Monday, November 20, 2023

Are crypto, carbon market reforms in the CFTC’s future?

By Mark S. Nelson, J.D.

In a speech delivered by CFTC Commissioner Kristin N. Johnson to an audience assembled by the Federal Reserve Bank of Atlanta and the Atlanta Economics Club, Johnson floated the possibility that the CFTC may soon issue additional guidance on crypto and carbon markets. Johnson said in her remarks that both markets suffer from a lack of transparency and corporate governance standards that are present in other, more stable markets. The commissioner also suggested that the CFTC already has tools at its disposal to address fraud in spot markets for these products.

Johnson began her remarks by noting the seeming incongruity of crypto and carbon markets, but she observed that some in the blockchain industry have posited the development of tokenized carbon credits, thus bringing the twin subjects of her speech closer together than previously hypothesized.

“In the coming weeks, I believe that the Commission will take important first steps introducing market structure reforms in both of these markets,” said Johnson. “These critical reforms will establish customer property protections in non-intermediated clearing markets (a reform that is increasingly important as market participants seek to adopt this approach to offer leveraged, crypto-products to retail investors) and long-awaited guidance on voluntary carbon markets.”

After noting how crypto and carbon markets might fuse in a future state of affairs, Johnson addressed each of these markets individually. Starting with crypto, Johnson provided “observations” about what she believes has gone wrong in crypto markets. She said many of the firms involved in the highest profile flops had sought bankruptcy protection, which put in jeopardy any recovery by harmed customers. She also said the lack of transparency about crypto firms’ risk management practices had resulted in bigger customer losses and had increasingly strained markets. Lastly, Johnson said that “imperial CEO[s]” at some crypto firms were able to flourish without traditional corporate governance mechanisms that might have checked their influence over the operations of their companies.

With respect to carbon markets, Johnson noted several early steps taken by the CFTC in recent years, including the issuance of a report on carbon markets by the CFTC’s Market Risk Advisory Committee’s Subcommittee on Climate-Related Financial Risks. Another key development was the CFTC’s hosting of a pair of carbon markets convenings. Yet despite these steps, Johnson suggested that more was needed in the form of new guidance and stepped-up enforcement.

Johnson explained that: “To ensure integrity in environmental commodities markets, we may need further reforms, including, among others, the creation of carefully developed registries; mitigation of vulnerabilities, such as double-counting, greenwashing, or the risk of leakage; and the introduction of a rigorous standard for demonstrating additionality and permanence.”

For Johnson, both crypto and carbon markets could benefit from similar reforms. For example, she suggested that without stronger guardrails, fraudsters will continue to exploit these markets because of their obscurity and complexity. Both markets, she said, could benefit from corporate governance and market reforms. But although Congressional action could help to clarify regulatory roles, Johnson said the CFTC already has tools it can deploy to improve both crypto and carbon markets.

Johnson also offered some more specific types of reforms the CFTC could mull:
  • Transaction reporting;
  • Secondary market regulation (e.g., guidance regarding clearing and settlement);
  • Accountability standards for intermediaries focused on integrity and reliability (for carbon markets, these reforms would include standards for additionality—In a previous speech (see, n. 5) on the topic, Johnson cited The Integrity Council for the Voluntary Carbon Market, Core Carbon Principles, Assessment Framework and Assessment Procedure, Draft for public consultation (July 2022) for the proposition that the impact of carbon credits would be “additional” if the impact “would not have occurred in the absence of the incentive created by carbon credit revenues”);
  • Business conduct standards; and
  • Guardrails to protect retail investors.
Johnson closed her remarks by calling for the CFTC to move beyond enforcement actions to offer more comprehensive guidance and regulations for crypto and carbon markets. “Similar to our leadership in bringing critical enforcement actions, the CFTC must lead in issuing advisories, guidance, and begin developing rule makings that introduce transparency and market structure reforms in crypto and environmental commodities markets,” said Johnson.