Podcast - Cracking Down on Carbon Markets: CFTC and FTC Exercise Heightened Scrutiny

Halley Townsend: Welcome to a podcast by Holland & Knight's Greenwashing Mitigation Team on the CFTC's and FTC's recent actions in the carbon market space. So today we're going to be talking about all things greenwashing, the CFTC's new Environmental Fraud Task Force, how that relates to the FTC's updates to the Green Guides and how that could impact your businesses' trade and carbon offsets, as well as claims related to your businesses' use of carbon offsets. If you haven't listened to Alex Holtan and Andy Kriha talk about voluntary carbon markets in our March podcast, we highly recommend that as background. We also just put out an alert on this topic on August 14, if you want to read more. So without further ado, we'll introduce ourselves and I'll go first. My name is Halley Townsend and I'm an associate in the Public Policy & Regulation Group in Holland & Knight's Washington, D.C., office. My practice focuses primarily on regulatory issues arising from CFTC regulations and guidance in the derivatives area, as well as various EPA programs impacting businesses in the renewable fuels space. Andy, do you want to tell our listeners a little bit about yourself?

Andy Kriha: I'm Andy Kriha, I'm an associate in our Washington, D.C., office. My practice focuses largely on regulatory and compliance matters with carbon markets, both compliance carbon markets and voluntary carbon markets. I also do transactional work related to the trading of carbon offsets and other environmental attributes, and I do general decarbonization strategies. I help companies determine how best to monetize the carbon reductions that they make and also help companies purchase environmental attributes and structure claims around those purchases. Alex.

Alex Holtan: Thanks, Andy. I'm Alex Holtan, I'm a partner in Holland & Knight's D.C. office. My practice is focused on the trading of commodities and derivatives, and most relevant for today's podcast, I represent clients in connection with CFTC and exchange enforcement actions, provide clients with regulatory advice on compliance with CFTC matters, as well as provide advice to a number of clients on the intersection of climate regulation and the trading of financial products.

Background: CFTC, FTC and Carbon Offsets

Halley Townsend: Thanks, Alex and Andy. So I'm just going to jump right in. And to give a little bit of background, there are two main federal agencies we're going to be talking about today. The CFTC refers to the Commodity Futures Trading Commission, as well as the FTC, which is the Federal Trade Commission. And among other things, the CFTC enforces against fraud and manipulation in physical commodity markets. And among other things, the FTC enforces against fraudulent or deceptive claims made about products or services. So now we're going to talk about carbon offsets. Andy, can you tell our listeners what carbon offsets are?

Andy Kriha: So at the most basic level, a carbon offset is an instrument that's created when one company reduces its carbon emissions beyond what it is allowed to emit or actually removes carbon from the atmosphere and then sells the right to make any claims about those carbon reductions to another company or person. The purchasers are usually buying these so that they can claim that a product or an activity or in some cases their entire business is net zero or carbon neutral or something along those lines. And so that's where these can get really hairy, because in order for those types of claims to be true, the carbon reduction has to be what's known as additional. And that means that it's in addition to any reduction that's required by law or any reduction is beyond the business as usual scenario. So if a company claimed a tax credit in association with reducing its carbon emissions and that tax credit would have been enough to make the activity profitable, then also selling an offset arguably could be fraudulent.

At the most basic level, a carbon offset is an instrument that's created when one company reduces its carbon emissions beyond what it is allowed to emit or actually removes carbon from the atmosphere and then sells the right to make any claims about those carbon reductions to another company or person.

Physical Delivery of Offsets and Size of Carbon Markets

Halley Townsend: Thanks, Andy. And I would just add that there are futures contracts on various types of carbon offsets, many of which allow physical delivery of the offsets at settlement. And this is how the CFTC's anti-fraud authority will kick in, which we'll discuss a little bit more in a few minutes. Alex, can you explain more about how this physical delivery of offsets works and also tell our listeners about how big carbon markets currently are and are expected to be?

Alex Holtan: Sure, happy to, Halley. So as you noted, the tie-in to the futures market through the physical delivery of offsets is one of the bigger jurisdictional hooks that the CFTC has into the voluntary carbon market generally, and we'll get to, to that in more detail a bit later in the podcast. But in terms of the mechanics of delivery, a number of exchanges, both primarily here in the U.S., the CME Group and the Intercontinental Exchange list, contracts based on a variety of different kinds of voluntary carbon offsets with the ability to essentially go to delivery once those contracts expire. So if you were to hold a, say a CMEG contract to expiry, you would take delivery if you are the buyer of a qualifying carbon offset through the CME settlement process. ICE, as I mentioned, also offers a number of environmental product futures contracts where you can take delivery of instruments like California, carbon allowances — not a topic for today — and a number of different instruments in Europe as well. So they're frequently used and actively traded. And many of our clients will use these futures contracts to actually take delivery and buy or sell offsets in terms of the voluntary carbon market or voluntary carbon offset market globally. Estimates are that at this point, or maybe in 2022, the market size was about $2 billion, with projected growth going upwards of $10 billion by 2030. I think one interesting fact here is that the growth has actually stalled within the last year or two, inconsistent with prior expectations. And some of what we're going to talk about today in terms of the uncertainty around the quality of carbon offsets, I think that's one of the driving factors behind the stalling growth in these markets.

I think one interesting fact here is that the growth has actually stalled within the last year or two, inconsistent with prior expectations. And some of what we're going to talk about today in terms of the uncertainty around the quality of carbon offsets, I think that's one of the driving factors behind the stalling growth in these markets.

The FTC's Updates to the Green Guides

Halley Townsend: Thanks, Alex. So transitioning to talk a little bit about what the FTC has been up to in this space. So Andy, can you tell us what the FTC has been doing with respect to carbon offsets and this update to the Green Guides?

Andy Kriha: Yeah, the FTC has pretty broad authority under the FTC Act to prosecute what are known as unfair and deceptive practices. And so this authority isn't really defined. And so the FTC over the years has given various guidance on how it interprets the authority, what it considers to be unfair or deceptive for specific sectors in specific markets. In 1992, it created the Green Guides, which are its definitive interpretation on its authority for environmental based claims. The Green Guides are broken down into various topics, including claims such as organic, but also claims related to carbon offsets and claims related to recs. The guides were last updated in 2012, and so the FTC has decided that with renewed interest and renewed focus in this area, it should probably update the guides, since there hasn't really been much enforcement in this area to interpret what kind of claims are acceptable. So last winter it released a request for information. It collected comments from the public throughout the spring. And these are all going to lead to updates to how it evaluates claims such as the ones I mentioned earlier, carbon neutral net zero, as well as low carbon and carbon negative, when those claims are based off of the purchase and use of offsets. At this point it's just a request for information. So it will have to digest that information and actually update the guides. Because this is non-binding guidance, it could just update the guides without additional public input, although I don't think we expect that to happen. I think once they have some language that they like, they will put that out for more public comment. But also they're taking comments on whether or not they should turn this from non-binding guidance into binding regulation. And if they do that, then they would definitely need to go through another round of public comment likely next year or sometime.

The Green Guides are broken down into various topics, including claims such as organic, but also claims related to carbon offsets and claims related to recs. The guides were last updated in 2012, and so the FTC has decided that with renewed interest and renewed focus in this area, it should probably update the guides, since there hasn't really been much enforcement in this area to interpret what kind of claims are acceptable.

The CFTC's Jurisdiction Over Carbon Offsets

Halley Townsend: Yeah, and I would just throw in that Andy wrote a great alert in June about the update to the Green Guides. So if you want to learn more, you should check that out. So now we're going to transition to talk about what the CFTC has been up to. So Alex, first, can you tell us a little bit more about what the CFTC does and how that relates to carbon offsets and claims that businesses can make about their use of offsets?

Alex Holtan: Sure. So the CFTC or Commodity Futures Trading Commission is the primary derivatives regulator here in the U.S. They have jurisdiction over the over-the-counter swaps markets and the futures markets as we have noted earlier. For the derivatives markets that it regulates, the CFTC has the authority to put in place what I'll call proactive compliance obligations or regulations. So rules around things like reporting, margining, the process for entering into transactions, registration of market participants, etc., essentially a financial markets regulator. When it comes to the prosecution of fraud and manipulation, the CFTC's jurisdiction goes broader than just the derivatives markets and can reach the underlying physical commodity markets. Their strongest jurisdictional hook is to markets where there are related listed futures. But arguably the CFTC can reach fraud manipulation in any commodity market here in the United States. In terms of its focus on carbon markets, this has been an area where the current CFTC chairman, going back to when he was just a commissioner, Commissioner Benham, now Chairman Benham, has really put some emphasis in terms of the commission and the use of its resources. So they've held a number of meetings. They've looked at this issue in a number of different contexts. But, Halley, why don't you tell the group a bit about what the enforcement division at the CFTC has been doing since that's most relevant to today's podcast?

So the CFTC or Commodity Futures Trading Commission is the primary derivatives regulator here in the U.S. They have jurisdiction over the over-the-counter swaps markets and the futures markets as we have noted earlier.

The CFTC's Enforcement Division and Environmental Fraud Task Force

Halley Townsend: Sure. So earlier this summer, within a little over a week of each other, the CFTC issued a whistleblower alert, and this sought tips related to misconduct in carbon markets, and then announced the creation of a new task force called the Environmental Fraud Task Force. And at the time, the CFTC Director of Enforcement Ian McGinley said the Environmental Fraud Task Force will focus on addressing fraud and manipulation in carbon credit markets. And here's where I think it's interesting, as well as other forms of greenwashing, including material misrepresentations about ESG investment strategies. And then the way the whistleblower program works is this program offers a monetary reward not only to the victim of the fraud, but also to any company insiders and any other market participant who voluntarily provides information about violations of the Commodity Exchange Act or CFTC regulations that ultimately lead to successful enforcement. So we anticipate that the Environmental Fraud Task Force will use this whistleblower alert as a tool to gather information to bring cases. And the whistleblower alert is sort of most helpful here because it lists out specific types of conduct and misconduct that the CFTC is looking for in assessing potential violations here. So the CFTC is interested in manipulative and wash trading or other violations of the Commodity Exchange Act in carbon market futures contracts, fraud in the underlying spot markets related to ghost or illusory carbon offsets listed on carbon market registries, double counting, which is when the same offset is claimed by more than one entity without an additional carbon benefit. And this relates back to what Andy was talking about earlier with additionality. It's also looking for other fraud related to carbon offsets and fraudulent statements relating to material terms of the carbon offsets and finally manipulation of tokenized carbon markets. So some of these descriptions are super broad. Alex, what does this all mean for clients wishing to trade carbon offsets or make claims about their use of carbon offsets? And what does the creation of this new task force mean?

So the CFTC is interested in manipulative and wash trading or other violations of the Commodity Exchange Act in carbon market futures contracts, fraud in the underlying spot markets related to ghost or illusory carbon offsets listed on carbon market registries, double counting, which is when the same offset is claimed by more than one entity without an additional carbon benefit.

Alex Holtan: Good question Halley. And what I think we're seeing here from the CFTC is a clear public statement that they are going to do everything within their power to regulate the space. And because of the scope of their jurisdiction, they can't really set rules and regulations or standards for the market proactively. The only hook they have here is their anti-fraud, anti-manipulation authority. So that's the stick that they're going to wield. There have been a number of different articles, publications and the like that have delved into the various issues that the voluntary carbon market is having with things like projects, overestimating the amount of emission reduction generated by a particular project, double counting, which we've covered multiple times here, selling more offsets than, you know, than is viable under a particular project and just outright fraud selling offsets for projects that do not exist. And I think the CFTC has rightfully identified this as an issue holding back the growth in this market. Essentially, there are a number of large corporate investors or corporate companies that were users of carbon offsets that have taken a step back or limited the types and amount of offsets that they're using because of concerns regarding the validity of the instruments themselves. So this is the CFTC signaling, you know, if you are going to be a bad actor in this space or if you're just going to be an entity that doesn't do the required diligence, we are going to come after you to the extent that our jurisdiction allows. So it will look at the types of behavior the CFTC has classically regulated and prosecuted things like manipulative and wash trading in carbon offset related futures, but also things that go down to more of the project level and for voluntary carbon offset projects. So that would be, you know, fraudulent statements relating to the terms of an offset or the characterization of a project and also the claims that market participants are making based on their use of offsets. So things like, again, like double counting and marketing claims. So, you know, this I think is the CFTC making a broad and loud statement as to the scope of their jurisdiction here and the fact that they are paying attention. What will be interesting going forward is the extent to which the CFTC plays a lead role in some of these prosecutions, or whether they cooperate with a regulator like the FTC or perhaps some state AG's offices in bringing fraud or greenwashing cases.

So, you know, this I think is the CFTC making a broad and loud statement as to the scope of their jurisdiction here and the fact that they are paying attention.

FTC's Authority Over Carbon Markets and Climate Claims

Halley Townsend: Thanks, Alex. That's really helpful. All this discussion of enforcement in this space has me curious. What exactly is the FTC's and the CFTC's authority over carbon markets and climate claims? Andy, can you explain a little bit more about the FTC's authority in this area?

Andy Kriha: Absolutely. So, you know, I mentioned above that the Green Guides are non-binding guidance, but that just means that the FTC could be more strict or less strict than the specific bounds that they set out. Their authority in this area is still very much real. The FTC has authority when they deem a practice to be unfair or deceptive, to investigate, and then if they determine there's a violation, they can institute an administrative process or a judicial process to enforce against those violations. Technically, the FTC's authority extends to any unfair or deceptive practices in the market. When we're looking at the Green Guides, we're specifically talking about marketing claims. And so that can mean, you know, the seller of a carbon offset to the buyer of a carbon offset. But as of right now, those are generally pretty niche markets, and the people participating in them are generally fairly sophisticated. The FTC's focus is really more broadly on consumer protection. So I think it's fair to expect that they'll be looking more at the advertising that occurs by the purchasers of the carbon offsets. So if you're a company that bought carbon offsets and you're putting an ad on television saying our product is carbon neutral, our business is net zero and you can't back up those claims, that's, those are the type of entities that are going to be the focus of the FTC's authority in this area. And so really, you just have to be good about doing your due diligence, making sure that the offsets that you're buying are legitimate and valid and additional, and then also appropriately qualifying their claims when you craft them and covering yourself off from some of that risk.

The FTC's focus is really more broadly on consumer protection. So I think it's fair to expect that they'll be looking more at the advertising that occurs by the purchasers of the carbon offsets.

CFTC's Authority of Carbon Markets and Climate Claims

Halley Townsend: Thanks, Andy. Alex, what about the CFTC? We've already kind of hinted at it, right. But what is the CFTC actually allowed to do in the carbon markets and climate claims space?

Alex Holtan: Sure. So, you know, as we've touched on earlier in the podcast, the CFTC has anti-fraud, anti-manipulation authority in the physical commodity markets here in the U.S. Historically, they've looked at the commodity markets tied to listed futures contracts. But, you know, that authority can go beyond commodities where there are currently listed futures contracts to essentially any sort of commodity which you could theoretically list a futures contract on in the future. And commodity here is really thought of in a very broad sense. It includes what you would think of wheat, oil, electricity, natural gas and metals, but it also includes in a number of intangible attributes like environmental credits. So carbon offsets, RINs, your RGGI certificates, as well as things like crypto. So, in terms of, you know, the CFTC's ability to extend its authority into physical markets, so in this case voluntary carbon offset markets, it's helpful to look at what they've done in the past in both the precious metals space of physical precious metals and, more recently, the crypto space where, you know, they have gone aggressively after bad actors, especially in the context of fraud and deception. And there have been a few circumstances where, you know, the targets of their investigations have challenged in court the scope of their authority and their ability to bring fraud cases in particular in connection with physical activity. And one of the more recent cases I'm thinking of is the Monex case where the Ninth Circuit confirmed the fact that the CFTC in that case had the ability to reach into physical precious metals markets and essentially reaffirmed the CFTC's authority to go after misconduct in physical commodity markets. So, you know, I think it's not necessarily settled law at this point that the CFTC can actively go after bad actors in the carbon offset space. But, you know, reasoning by analogy and looking at the broad breadth of precedent in the space, I think the CFTC is quite comfortable that they really do have the authority under the Commodity Exchange Act to follow through with their, you know, essentially the threats made in the whistleblower alert and with the task force that they've set up on environmental issues.

The CFTC has anti-fraud, anti-manipulation authority in the physical commodity markets here in the U.S. Historically, they've looked at the commodity markets tied to listed futures contracts. But, you know, that authority can go beyond commodities where there are currently listed futures contracts to essentially any sort of commodity which you could theoretically list a futures contract on in the future.

Will the CFTC and FTC be Impacted by The Supreme Court's Review of Agency Authority

Halley Townsend: So the CFTC and the FTC may feel pretty confident about their authority in this space. But Andy, how does this fit into the Supreme Court's upcoming review of agency authority in general?

Andy Kriha: So there's been a trend the last couple of years that is really going to accelerate in this coming term where the Supreme Court has been chipping away at agency authority. They've been particularly focused on instances where they think statutes are ambiguous and agencies are using that to broaden into areas that weren't necessarily intended by Congress or areas where the law is just extraordinarily broad. And the court views that as granting the agency too much power. You know, with the FTC in particular, the FTC Act really kind of falls into that overbroad category where the court had a case last year called West Virginia v. EPA, where it decided that where there's a broad grant of authority to agencies, if the agency uses that, to kind of deviate from the norm, from kind of its wheelhouse of where it's regulated in the past and really extend that authority to its limits, that the court can knock down those regulations and rein it in. There is an upcoming case in this term called Jarkesy v. SEC, where the court could theoretically take that to the next level and say under a theory called the non-delegation doctrine, that when agencies are given too much authority, that the entire law is invalid. For reasons outside the scope of this podcast, I don't think that's necessarily going to happen with this case, but it is something to watch and a direction the court is going. So when we specifically look at it in terms of the FTC, their authority is extraordinarily broad, unfair and deceptive practices. That's not defined. They get to choose. So when the FTC wades into an area like carbon markets and starts looking technically at things like additionality and what makes a carbon credit valid, you know, the court might start to think it's looking more like an environmental regulator than a consumer protection regulator and could potentially knock down that authority and say you're really, you've gone too broad, you've gone outside of your wheelhouse, and potentially the same for the CFTC. So definitely something to watch as these two agencies kind of enter this market.

Halley Townsend: Alex, do you have anything to add from a CFTC perspective, or does that about cover it?

Alex Holtan: Well, I mean, I think with the CFTC’s jurisdiction, we perhaps have a bit more to go on as to the historic interpretation of the scope of the jurisdiction and the court’s comfort with it. I mean, to sum up in the precedent, essentially the stronger the tie between the action the CFTC is taking and the futures market or, you know, over-the-counter derivative, you know, the better off the CFTC will be from a jurisdictional perspective. You know, for example, if the type of attribute underlying the claim the CFTC is making is linked to a futures contract and actively traded in the U.S., I think it's clearly within the CFTC's wheelhouse to bring, and jurisdiction to bring, an enforcement action in that circumstance. If we are talking about fraud linked to a project in Indonesia, for example, does the CFTC have the authority under the Commodity Exchange Act to bring an enforcement action when there's no related derivatives trading with the U.S. person? I think that would be a stretch. And whether that's something a court would generally look at and disapprove or whether it would come out or that would be an issue under the Supreme Court's recent rulings and potential rulings that Andy mentioned, we'll be interested to see. But, you know, I think that the CFTC is quite cognizant of the fact that they are new in the space. They want to exercise jurisdiction to lay a marker. But I can also see them being somewhat cautious in the first few cases that they bring to make sure they pick fact patterns that are clearly within the scope of their jurisdiction to establish their right to prosecute in voluntary carbon markets.

I think that the CFTC is quite cognizant of the fact that they are new in the space. They want to exercise jurisdiction to lay a marker. But I can also see them being somewhat cautious in the first few cases that they bring to make sure they pick fact patterns that are clearly within the scope of their jurisdiction to establish their right to prosecute in voluntary carbon markets.

Closing Thoughts

Halley Townsend: That makes sense. Thanks, Alex. So as if there wasn't already enough going on in this space, to bring this to a close, it's worth noting that the CFTC and the FTC are not the only agencies asserting jurisdiction over carbon markets. In addition to these two agencies, the Securities and Exchange Commission, Department of Labor and the Federal Energy Regulatory Commission have all indicated that they're at least looking at environmental markets and potential misconduct. Andy, did you have anything to add as we wrap this up?

Andy Kriha: Sure. I mean, I think the big takeaway here for me is there's going to be a lot of uncertainty and recent actions by these agencies, as well as lawsuits that have been brought in state courts, lawsuits that are likely to come, are only going to continue to inject some uncertainty into this market. But, you know, I don't want the takeaway to be that you shouldn't get involved in carbon offset markets or that you should engage in some of these new things we've heard about, like greenhushing, where you take good environmental action, but then don't advertise it because you're afraid of the FTC or state regulators. You know, there is still a tremendous opportunity in this market as long as you do your due diligence, as long as you are engaging in projects that are verifiable and additional. And when you make claims based on them, you know, you're talking to your lawyers and crafting the claims appropriately, it's really just going to increase the value, I think, of those offsets that are real and verifiable. And so still a lot of opportunity in this market and still can absolutely be a cornerstone of at least the short- to medium-term decarbonization strategy for most companies.

I don't want the takeaway to be that you shouldn't get involved in carbon offset markets.

Halley Townsend: Thanks, Andy. Alex, did you have any final thoughts?

Alex Holtan: Sure. So I would echo Andy's theme there on uncertainty in these markets. I think over the short to medium term, we are going to see a combination of regulator action to try to bring some certainty, whether it's the FTC or the CFTC or perhaps others, and voluntary action by market participants to try to do things like setting up standards or conduct standards or standards for particular types of, you know, more valid offsets in an effort to bring stability and clarity to the market and give people comfort that the products that they are buying are, in fact, what they say they are. And I would echo Andy's advice on not taking this uncertainty as a reason to avoid the markets altogether, just more as a signal that, you know, you need to be diligent, you need to be somewhat conservative in the way that you approach your use of offsets and your trading of offsets. But as long as you do your diligence and you are conservative, don't push the envelope, there is incredible opportunity here, especially perhaps because of the uncertainty in the markets.

I would echo Andy's advice on not taking this uncertainty as a reason to avoid the markets altogether, just more as a signal that, you know, you need to be diligent, you need to be somewhat conservative in the way that you approach your use of offsets and your trading of offsets.

Halley Townsend: Thank you both. I think, as you have both said, it's a very, very developing area. And I would just end by saying we would be happy to discuss anything we talked about today in more detail as needed.