ISDA Calls for Legal Clarity on Voluntary Carbon Credits

Clarification would support the drafting of standardised documentation for a voluntary carbon credit OTC derivatives market.

The International Swaps and Derivatives Association (ISDA) has published a new paper calling for greater certainty over the legal implications of voluntary carbon credits (VCCs).

The paper says an effective and liquid voluntary carbon market can help provide the investment required to transition to a low carbon economy, by channelling financing into projects that aim to reduce carbon emissions or remove carbon from the atmosphere.

“A robust voluntary carbon market must be grounded in a strong legal foundation,” ISDA says, noting that much of the process of creating, verifying and transferring the benefit of project activities that reduce emissions already exists within robust legal frameworks.

However, as the market grows in size and complexity, secondary markets in fungible VCCs would be “significantly enhanced” by steps being taken both nationally and internationally to better understand the legal nature of VCCs, including how – as a fungible instrument – they can be created, bought, sold and retired.

The paper says the legal nature of VCCs affects what type of security may be taken and enforced, as well as how VCCs would be treated following an insolvency – including with regard to netting. It may also have an impact on broader considerations, including the regulatory, tax, accounting treatment of VCCs, and how they should be treated for capital, margin and trade reporting purposes.

ISDA says understanding the legal treatment of VCCs is necessary to achieve deep and liquid secondary markets, which, in turn, will “enable the development of a clear price signal for carbon and allow funds to be efficiently channeled to emissions-reducing projects”.

The paper explores the legal treatment of VCCs and considers certain other aspects of VCC transactions, including when they might be regulated as derivatives. The recent launch of exchange-traded derivatives contracts in VCCs has galvanised focus on further developing VCC derivatives, ISDA says.

The paper sets out recommended steps that can be taken to further develop legal certainty in VCCs at both a global and jurisdictional level, including the issuance of an authoritative legal statement, legislative amendments or regulatory guidance at a jurisdictional level.

“Further steps could also be taken in parallel at an international level to drive greater standardisation of the legal treatment of VCCs across jurisdictions,” ISDA says, adding that this would support the drafting of standardised documentation and legal opinions for a voluntary carbon credit OTC derivatives market.

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