The voluntary carbon market (VCM) is undergoing significant changes to bolster governance and improve transparency and trust in the climate outcomes it delivers. Confirming support for the VCM while helping to define high integrity is at the heart of a number of government and regulatory initiatives in the U.S., including the recent launch of the Government’s Voluntary Carbon Markets Joint Policy Statement and Principles. As Treasury Secretary Janet Yellen noted in her remarks launching the U.S. government’s Voluntary Carbon Markets Joint Policy Statement and Principles, “there’s a lot more work to do, but if we do it well, we will have the chance to enlist markets as a powerful ally in the fight against climate change.”[i]
In parallel, the U.S. Securities and Exchange Commission’s (SEC) climate change disclosure rules require public companies to disclose climate change related information, including related to the use of carbon offsets and Renewable Energy Credits (REC).[ii] The aim of these rules is to support informed investor decision-making by providing greater transparency and accountability. Though the requirements and impacts of the new SEC rules are much broader than the VCM, it is yet another significant change that is expected to increase transparency within the VCM, which, if understood in the context of the other governance developments, could further bolster confidence in the VCM and demand for credits known to be from high-integrity sources.
We note that the implementation and enforcement of the SEC rules has been voluntarily suspended by the SEC pending judicial review. The key question put to the courts by critics of the SEC’s rules is whether the SEC has clear Congressional authority to require the types of disclosures the rules contemplate. This question has become even more critical following several recent U.S. Supreme Court decisions rolling back agency power and rulemaking authority, including its June 28th decision in Loper Bright Enterprises v. Raimondo,[iii] which eliminated a decades-old legal doctrine of deference to agency expertise in interpreting ambiguous laws, known as Chevron deference. In aggregate, the recent decisions by the high court may make the path to upholding the SEC rules more challenging. However, the SEC anticipated legal challenges to its rules when crafting them and the basis for upholding them based on the statutory mandate afforded to the SEC is stronger than other examples of agency interpretations of ambiguous statutes that have been thwarted by the courts.[iv]. Thus, public companies engaged in the VCM should understand the requirements and implications of the SEC disclosures in anticipation of some version of the Final Rules taking effect and of ongoing investor scrutiny.
Which brings us back to the VCM. The SEC rules contain specific VCM related provisions that warrant further examination.
Basics of the SEC carbon offset and REC disclosure requirements
The new disclosure rules require SEC registrants to disclose specific climate-related information in registration statements and annual reports, applying a phased-in compliance period, which is dependent on the registrant’s filer status and the content of the disclosure.
Under the disclosure requirements, if a registrant’s use of carbon offsets or RECs is a material component of its plan to achieve its climate-related targets or goals, the registrant must disclose certain additional information. To establish whether its use of carbon offsets or RECs is material to its plan to achieve climate-related goals, a registrant will need to make a fact-based determination about the importance of carbon offsets and RECs to its overall transition plan. The SEC states that the purpose of this disclosure is to allow investors to assess the risks and financial impacts of utilizing carbon offsets or RECs as a material component of a climate transition plan.[v] Regulation S-K requires a mix of quantitative and qualitative information regarding a registrant’s use of carbon offsets or RECs, whereas Regulation S-X asks registrants to provide quantitative disclosures related to costs, expenditures and losses associated with carbon offsets and RECs.
The different details each regulation requires to be disclosed by most U.S. public companies are as follows:
Regulation S-K (Item 1504(d)) Requirements[vi]:
- “[T]he amount of carbon avoidance, reduction or removal represented by the offsets or the amount of generated renewable energy represented by the RECs,”
- “[T]he nature and source of the offsets or RECs,”
- “Nature” refers to whether the offset “represents carbon avoidance, reduction, or removal”, or if a REC is “bundled or unbundled”;
- “Source” refers to “the party that issued the offset or REC.”[vii]
- “[A] description and location of the underlying projects,”
- “[A]ny registries or other authentication of the offsets or RECs,” and
- “[T]he cost of the offsets or RECs.”
Regulation S-X (Rule 14-02(e)) Requirements[viii]:
- “[T]he aggregate amount of carbon offsets and RECs expensed,”
- “[T]he aggregate amount of capitalized carbon offsets and RECs recognized,”
- “[T]he aggregate amount of losses incurred on the capitalized carbon offsets and RECs, during the fiscal year,” and
- The “beginning and ending balances of capitalized carbon offsets and RECs for the fiscal year.”
- Additionally, if a registrant is required to disclose the above information, the registrant must state its “accounting policy for carbon offsets and RECs.”
Improved data and insights for investors, carbon project developers and carbon market observers
The new disclosures will provide important data and insights for a range of stakeholders, including investors, carbon project developers and carbon market observers.
On the demand side, the new rules will increase visibility into carbon offset transactions. This additional transparency into carbon markets will provide critical information to investors and carbon market practitioners concerning the demand side of the VCM. Most investors and carbon market participants currently only have a high-level view of the voluntary carbon market from the demand side (e.g., through information like Ecosystem Marketplace’s State of the Voluntary Carbon Market report), but they typically lack visibility into who is purchasing what type of carbon credit, thereby making it difficult to know specifically what credit characteristics are driving demand. The SEC’s new disclosure requirements will reveal new data points that better illustrate how corporate money is flowing into the VCM and the factors that are influencing demand.
Some may argue that the requirement for additional transparency could dissuade corporations from purchasing and retiring carbon offsets to avoid the perceived controversy associated with carbon offset usage. However, as the market settles on what high-integrity carbon offsets look like consistent with the US government’s principles and the evolving guidance from the VCM governance institutions, there is a potential for the current softened demand dynamics to reset. Greater transparency coupled with greater trust could yield the outcomes Secretary Yellen has signaled.
Second, investors will have additional information to evaluate a corporation’s environmental impact. When a corporation discloses its carbon offset purchases under Regulation S-K and Regulation S-X, it is declaring that carbon offsets are a material, and therefore an integral, component of achieving its climate goals and strategy. This information will help investors better understand how companies are addressing their emissions and investing in climate change mitigation. In addition, investors can more readily compare carbon market engagement among different companies and evaluate how different economic sectors utilize carbon offsets. Studies show that companies that invest in carbon offsets ahead of their peers in terms of setting science-based targets, being on track for those targets, and decarbonising more rapidly.[ix]
The SEC disclosure requirements will reveal additional data points to test this correlation, providing investors and market observers with additional visibility on whether a corporation’s carbon offsetting strategy is appropriately contributing to its overall decarbonization strategy.
Third, the new SEC rules may benefit carbon project developers in refining and improving their services. In particular, the requirement for registrants to disclose project information, the registry utilized, and the “nature and source of the offsets” could provide critical insights to carbon project developers. Such insights may include the types of projects corporations are currently funding as well as major buyers in the market. With greater transparency in offset purchase and use, corporations may also increase due diligence of carbon project developers and projects, further driving integrity and trust in the market.
Finally, market observers will have additional data points regarding carbon offset price and volume, which will drive better evaluation of the overall market and surface important purchasing and investment trends. A substantial portion of carbon offsets in the primary market are transacted in over-the-counter transactions wherein prices are negotiated directly between the buyer and seller of credits. Additional information on the market value of these credits will inform price negotiations. Carbon price transparency may also help interested parties discern the price premium for high-integrity offsets and projects that include additional co-benefits beyond emissions reductions and removals. More information about corporate investment in carbon projects may also validate the efforts of carbon market integrity initiatives like the Integrity Council for the Voluntary Carbon Market if it shows that capital is flowing towards high-quality projects.
Near-term SEC impact remains uncertain, but there are other disclosure regimes that will likely apply
While the market awaits the final outcome of the SEC rules, there are a host of similar disclosure laws emerging in the US and around the world that companies need to understand and plan for. For instance, many companies will likely be subject to corporate disclosure requirements given California’s SB 253 (Climate Corporate Data Accountability Act) and SB 261 (Climate-Related Financial Risk Act), the European Union’s Corporate Sustainability Reporting Directive, and upcoming climate-related disclosure legislation in Australia and Canada.[x] There will also likely be many corporations that are subject to overlapping disclosure regimes across jurisdictions, and how the various regimes interact and intersect will be a crucial issue to navigate.[xi]
Arriving at a significant moment in the evolution of the VCM, the SEC rules are an important regulatory addition to the policy and technical ecosystem that governments and civil society are developing to accelerate the transition to a low carbon economy. The VCM stands to benefit from increased transparency on corporate climate action and increased clarity on what types of credits count as high-integrity. Indeed, if we get this right, markets—including the VCM—can be a “powerful ally in the fight against climate change”.
References
[i] “Secretary Yellen, Biden Administration Officials Deliver Remarks on Voluntary Carbon Market Principles,” May 28, 2024, U.S. Department of the Treasury, available at https://www.youtube.com/watch?v=zopVLuxUwrU
[ii] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 FR 21668-21921 (March 28, 2024) (to be codified at 17 CFR 210, 229, 230, 232, 239, and 249).
[iii] Loper Bright Enterprises v. Raimondo, No. 22-451, slip op. (U.S. June 28, 2024), https://www.supremecourt.gov/opinions/23pdf/22-451_7m58.pdf. Other relevant recent rulings that may impact the judicial review of the SEC rules include: (1) Securities and Exchange Commission v. Jarkesy, No. 22-859, slip op. (U.S. June 27, 2024), available at https://www.supremecourt.gov/opinions/23pdf/22-859_1924.pdf (narrowing the range of penalties that agencies can impose through their own adjudicative processes and ruling that defendants have a constitutional right to make their case to a federal jury when the agency is seeking financial penalties); (2) Ohio v. Environmental Protection Agency, No. 23A349, slip op. (U.S. June 27, 2024), available at https://www.supremecourt.gov/opinions/23pdf/23a349new_h3ci.pdf (staying a U.S. EPA rule that would have required the implementation of additional significant emissions controls in power plants and other industrial facilities across 23 states indicating that the rule was likely to be found arbitrary and capricious because EPA had not adequately explained the basis for its conclusions); and (3) Corner Post, Inc. v. Board of Governors of the Federal Reserve System, No. 22-1008, slip op. (U.S. July 1, 2024), available at https://www.supremecourt.gov/opinions/23pdf/22-1008_1b82.pdf (significantly expanding the window for rulemaking challenges and creating a new pathway for regulated entities to challenge long-settled regulations).
[iv] Luis Aguilar, et al., Working Group on Securities Disclosure Authority Comments on Climate-Related Disclosures for Investors, Securities and Exchange Commission, File No: S7-10-22 (June 16, 2022), available at https://www.sec.gov/comments/s7-10-22/s71022-20131670-302060.pdf.”
[v] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 FR 21668, 21726 (March 28, 2024) (to be codified at 17 CFR 210, 229, 230, 232, 239, and 249).
[vi] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 FR 21668, 21726 (March 28, 2024) (to be codified at 17 CFR 210, 229, 230, 232, 239, and 249).
[vii] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 FR 21668, 21921 fn. 879 (March 28, 2024) (to be codified at 17 CFR 210, 229, 230, 232, 239, and 249).
[viii] The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 FR 21668, 21800 (March 28, 2024) (to be codified at 17 CFR 210, 229, 230, 232, 239, and 249).
[ix] For two recent analyses, see (1) MSCI, Corporate emission performance and the use of carbon credits, 2023, available at https://trove-research.com/report/corporate-emission-performance-and-the-use-of-carbon-credits, and (2) Ecosystem Marketplace, All in on Climate: The role of carbon credits in corporate climate strategies, 2023, available at https://app.hubspot.com/documents/3298623/view/688132803?accessId=5f7206.
[x] See Parliament of Australia, Treasury Laws Amendment (Financial Market Infrastructure and Other Measures) Bill 2024 (March 27, 2024), available at https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=r7176; FRAS Canada, Canadian Sustainability Disclosure Standards, available at https://www.frascanada.ca/en/sustainability.
[xi] For an example of one way to navigate these challenges, see, ESRS-ISSB Standards Interoperability Guidance (May 2, 2024) available at esrs-issb-standards-interoperability-guidance.pdf (ifrs.org). The Interoperability Guidance produced for the European Sustainability Reporting Standards (ESRS) and the IFRS/ISSB Sustainability Disclosure Standards enable an entity to comply with the climate requirements of both sets of standards.
