Comment Text:
Kita is the carbon insurance specialist, offering bespoke carbon insurance products that act as a stamp of confidence carbon market players. We provide extensive due diligence and a safeguard against loss, thus reducing risk of engagement in carbon transactions. Kita’s insurance protects clients against loss of carbon credits due to risks such as natural catastrophes; fraud and negligence; insolvency and abandonment; and changing carbon standards. We can pay insurance claims in cash or in replacement carbon credits, providing flexibility for clients' individual risk appetites and carbon strategies.
Kita provides its public comment as a direct response to each question posed by the US CFTC regarding 88 FR 89410.
General
1. In addition to the VCC commodity characteristics identified in this proposed guidance, are there other characteristics informing the integrity of carbon credits that are relevant to the listing of VCC derivative contracts? Are there VCC commodity characteristics identified in this proposed guidance that are not relevant to the listing of VCC derivative contracts, and if so, why not?
-Under the section ‘Quality of Carbon Standards’, leakage should be incorporated as a criterion. Leakage refers to the unintended displacement of emissions from one area to another due to climate mitigation efforts. Carbon Standards must ensure their methodologies identify and address potential leakage risks associated with carbon offset projects. The ability for leakage to occur in a carbon project, unabated or unknown, would directly influence the integrity of a VCC.
-Consider the uniformity of historic transaction pricing for VCC types under consideration for inclusion in contract specifications as deliverable. Some existing derivatives have a wide range of potentially deliverable credits. While this raises the liquidity of physical supply, the wide range of prices for the underlying VCCs leads to price instability for the derivative and undermines its value for hedging. We recommend that DCMs put more emphasis on selecting types with comparable prices when specifying what VCCs are deliverable.
-DCMs should consider the volume and size of historic credit transactions when deciding derivative contract sizes. Setting too large contract sizes compared with typical VCC deals, will discourage smaller counterparties and new entrants from using derivative products. [A recent public study of typical VCC deal sizes is available on CDR.fyi here]
2. Are there standards for VCCs recognized by private sector or multilateral initiatives that a DCM should incorporate into the terms and conditions of a VCC derivative contract, to ensure the underlying VCCs meet or exceed certain attributes expected for a high-integrity carbon credit?
DCMs should consider the availability of insurance or similar financial protection when specifying the underlying VCCs that are deliverable for a derivative product. The presence of insurance and that risks can be priced, gives a clear distinction in the quality of due diligence and available data. Financial institutions with a strong incentive to correctly assess risk are a substantive independent check that transparency and integrity are of a high level.
Furthermore, we suggest that DCMs consider creating derivative products containing only underlying credits that have been bundled with insurance. The combination of VCCs with insurance or similar financial protection, that will replace the credit in the case of a failure, will act to price in risks. In this way, insurance will reduce VCC derivative price variance, standardize the underlying risk and raise integrity.
3. In addition to the criteria and factors discussed in this proposed guidance, are there particular criteria or factors that a DCM should consider in connection with monitoring the continual appropriateness of the terms and conditions of a VCC derivative contract?
No response.
4. In addition to the criteria and factors discussed in this proposed guidance, are there particular criteria or factors that a DCM should consider, which may inform its analysis of whether or not a VCC derivative contract would be readily susceptible to manipulation?
We recommend that DCMs consider VCC derivative contracts where the underlying VCCs involve some form of counterfactual baseline to be exposed to a higher risk of manipulation. Relatively subtle changes in project and baseline border areas can lead to significantly different issuances of credits. There is already an economic incentive for bad actors to cherry-pick to boost the issuance of VCCs. We would highlight that a derivative contract, where the liquidity and price of the underlying can be impacted by such changes to a few large projects, could be open to manipulation. We suggest that DCMs consider restricting eligible VCCs to those types where baselines are set transparently by an independent third party.
5. Should the VCC commodity characteristics that are identified in this proposed guidance as being relevant to the listing by a DCM of VCC derivative contracts, also be recognized as being relevant to submissions with respect to VCC derivative contracts made by a registered foreign board of trade under CFTC regulation 48.10?
No response.
Transparency
6. Is there particular information that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether a crediting program is providing sufficient access to information about the projects or activities that it credits? Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a contract’s terms and conditions, whether there is sufficient transparency about credited projects or activities?
Under the section ‘Quality of Carbon Standards’ subsection ‘Transparency’, there should be express consideration for two additional criteria:
Evidence of which entity retains the carbon rights associated with a carbon project; and
Evidence that Free, Prior and Informed Consent (FPIC) began and is ongoing where Indigenous Peoples (IP) are concerned and/or impacted by a carbon project.
Ascertaining who retains the carbon rights is integral to a carbon project as it determines who may sell the resulting carbon credits and/or retain the revenue from sale(s). FPIC is important as it can directly impact a project's success in relation to IP involvement and subsequent emissions abatement. Both criteria would directly influence the integrity of a VCC.
Additionality
7. Are there particular criteria or factors that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether the procedures that a crediting program has in place to assess or test for additionality provide a reasonable assurance that GHG emission reductions or removals will be credited only if they are additional?
We recommend that DCMs make clear, which bodies have accredited additionality, paying particular attention to governance and independence from conflicting commercial concerns. Furthermore, consider restricting which bodies can assess & quantify additionality within contract specifications.
Consider the systemic science risk to additionality that may exist within specific methodologies/technologies employed and potentially differentiate, group or otherwise separate these within the contract specifications. For example, by underlying technology type or maturity level (TRL).
8. In this proposed guidance, the Commission recognizes VCCs as additional where they are credited for projects or activities that would not have been developed and implemented in the absence of the added monetary incentive created by the revenue from carbon credits. Is this the appropriate way to characterize additionality for purposes of this guidance, or would another characterization be more appropriate? For example, should additionality be recognized as the reduction or removal of GHG emissions resulting from projects or activities that are not already required by law, regulation, or any other legally binding mandate applicable in the project’s or activity’s jurisdiction?
The US CFTC should expand its definition of additionality to include financial, legal/regulatory, and common practice. The definitions provided by the US CFTC for financial additionality (“projects or activities that would not have been developed and implemented in the absence of the added monetary incentive created by the revenue from carbon credits”) and legal/regulatory additionality (“projects or activities that are not already required by law, regulation, or any other legally binding mandate applicable in the project’s or activity’s jurisdiction”) are appropriate. Common practice additionality indicates that the activities within a carbon project are not already reflective of business as usual in the applicable region or jurisdiction.
Risk of Reversal
9. Are there particular criteria or factors that DCMs should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, a crediting program’s measures to avoid or mitigate the risk of reversal, particularly where the underlying VCC is sourced from nature-based projects or activities such as agriculture, forestry or other land use initiatives?
We recommend that DCMs consider the size and condition of any standard-specific buffers designed to provide some standard-wide protection for VCC reversal risks. Paying particular attention to the health of such buffers, any depletion and clarifying under which exact conditions standards will cancel buffer credits to replace VCC credits from projects that have experienced reversals. We find that documentation on the process and exactly which situations would trigger a buffer cancellation are often vague and unclear. This undermines the perceived protection provided by buffers and introduces systematic risks and mispricing between standards.
DCMs should consider including insurance or similar financial protections that address reversal risks for VCCs within contract specifications and make the level of any such protection clear and consistent. The limiting of downside risk will help support liquidity and reduce variance between the underlying VCC prices. Moreover, the pricing and transfer of risk to high-credit-rating insurance companies and financial institutions will raise integrity and due diligence levels.
10. How should DCMs treat contracts where the underlying VCC relates to a project or activity whose underlying GHG emission reductions or removals are subject to reversal? Are there terms, conditions or other rules that a DCM should consider including in a VCC derivative contract in order to account for the risk of reversal?
Under the section ‘Quality of Carbon Standards’ subsection 'Permanence’, there is reference to “buffer reserve or other measures in place that provide reasonable assurance that, in the event of a reversal, the VCCs intended to underlie the derivative contract would be replaced by VCCs of comparable high quality that meets the contemplated specifications of the contract.” Where “other measures” is referenced, Kita recommends the US CFTC to consider the place of insurance. In the current state of the voluntary carbon market only two standards, American Carbon Registry (ACR) and C-Capsule, allow insurance to be used in place of projects making credit contributions to a buffer pool. This optionality benefits a project developer’s bottom line and liquidity of credits in the wider voluntary carbon market. However, there is an emerging market of carbon insurance providers and policies which may supplement carbon projects and standards in protecting against key risks – including reversal and ultimately replacement of cancelled credits with those of comparable quality. For example, Kita provides insureds with the choice of claims being paid out in cash or carbon credits. Kita’s ability to make companies whole via paying claims in carbon credits aligns with the above quoted text from the US CFTC (and breaks into the wider topic of fungibility within the carbon markets). The US CFTC could further consider inclusion of insurance as part of terms, conditions or other rules that a DCM should include in a VCC derivative contract to account for the risk of reversal. Inclusion of insurance in this capacity could be done at the level of the derivative contract or the DCM.
To consider carbon insurance further, please reference the report ‘Buffers & Insurance in the Voluntary Carbon Market’.
Robust Quantification
11. Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a contract’s terms and conditions, whether a crediting program applies a quantification methodology or protocol for calculating the level of GHG reductions or removals associated with credited projects or activities that is robust, conservative and transparent?
No response.
Governance
12. In addition to a crediting program’s decision-making, reporting, disclosure, public and stakeholder engagement, and risk management policies, are there other criteria or factors that a DCM should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether the crediting program can demonstrate that it has a governance framework that effectively supports the program’s transparency and accountability?
No response.
Tracking and No Double Counting
13. In addition to the factors identified in this proposed guidance, are there other factors that should be taken into account by a DCM when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether the registry operated or utilized by a crediting program has processes and procedures in place to help ensure clarity and certainty with respect to the issuance, transfer, and retirement of VCCs?
No response.
14. Are there particular criteria or factors that a DCM should take into account when considering, and/or addressing in a VCC derivative contract’s terms and conditions, whether it can be demonstrated that the registry operated or utilized by a crediting program has in place measures that provide reasonable assurance that credited emission reductions or removals are not double-counted?
No response.
Inspection Provisions
15. Should the delivery procedures for a physically-settled VCC derivative contract describe the responsibilities of registries, crediting programs, or any other third-parties required to carry out the delivery process?
Yes.
Sustainable Development Benefits and Safeguards
16. Certain private sector and multilateral initiatives recognize the implementation by a crediting program of measures to help ensure that credited mitigation projects or activities meet or exceed best practices on social and environmental safeguards, as a characteristic that helps to inform the integrity of VCCs issued by the crediting program. When designing a VCC derivative contract, should a DCM consider whether a crediting program has implemented such measures?
Yes.
17. Certain private sector and multilateral initiatives recognize the implementation by a crediting program of measures to help ensure that credited mitigation projects or activities would avoid locking in levels of GHG emissions, technologies or carbon intensive practices that are incompatible with the objective of achieving net zero GHG emissions by 2050, as a characteristic that helps to inform the integrity of VCCs issued by the crediting program. When designing a VCC derivative contract, should a DCM consider whether a crediting program has implemented such measures?
Yes.
Additional Comment
Kita recommends in the US CFTC’s consideration for the listing for trading of voluntary carbon credit derivative contracts that it takes a holistic rather than piecemeal approach. By being a leader in carbon credit regulation, the US CFTC holds a unique opportunity to gain international recognition and alignment via its final recommendation. This can lead carbon market stakeholders towards a global approach to carbon credit regulation which avoids a patchwork of compliance hurdles.
The voluntary market is in dire need of high-quality regulation to raise integrity and lower the risks to new entrants. We welcome and support the CFTC in its mission and firmly believe this will have a positive influence on the VCM and in turn a significant impact on the fight against climate change.
