Voluntary Carbon Markets (“VCMs”) are touted as a promising solution to rising global carbon emissions. They have the potential to strengthen climate technology and promote projects that reduce carbon dioxide emissions and remove Greenhouse Gases (“GHGs”) from the atmosphere. VCMs are estimated to be worth $2 billion, and the burgeoning sector is forecasted to grow to $250 billion by 2050. However, fraud and manipulation in the issuing of carbon credits threaten to undermine the environmental benefits of VCMs and the public’s confidence in the market.

The Commodity Futures Trading Commission (“CFTC”) recently announced the first enforcement action for fraud in VCMs. Two weeks prior to the unprecedented enforcement action, the CFTC finalized guidance regarding the listing for trading of Voluntary Carbon Credit Derivative Contracts. These steps, and the CFTC’s creation of the Environmental Fraud Task Force, align with the agency’s recent priorities of reducing fraud in the environmental space and building trust in Voluntary Carbon Markets. These efforts follow the Biden-Harris Administration’s broader priorities of improving environmental, social, and governance (“ESG”) efforts and advancing high-integrity VCMs.

The CFTC’s hugely successful whistleblower program will be critical to the agency’s efforts to combat fraud in VCMs, as it plays a key role of detection in all the agency’s enforcement efforts. The CFTC Whistleblower Office released the Whistleblower Alert on Fraud on Market Manipulation in the Carbon Markets to encourage whistleblower disclosures in the sector in 2023. The alert called on whistleblowers to report Commodity Exchange Act (“CEA”) violations in the carbon markets and outlined common types of fraud to be on the lookout for.

Rampant Fraud Currently Undermines VCMs

In VCMs, private carbon credit projects design decarbonization initiatives, reporting the amount of carbon emissions reduced by their work to carbon credit registries and third-party verifiers. Registries then issue carbon credits to projects in proportion to their reported GHG reductions, where one carbon credit represents one metric ton of carbon dioxide removed from the atmosphere. In an effort to increase market integrity and transparency, registries and carbon projects will oftentimes work with third-party verifiers who substantiate project developers’ claims and grant project certifications.

Despite these safeguards, fraud and corruption run rampant in the burgeoning market as international players evaluate and trade intangible commodities with minimal regulation. When reporting to third-party certifiers and registries, project developers have a recorded history of skewing data, committing carbon accounting fraud, and overestimating their project baselines to secure more carbon credits than their projects are worth. According to Carbon Market Watch, only 1 in every 13 REDD+ Certified forestry carbon credits represents an actual reduction in carbon emissions.

Registries and verifiers also fail to implement appropriate methodologies to prevent data manipulation and fraudulent reporting. Verra, a leading carbon registry that controls over 70% of the carbon credit market, has come under fire in recent years for alleged conflicts of interest in the third-party verification process, enabling fraudulent reporting by giving project developers overbroad discretion and failing to address detected fraud in the market. Opaque and ineffective methodologies to oversee carbon credit projects have loosed subprime credits onto the market, which often represent no real carbon emission deductions.

CFTC Announces Historic Enforcement in VCMs

On October 2, 2024, the CFTC published a press release announcing its first enforcement action against fraud in Voluntary Carbon Markets. The CFTC filed a complaint against Kenneth Newcombe, former CEO and majority shareholder of Washington, D.C.-based carbon credit project CQC Impact Investors LLC (“CQC”), for fraud and false reports relating to voluntary carbon credits. The CFTC also settled charges against CQC and against Jason Steele, CQC’s former Chief Operating Officer. The Newcombe and CQC complaints stemmed from alleged fraud in the registration, credit issuing, verification, and implementation phases.

The CFTC alleges that Newcombe reported false and misleading information to at least one carbon credit registry and third-party reviewer to exaggerate the quality of CQC’s emissions-reduction projects, initiatives that included installing efficient cookstoves and LED light bulbs in sub-Saharan Africa, Asia, and Central America. This alleged fraud allowed Newcombe and CQC to obtain millions more carbon credits than their projects were entitled to receive. Newcombe faces civil monetary penalties, disgorgement, permanent trading and registration bans, and more. In a settlement with the CFTC, CQC paid a $1 million civil monetary penalty and agreed to address other compliance provisions.

While these first actions demonstrate a major step forward in the CFTC’s progress in fighting manipulation and fraud in VCMs, the press release also urged whistleblowers to contact the Whistleblower Office with tips related to carbon market misconduct to enable more successful actions.

Whistleblowers are Key to Future Successful Enforcement

The CFTC Whistleblower Program plays an indispensable role in the CFTC’s enforcement initiatives, with 30% of all enforcement investigations originating from whistleblower disclosures. Since the CFTC Whistleblower Office’s inception in 2010, the program has recouped $3.2 billion in sanctions. Through the whistleblower program, individuals who report original information that leads to a successful enforcement action with a sanction over $1 million are eligible for monetary awards of 10-30% of the funds collected in the action. The program also offers anti-retaliation protection, as well as anonymous and confidential reporting channels.

In June 2023, the CFTC issued the CFTC Whistleblower Alert: Blow the Whistle on Fraud or Market Manipulation in the Carbon Markets, calling for whistleblowers with insider knowledge or suspicion of fraud and corruption in VCMs to come forward with a tip to the agency. The global alert asserted that the agency “will diligently investigate all credible tips and complaints from whistleblowers relating to carbon credit markets.”

The alert details what fraud carbon market sector employees should be on the lookout for, including: wash trading, ghost/illusory credits, double counting, and fraudulent reporting. The CFTC instructed readers on how to blow the whistle and reaffirmed prospective whistleblowers’ eligibility to award payments for tips resulting in successful enforcement actions.

The efficacy and power of the CFTC Whistleblower Program positions VCM sector employees as the solution to combating the fraud that undermines the market and real efforts to reduce carbon emissions. In an accompanying press release by the agency, Director of the Division of Enforcement Ian McGinley stated, “As carbon credit markets continue to grow, we will act to foster the integrity of these markets by fighting fraud and manipulation. […] Whistleblowers are invaluable allies in these efforts.”

CFTC Announces New Guidance for VCC Contract Listing

In another effort to remedy the integrity of VCMs, the CFTC worked closely with market participants to design its final Guidance Regarding the Listing of Voluntary Carbon Credit Derivative Contracts in September 2024. The final guidance lists factors that Designated Contract Markets (“DCMs”), CFTC-regulated exchanges that list VCC Derivative Contracts (“VCC Derivatives”), should consider when listing VCC Derivatives. The guidance aims to increase standardization of Voluntary Carbon Credits (“VCCs”) and foster transparency, accurate pricing, and liquidity, enabling market participants to make informed decisions about VCC Derivatives to increase market integrity and confidence.

The final guidance directs DCMs listing VCC Derivatives to the agency’s DCM statutory Core Principles established in the CEA, with particular focus on Core Principles 3 and 4. In accordance with Core Principle 3, DCMs are required to list contracts “that are not readily susceptible to manipulation;” VCC contracts need to clearly consider quality standards, delivery points and facilities, and inspection provisions as laid out in Appendix C to Part 38, Title 17. To align with this principle, DCMs will ensure VCC contracts are transparent, include protocol in the case that underlying projects are canceled, and disclose additionality, along with other quality standard assurances. DCMs should consider whether crediting programs have governance frameworks to address accountability, anti-money laundering (“AML”), conflicts of interest, and more to prevent double counting and fraud, ensuring that one VCC is a unique commodity reflecting a single emissions reduction. Under Principle 3, DCMs are charged with reasonably ensuring that crediting and third-party verification programs comply with industry best-practices.

Core Principle 4 asserts DCMs are required to “prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process through market surveillance, compliance, and enforcement practices and procedures.” Under this principle, final guidance instructs DCMs to monitor VCCs’ compliance with certification standards in their terms and conditions. The final guidance also includes product submission requirements, where DCMs may elect to list new derivatives contracts by certifying with the CFTC that contracts comply with regulatory requirements and submitting analysis, supporting documentation, and evidence to substantiate those claims.

The CFTC’s final guidance affirms the agency’s regulatory authority of VCC Derivatives under the CEA and establishes best practices for DCMs in order to increase VCMs’ market integrity. The new guidelines, in conjunction with the CFTC’s call for carbon market whistleblowers and their first enforcement, signals the agency’s commitment to combating fraud in the sector and their regulatory authority to do so.

Conclusion

The CFTC’s new guidelines on the listing of VCC Derivative Contracts, the creation and successful actions of the CFTC Environmental Fraud Task Force, and the agency’s Whistleblower Alert all signal an aggressive new posture toward rampant fraud in VCMs, with a special role for whistleblowers being designated by the agency in combating this crime. The agency’s recent enforcement against CQC has exemplified the fruits of this new strategy.

The integrity of Voluntary Carbon Markets must be ensured for the prospective benefits of climate finance to be realized. Whistleblowers are the key to exposing and uprooting the financial and environmental crime that currently plagues the market, and the CFTC is committing itself to bolstering its efforts.

Erin Craig and Allison Nguyen also contributed to this article.