New CFTC Enforcement on Carbon Markets Misconduct

Introduction

On June 20, 2023, the United States Commodity Futures Trading Commission ("CFTC") Whistleblower Office, a unit of the agency's Division of Enforcement ("DOE"), issued a rare alert, soliciting tips about potential fraud and manipulation in the carbon markets. This is an exceedingly unusual move by the CFTC. It signals an aggressive new posture in its regulation of the nascent market for carbon allowances, carbon credits, and other environmental commodities, including "tokenized" credits. Less than two weeks later, the CFTC announced the formation of a new DOE Environmental Fraud Task Force ("EFTF") to "combat environmental fraud and misconduct in derivatives and relevant spot markets." The EFTF will be comprised of DOE attorneys and investigators who will prosecute cases, serve as subject-matter experts, and coordinate efforts with the CFTC's other divisions and offices.

Background

The CFTC has been an early mover among federal financial regulators in asserting jurisdiction over the carbon markets. In fact, on March 17, 2021, the CFTC established a Climate Risk Unit ("CRU") to focus on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy. The CRU is comprised of staff from across the CFTC's operating divisions and offices. 

Last year, the CFTC hosted a public carbon markets convening. Participants in the convening discussed potential challenges with access to high-quality carbon credits and allowances. Afterwards, the CFTC issued a request for information ("RFI") on voluntary carbon markets. Among other things, the RFI sought comment on whether those markets are susceptible to fraud and manipulation. 

To build upon information gathered at the first convening and public comments submitted in response to the RFI, the CFTC hosted a second carbon markets convening on July 19, 2023. This latest convening began with the agency sharing its two main takeaways from the public input it received: (i) the CFTC should employ comprehensive anti-fraud and anti-manipulation enforcement authority; and (ii) the agency should support the establishment of standards that will expand the use of high-integrity carbon offsets. This convening also commenced the CRU's workstream to draft agency guidance regarding voluntary carbon market standards for the CFTC to review. To assist the CRU in preparing its recommendations, the CFTC also held discussions on the following topics: 

• Recent private sector initiatives for high-quality carbon credits; 
• Current trends and developments in the cash and derivatives markets for carbon credits; 
• Public sector initiatives related to carbon markets; and 
• Market participants' perspectives on how the CFTC can promote integrity for high-quality carbon credit derivatives.

Whistleblower Alert and Environmental Fraud Task Force

The press release announcing the whistleblower alert highlighted that potential fraud in carbon markets includes manipulative and wash trading, "ghost" credits, double counting, fraudulent statements relating to material terms of the carbon credits, and potential manipulation of tokenized carbon markets. The whistleblower alert and the creation of the EFTF are likely outgrowths of these other recent efforts to understand the carbon markets. The EFTF, among other things, is empowered to examine fraud with respect to the purported environmental benefits of purchased carbon credits and material misrepresentations regarding ESG products or strategies. In announcing the formation of the EFTF, CFTC Chairman Behnam stated that the creation of the EFTF "demonstrates the vigorous and forward-looking approach the CFTC will take to address misconduct in th[is] critical area[]."

These actions and the statement made by Chairman Behnam indicate that the CFTC will prioritize enforcement as it navigates its path forward in carbon markets. Regulation by enforcement is also the most logical path, as the CFTC does not have the authority to substantively regulate cash markets the way it does derivatives markets. 

Tips from whistleblowers often lead directly to CFTC investigations. Approximately half the CFTC's annual enforcement docket stems from whistleblower reports, and the rewards often are for several million dollars. So the financial incentives for tipping are real. Firms, therefore, should anticipate increased government investigations and monitor for settlements and other potential litigation by the CFTC. It therefore may be advisable for firms to consider developing whistleblower policies for their carbon market activities or applying existing policies to that activity. In doing so, firms may wish to consider evaluating whether those policies align with CFTC anti-fraud and anti-manipulation requirements.

To hear more about CFTC's enforcement initiatives for carbon credit markets, check out the Firm's Jones Day Talks podcast.