By Suzanne Cosgrove
Members of the CFTC’s Market Risk Advisory Committee and its subcommittees met Monday to debate central counterparty clearing Risk and governance, celebrate LIBOR’s laborious transition to SOFR, fret over the future of finance and the challenges of digital assets, and set the stage for the Commission’s role as a regulator of the carbon credit markets.
Citing examples of the benefits of the committees’ collaboration, Commissioner Kristen Johnson noted the Commission last month approved a final rule expanding derivatives clearing organization (DCO) risk management regulations and creating additional opportunities to identify, mitigate, and manage DCO risks. “These amendments adopt the MRAC CCP Risk and Governance Subcommittee’s recommendations to enhance the Commission’s DCO governance standards,” she said in opening remarks.
Smooth SOFR transition. In addition, “the multi-year global effort to transition away from London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) will serve as a case study for successful public-private sector partnership,” Johnson said at the start of the MRAC meeting. It was a successful transition across uncleared and cleared over-the-counter markets, as well as exchange-traded derivatives markets, Johnson said.
Echoing that statement, Ann Battle, senior counsel, Market Transitions & Head of Benchmark Reform at International Swaps and Derivatives Association (ISDA), said the multiyear effort to exit LIBOR resulted in a “safe, smooth transition.”
Carbon markets emerge. Ahead of the Commission’s Second Voluntary Carbon Market Convening, set for July 19, the final MRAC panel tackled jurisdictional questions that have emerged recently in the environmental commodities, including both voluntary and compliance-based carbon markets.
“Market risk is never static,” said Commissioner Christy Goldsmith Romero in prepared remarks. “Where that risk arises is an area that must be closely monitored. This includes both traditional areas of risk and emerging areas.”
Seeking credible offsets. Credibility and risk are current concerns in the voluntary carbon markets, said Tyson Slocum, director of Public Citizen’s Energy Program and a member of the CFTC’s Energy and Environmental Markets Advisory Committee. “Not long ago, corporations would announce their move to ‘net zero’ by using the voluntary carbon offset markets,” he said. But the market became “problematic,” when “self-certified organizations failed to resolve underling credibility problems,” Slocum said.
Currently, “there is limited trading volume in voluntary markets because of concerns about reliability and greenwashing,” said Peter Malyshev, partner in Cadwalader ‘s Financial Services Group. “Market participants are realizing that not all carbon credits are created equal. Some have more reliability than others.”
“I question whether carbon offsets can be an effective tool to solving the climate crisis,” said Slocum. “Instead, we should be encouraging actions that encourage direct emissions avoidance” from various sources, including supply chains.
Imposing new standards. “That said, I do support efforts to impose regulatory standards for carbon offset markets,” Slocum continued. That includes the CFTC’s creation of an environmental fraud task force within the CFTC's Division of Enforcement to, among other things, “encourage whistleblowers to come forward to expose fraud in the offset markets,” he added.
Malyshev noted there are two active carbon markets in the U.S.: the compliance markets, which originate from a state statute with an established regime, like the California cap-and-trade market; and the voluntary markets, “which has a lot more issues,” in that nobody is mandated to participate in these markets and “there are clearly issues relating to additionality and reliability and other registries.”
We need a heightened review framework for self-certified carbon offset products, “similar to what the CFTC did for digital assets,” Slocum said.
Establishing authority. Propelled by news of recent floods and heat waves, the public is “catching up” with climate-related proposals, said Malyshev. “Regulators are catching up too.… We need to make sure these markets develop as reliable, transparent -- and more importantly, are not associated with fraud and manipulation,” he said.
“What can the CFTC do? Most environmental products trade as commodities, not as derivatives,” Malyshev said. But he added there is “increased interest in setting up a spot market on existing DCM platform, which would be fully regulated at the entity level. … If they trade, the CFTC will have enforcement jurisdiction,” Malyshev said.
Malyshev said the CFTC’s 2012 product definitions provide guidance as to which carbon-based products qualify as commodities, “and more importantly” that those that qualify can be physically delivered and can be subject to a forward contract.
“The takeaway here is that you cannot assume that if it's an environmental product it would automatically qualify as a commodity,” Malyshev said.