Podcast - Carbon Markets Lightning Round: State and Federal Updates

Andy Kriha: Welcome to this episode of An Energized Exchange. I'm Andy Kriha, an associate in the D.C. office of Holland & Knight, and I'm joined today by Alex Holtan, a partner also in the D.C. office of Holland & Knight. Today we are going to be talking about all things carbon markets, both voluntary and compliance. There's a lot to talk about here. A lot has happened recently, a lot is happening in the future, and we thought that this would be a good time to just give a very broad, general update of things that are happening, because, frankly, we've been getting a lot of questions from clients recently. Because of the breadth of what we're covering today, we're going to call this the carbon markets lightning round. We're going to be going through at a very high level, but hopefully letting you know what you need to know about the latest updates. And we will, of course, discuss in, more in depth in the future. So let's kick it off. Recently there were some federal voluntary carbon market principles released. Alex, can you tell us a little bit about that?

Alexander Holtan: Thanks, Andy. And you know, the recent action out of the Biden Administration is in the form of what is officially called the Voluntary Carbon Markets Joint Policy Statement and Principles. It was issued by some cabinet-level agencies, specifically Treasury, Agriculture and Department of Energy, as well as the administration's climate adviser, John Podesta. So, I think it's evidence that this is something the administration strongly supports in the form of well-functioning voluntary carbon markets. The document is short. It lays out a number of principles that the administration believes should, should be observed and will lead to well-functioning voluntary markets. But it's just that: It's a statement of principles, it's guidance and supportive. It is not a sign of further, you know, actual official government regulatory action to come. And if you dig a bit deeper into, you know, the principles themselves, they should be quite familiar to those that have followed developments in voluntary carbon markets recently. They're, they're similar to, for example, the Integrity Council for Voluntary Carbon Markets' Carbon Core Principles, and they overlap with the Voluntary Carbon Markets Initiatives' Claims Code. So, you know, I think this is reinforcing what the voluntary carbon markets community has been doing already, but for various reasons that I think we've discussed before, there's not much else the administration can do here other than show its support. There's really a statutory gap in the regulatory universe here in the U.S., where we don't have a particular regulator that has the authority to impose rules and regulations on voluntary carbon markets.

Andy Kriha: Great. Thanks for that, Alex. And you know, I have to say, I agree with everything you just said. This really does feel like, you know, predominantly a signaling effort to show the business community that the administration is behind carbon offsets without saying it forcefully in a way that might turn off certain other parts of the electorate, such as environmentalists. So will be interesting to see what comes if this administration is still around after the election. So moving on, last year, the CFTC formed an environmental commodities task force. Can you tell us a little more about what they have been up to since that started?

Alexander Holtan: Good question, Andy. And a question that we've received from a number of different clients. The long and short of it is there have been no public enforcement actions undertaken by the Environmental Fraud Task Force. However, I, you know, recent CFTC statements, public statements have indicated that there are several activities under active investigation by the commission, and that we may see some form of, you know, sign of that activity in the not-so-distant future. That's a long way of saying our view is that the the Division of Enforcement at the CFTC likely has a number of ongoing investigations and inquiries in the carbon space, and that they believe at least one or two of them will reach a point of resolution probably before the end of the fiscal year for the federal government, which is September 30. We typically see of a flood of enforcement actions settled before that date for a number of different reasons, so I wouldn't be surprised to see one or two carbon-related enforcement actions at the end of September this year. And one more thing to mention about the CFTC that they did issue, you know, guidance with respect to the voluntary carbon credits that underlie listed futures contracts and, you know, provided guidance that was effectively a roadmap for the exchanges that list those futures products to verify and validate the underlying carbon offsets for the particular contracts. I think we've discussed this previously, at least you and I have, played the markets, but they're signaling to the exchanges that they expect them to do a fair amount of diligence on the voluntary carbon credits that underlie their futures contracts and that they can't just push off that, that effort to third parties, that the exchanges may have some liability here if it turns out, for example, fraudulent voluntary carbon offsets were delivered under a futures contract listed by their exchange. That was proposed, you know, earlier, and we should see, I would expect final guidance before the end of the year, probably before the end of September, as well.

Andy Kriha: Great. Thanks for that, Alex. Next, you can't talk about carbon without talking about California. That is where a lot of the action is, and it's no different here. We have three different items out of California to talk about today. And the first one — not directly carbon markets-related, but could have a rather large impact nonetheless — is this tax ballot initiative. So pending some things we're going to talk about at the end of the discussion here, this measure will appear on the California ballot this November, to be voted on by the people. Plenty to discuss. This could be its own two-part episode by itself. But suffice it to say that if passed, this measure would make it significantly more difficult to pass any sort of tax increase or new tax in the state of California. This matters for us because there's been kind of this open debate for a while about whether or not California's cap and trade program qualifies as a tax. The last time the program was extended, they were very careful to make sure they got enough support that it would remain valid whether or not it was considered a tax. And so we've avoided actually having to have a court answer that question so far. But if it passes, if the court decides that it is a tax, then it could be significantly harder to extend the cap and trade program beyond its current 2030 end date. It's also less clear if a rulemaking, such as the one that we're about to talk about — that is a rulemaking with an existing program, but nonetheless could have the effect of increasing carbon allowance prices — might also be considered a tax and be drawn in. There's a few hurdles other than just merely passing on the ballot this November. First of all, there is a challenge in the courts to whether or not this can even be placed on the ballot. That is currently in front of the California Supreme Court. Oral argument was in early May, that decision is still pending. And then second, the state legislature placed another initiative on the ballot that would require this measure to pass with a two thirds majority instead of a simple majority of the people. And it's unclear if both were to pass, whether or not the legislature's initiative could, you know, retroactively, or at least simultaneously, apply to this initiative. So that's something to watch. That's something that I am certain we'll be talking about in more depth, probably with our California colleagues, as we approach the election — unless, of course, the Supreme Court knocks it off the ballot earlier.

Next up from California, as I alluded to, there is a rather large rulemaking going on for the cap and trade program. This rulemaking is meant to align the cap and trade program with the 2022 scoping plan, which is a large-scale plan that is meant to update all of California's various climate-related goals and regulations. The cornerstone of this rulemaking would be increasing the program's stringency for the remaining 2025 to 2030 period, as well as to revise post-2030 budget allowances, assuming the program is extended. It also includes changes to corporate associations, disclosure and aggregation rules, which I'm going to ask you about, Alex, in a minute. But quickly, the other things it does is update free allowance allocations to certain industries, minimizes emissions leakage in the electricity sector and ensures compliance obligations are applied consistently to imported electricity. It replenishes the voluntary renewable electricity reserve and implements various streamlining rules such as changes to the market monitoring rules and updated compliance offset protocols. But before we get to the timing of when we might see that rule, one thing that is very important to our client base, Alex, is these corporate disclosures and aggregation. So can you talk a little bit more about that?

Alexander Holtan: Sure, happy to. So the California cap and trade rules require certain types of disclosure based on a number of different factors, but they essentially, if there's an existing corporate association between account holders, certain types of disclosure have to happen. And the triggers for that corporate association can be things like joint ownership, joint control, access to market position information, are really the big three. And California has taken or — CARB, more accurately, has taken — a look at their corporate association rules and decided that they, they want to tighten them up for a handful of reasons. In addition to disclosure, if you have what's called a direct corporate association between entities with accounts, this could actually trigger a joint holding limit. So subjecting two accounts to the same holding limit, greatly reducing the amount of exposure that you can get to this particular market. So for voluntary participants that are playing in this market for investment purposes, these rules can have some pretty significant impacts if you're found to have a, especially a direct corporate association across accounts.

So CARB proposed three different potential tweaks to their corporate association rules. One, they're looking at individuals with shared roles. While it's a large market from a global emissions trading perspective, it's a small universe of individuals who are expert in this market. And there are a lot of overlaps between advisers and consultants in the space. So CARB has, has taken note of this and is trying to both limit the ability of those outside advisers and consultants to influence trading decisions across numerous accounts, and then also, you know, tighten up the triggers too, and to aggregate when individuals with shared rules do, in fact, have the ability to control decision making across more than one account. They're also looking at circumstances where there are investment advisers. And, you know, a number of different forms that have the ability to at least suggest trading decisions to participants with, or to multiple market participants, and having that trigger a potential aggregation requirement in the form of a direct corporate association. And then lastly, in circumstances where the same company or individual has the ability to appoint directors or advisers or investment managers over entities that control, or have the cap and trade accounts, there's a potential obligation to aggregate there in the form of, again, a direct corporate association. So this is all something that CARB is looking at closely. You know, one of the, one of the advantages to CARB, if they were to go forward with these changes as proposed, is that from their perspective, it would free up potentially 30 million allowances for the rest of the market. So effectively, you know, a portion of what's being called but held by passive investors would get returned to the market, increasing liquidity and probably holding prices down to some extent. The impact on the market could be pretty significant, but that's really dependent on the compliance timeline that CARB decides to attach to whatever the final rulemaking looks like. They suggested that compliance for the corporate association changes could be as little as 30 days. So, you know, effectively trying to free up 30 million allowances in 30 days could have a pretty significant market impact. Or, this could stretch out as far as seven years where, I think the impact would be pretty muted on market integrity. But, Andy, in terms of timing for the rulemaking generally, what are your thoughts?

Andy Kriha: Yeah. You know, it's a little bit hard to say. CARB has been holding several workshops with the public and various stakeholder groups to discuss the changes. The only thing they've said publicly is that they plan to release the proposed language in the coming months. However, once they release the proposed language, there's a minimum 45-day comment period before the board can actually vote on and finalize the rules. There's some pretty strong incentives for them to get this done this year and make it effective January 1 of '25. Mostly just because they are running out of time to achieve these scoping plan goals and make changes to the 2025 compliance year that will set them up for success for the remainder of the existing program. But, you know, I analogize to the LCFS rule, which Susan Lafferty and I talked about in a previous podcast. That rule was originally supposed to come out sometime last year. They finally released a proposed language in December with a date of March of this year for finalization. They got an overwhelming number of comments during that 45-day comment period and ultimately delayed a vote until November 8 of this year. Really, you know, over a year delay from what they were originally thinking when they released some, some partially drafted language in February of '23. So I think this rule could be even more contentious than that LCFS rule. And so, you know, it's difficult to say if they're going to hit that goal of getting it out this year or not.

The last thing from California to talk about before we move on to other states, are there voluntary carbon market regulations? A couple of things going on there. And our California colleagues have put out some great webinars on some of this already, and I'm sure will be continuing to put out more information as we go along, and we'll probably have them on future podcasts as well. But just as a quick update, California's new bill, AB 1305, which is one that passed last year, became effective January 1 of this year, and that requires public disclosure on a company's website of a lot of information related to the sales and purchases of carbon offsets and the technical basis of any marketing claims or public claims made about carbon reductions, whether or not those claims are based on the purchase and retirement of an offset, or, or if those reductions were made directly. In the weeks leading up to its effective date this past January, the bill's sponsor attempted to clarify his intent for the bill to be effective, actually in 2025. However, that was not written into the bill, and so that clarification has no legal force. That said, given the publicity around it, we're not aware of any attempts by prosecutors to initiate any cases so far this year and think it's unlikely any will do so. In the meantime, a bill is pending that would officially delay implementation until next year, and that bill has passed the Assembly and is currently being considered in the Senate. There's one other bill, SB 1036, which would make it illegal for any person to certify or issue a voluntary carbon offset if that person knows or has reason to know that the associated GHG reductions are unlikely to be quantifiable, real or additional. A variation of that bill passed both houses of the California legislature last year, but was vetoed by the governor because of concerns that it would be difficult to administer and could draw in good faith actors. In our most recent conversations with our California colleagues, I think they were of the belief that this bill is likely to pass again, and if so, it's hard to see the governor vetoing it again. So that is definitely something to watch as well.

But, California has taken up enough of our time now, so let's move on to Washington. Two big things to talk about in Washington today. The first is another ballot initiative. In this case, there is a ballot initiative that will be voted on by the citizens of Washington in November that would repeal the existing cap and trade program and prohibit state agencies from implementing a cap and trade program or carbon tax under any existing authorities. Under Washington law, that would restrict the legislature from passing any new cap and trade law or carbon tax for two years. But after that, the legislature could pass laws to, to implement any such program. The state legislature could propose a competing ballot measure, but as of now, it does not appear to do so. That's probably because any competing measure, if passed, would also lock in the program for two years, which would potentially complicate Washington's efforts to link its program with California and Quebec. So that segues us nicely into our second Washington discussion, which is linkage. Washington announced earlier this year that it plans to pursue linkage of its program with the California and Quebec programs, which are already linked to one another. The three governments expressed a mutual interest in linkage in a joint statement back in March. The Department of Ecology in Washington has identified several changes to the cap and trade rule that would need to be made in order to align the program with these other programs. It includes holding limits, which we talked about the California context already, registration requirements, the use of carbon offset credits, among many other items. There's a while to go yet in this process. First, an agreement between the three jurisdictions would need to be negotiated. All three jurisdictions would need to make some amount of rule changes in order to align the programs together — of course, the biggest ones would be in Washington. The Department of Ecology is publicly targeting early next year to finish its linkage efforts, which would imply an effectiveness of January 2026, in order to not disrupt that 2025 compliance year. But California is currently not considering linkage in its rulemaking. Given the negotiated agreement that has to happen, the rulemakings that have to happen, I am of the view, unless you disagree, Alex, that 2027 seems more likely.

Alexander Holtan: Yeah, I agree 100 percent. And I mean, I think this is the type of issue that, you know, can take a lot longer to resolve than initially anticipated. When you have three different jurisdictions that need to make overlapping regulatory changes, things tend to get complicated. And as you said, California didn't include changes that would be necessary for linkage in their current proposed rule. And it would be, I think, difficult for them to perhaps dual track their proposed changes to their cap and trade regulations with, you know, the needed changes for linkage. So it'll likely have to be a sequential process. So we'd have to wait and see what they get done on the current proposed changes to the cap and trade program, which, you know, in my view, we're probably going to bleed in for 2025 before they take up the pen on linkage. So, agree 100 percent, 2027. Perhaps even after that.

Andy Kriha: Great. So a few more programs to run through. I think these are going to be quite a bit quicker, maybe more of a true lightning round. First is Oregon. Oregon had a much more limited cap and trade program that involved natural gas utilities and fuel suppliers, only allowed a trading among obligated parties, did not allow outside participation. That program was invalidated by a court decision earlier this year. It was invalidated on procedural grounds, although the case in question also raised several constitutional questions. The Oregon regulator decided that rather than take its chances at the Supreme Court that the program would be struck down on constitutional grounds, which would make it more difficult to revive, they're going to restart the process, come out with a new rulemaking that will hopefully get more buy-in from industry and thus avoid a challenge, whether on procedural or constitutional grounds. So that rulemaking got kicked off this spring and is expected to go on for a few months with a target date of restarting that program in 2025.

Next up is New York. New York is required by statute to implement an economy-wide cap and trade program. I think we expect this to be far more similar to the California and Washington programs than to the Oregon program. New York has already missed that statutory deadline for creating the program. So clearly, deadlines not, not playing into their deliberations and how long they take. The state has publicly targeted finalization of a rule by the end of this year so that obligations can begin next year. Given the delays we've seen already, anybody's guess as to whether or not that happens. It has already gone through two separate rounds of pre-proposal public outreach. And the regulator's currently developing a formal regulatory proposal. Once we see that proposed language, there will of course be a notice and comment period and approval before it comes out. Remains to be seen. They have asked whether or not this should be something that is designed to potentially link with California, Washington and Quebec in the future. So we'll see if that is a route they pursue, or at least design it close enough to leave that on the table.

And the last program we're going to talk about here today is RGGI, or the Regional Greenhouse Gas Initiative. Just a couple updates here on two states that are part of that program and lawsuits that they have been going through. Virginia formally left the program effective January 1 of this year. That exit from the program was done entirely by executive action without the support of the legislature. A lawsuit was brought challenging the right to leave without a new statute. That lawsuit was delayed because some of the plaintiffs were dismissed as not having standing. The venue was deemed improper. It had to be moved to another county. That case is ongoing. There is still an effort under that case for a preliminary injunction that would require the state to remain in the program, pending a final judicial decision. But, no hearing has been scheduled to even make that injunction determination, and in the meantime, the state is outside of the program. Quick note, there was also an effort to rejoin the program via state budget legislation, but that effort failed in May. And last but not least, Pennsylvania. Pennsylvania technically joined RGGI in 2022, also via purely executive action without a statute, after some earlier lawsuits to prevent that executive action had failed. Very shortly after Pennsylvania joined and before they had an opportunity to participate in an auction or enforce any sort of obligations, an injunction was granted in another lawsuit that prevented participation. Most recently, in November of last year, a Pennsylvania court struck down the program on the merits. So it proceeded beyond that injunction phase and was definitively invalidated by a court. The state has appealed that decision to the state Supreme Court, but that decision is still pending with no timeline for, for when a decision could potentially be made. So there you have it. That is the state of play in carbon markets. Alex, any parting words for our audience?

Alexander Holtan: You know, I think one question that we've gotten frequently from clients from a variety of different backgrounds and industries is, you know, what impact will the federal elections have on carbon markets here in the U.S., especially if President Trump is reelected? And from my perspective, I think the answer to that is very little, other than the, you know, the, the principles, the voluntary market principles that we spoke about at the beginning of the podcast. Everything else we've talked about has largely been at the state level. And there's a reason why things have been concentrated at the state level here in the U.S., it's just that the federal government, for a number of reasons, hasn't been able to implement a nationwide carbon trading or carbon tax program, so it's a long way of saying from my perspective and, Andy, interested in yours as well, to the extent that we see a second Trump Administration, I think the states will continue to be the incubator, if you will, for carbon trading here in the U.S., and potentially there are ways that the Trump Administration could try to make that more difficult. But I don't necessarily see a sea change with these programs suddenly going away in the event of that particular outcome in November. But, Andy, what do you think?

Andy Kriha: Yeah. I mean, well, first of all, that is not a lightning round question. That is a seven-part series if we really wanted to answer this. But I think I largely agree with you, Alex. I think we'll continue to see a lot of state action. I don't think a Trump Administration would do much to roll back the little we have already seen at the federal level. It did not in the last iteration of that administration, and we frankly, to the extent there is federal enforcement capability, predominantly with the FTC, we haven't seen them really exercise that in the carbon market space at all to date. We'll note, I guess that does give a great opportunity to plug a future podcast coming likely next month. The FTC in a second Biden Administration would be expected to start enforcing greenwashing claims against users and sellers of voluntary carbon offsets, potentially through a new rulemaking related to the FTC Green Guides, or at least see finalization of updating the Green Guides, the guidance portion of the Green Guides, which is something that's been going on for quite some time. I think we will see the litigation around the FTC's recent non-compete rule have a major effect on their ability to regulate in the Green Guide area, which falls under a very similar authority stemming from the same section of the FTC Act. And so that litigation is something we will be talking about a couple of episodes from now and hope you all tune in for that. With that, thank you for listening, and I hope you join us next time.