntary carbon credits in derivatives. The CFTC, a key but lesser-known player in the carbon credit space, has authority under the Commodity Exchange Act to promote market integrity and prevent price manipulation. 

The CFTC’s previous efforts, including a 2023 whistleblower alert on carbon credit quality and the formation of an environmental fraud task force, illustrate that federal regulators are aware of the risks that junk credits pose to otherwise well-functioning markets. The upcoming guidance is an important next step and is expected to detail what information must be provided in contracts for derivatives that include bundled carbon credits. 

As a critical first step, the CFTC can strengthen quality standards related to carbon credit characteristics, improve data requirements for risk ratings, and require detailed project-level information for bundled carbon credits. Setting a high bar for quality standards, risk, and transparency will help weed out bad actors and prevent price manipulation. While this is one of many actions government regulators and agencies can take to restore investor confidence, strong guidance from the CFTC will signal that regulators are taking market oversight seriously.

Kathy Fallon is the director of the land systems program at Clean Air Task Force. The opinions represented in this contributed article are solely those of the author, and do not reflect the views of Latitude Media or any of its staff.