Remarks as Prepared

Good morning. Thank you very much for the generous invitation to join you for Rice University’s Baker Institute for Public Policy Annual Energy Summit.

Last summer, I had the tremendous pleasure of meeting with The Honorable Ambassador David M. Satterfield, Kenneth B. Medlock III, and researchers here at the Baker Institute. The issues explored, discussions advanced, and research produced by the faculty, visiting scholars and influential policymakers here at the institute engender invaluable contributions that seek to address cutting-edge issues and endemic global challenges.

For evidence of the Baker Institute’s important contributions, one need look no further than the program for today’s energy summit, the portraits of previous keynote speakers lining the walls reflecting the long history of Presidents, Senators, Governors, Ambassadors, and foreign heads of state, or the broader programming sponsored by the Institute. I believe that on Tuesday you welcomed Secretary of State Antony J. Blinken. Adding to the gravitas associated with the podium where I stand, I think that I heard that Secretary Baker will be here this afternoon. Now is the moment when someone should say, “no pressure.”

Before I begin, an anticipated disclaimer. The policy views that I will share are my own, but I am hopeful that they will resonate with many of you and my colleagues at the Commission.

The CFTC’s Role in Regulating Traditional Markets

A year ago last month, we celebrated the 100-year anniversary of Congress enacting the Grain Futures Act, which created the Grain Futures Administration agency. In the early years of our nation’s history, agricultural markets were at the center of our nation’s economy, in communities across the state of Texas, many not far from Dallas, that city in North Texas where I grew up. Many of these communities continue to serve as the bread basket of our nation, producing cattle, poultry, pork, grains, and other key crops in our food supply.

In the early days after the passage of the Grain Futures Act, regulation of derivatives focused on ensuring fair access to and preventing fraud in agricultural markets. By fulfilling the mandate set out by Congress to mitigate fraud in markets, we protect customers, increase market integrity, and reduce market transaction costs. Alongside these benefits, our effective “policing,” if you will, of derivatives markets engenders valuable economic benefits. Orderly markets enhance price transparency and price discovery, and efforts to eliminate misconduct help to ensure that markets work, protecting end users from abusive tactics and conduct. 

As derivatives markets have evolved, so too has the mission outlined in the Commodity Exchange Act, the mandate of the Commodity Futures Trading Commission (CFTC or Commission). Our broad anti-fraud and market manipulation authority stretches across an expanding and evolving universe of derivatives markets.

Expanding Derivatives Markets: Energy Derivatives

Again, thinking carefully about the history of the evolution of derivatives markets in our nation, there is no community more familiar with that expansion than the community right here in Houston, Texas. In the decades that followed the formal installation of the CFTC, markets witnessed an exponential growth in energy derivatives. These important contracts enable firms in the energy industry and those who rely on energy resources as a central input in their manufacturing, production or services to lay off the risk of price volatility and implement risk management practices that may lead to better pricing for consumers at one of the places that counts the most—the pump.

Environmental Derivatives: Carbon Offsets

I would like to focus my remaining remarks today on the growing market for environmental derivatives or carbon offsets.

In a report published in 2020 by the Market Risk Advisory Committee (MRAC), an advisory Committee that I now sponsor but was sponsored at the time by the current Chairman Rostin Behnam, the subcommittee on climate-related risks in financial markets observed: “U.S. financial regulators must recognize that climate change poses serious emerging risks to the U.S. financial system, and they should move urgently and decisively to measure, understand, and address these risks.”[1]

More recently, my colleague Commissioner Christy Goldsmith Romero explained that “it is critical for the CFTC to understand the actual role that derivatives markets are playing to promote climate risk resilience, specifically how market participants are using derivatives to manage climate risk.”[2]

During the last two years, the CFTC has hosted two events—Voluntary Carbon Market Convenings—each a day-long discussion that featured industry- and government-wide participation. In June of 2022, we issued a request for comment, seeking input and guidance regarding how the Commission might fulfill our century plus long mission to maintain the integrity of derivatives markets. While the Commission’s regulatory authority does not reach standard setting for the underlying assets, in this context, carbon offsets, we would have broad anti-fraud and market manipulation authority in the market for carbon offsets.

Attempting to tackle the issues raised in the context of carbon markets effectively would require considerably more time than I have been allocated, and I understand that the most thoughtful keynote speaker is often the one who is brief and ends her remarks on time.

Notwithstanding global growth in the increasingly diverse universe of carbon offsets, I would share one significant observation. Market infrastructure lacks an effective, universally adopted integrity assessment system.

Credibility Concerns in Carbon Markets: Greenwashing

Earlier this summer, the CFTC Division of Enforcement announced the creation of the Environmental Fraud Task Force (EFTF). The EFTF was designed to address misconduct in regulated derivatives and spot markets relating to efforts to address climate change, and would focus on “fraud with respect to the purported environmental benefits of purchased carbon credits, as well as registrants’ material misrepresentations regarding [Environmental, Social, and Governance (ESG)] products or strategies.”[3] The goal of the EFTF is to allow the Division to prosecute bad actors in the environmental sector more effectively, by developing subject matter expertise, facilitating the sharing of resources across the agency, and ensuring that the proper resources are brought to bear on misconduct that increasingly appears will be the new frontier of the CFTC’s anti-fraud jurisdiction.

Visibility Concerns in Carbon Markets

Top of my mind, as I begin to work with MRAC to develop policy proposals for responding to credibility concerns in carbon markets is the lack of visibility and integrity in carbon markets.

Greenwashing and Greenclaiming

Greenwashing and greenclaiming all too often involve overinflated descriptions of the environmental benefits of carbon credits and other carbon emission reducing activities.

The nascent infrastructure for the carbon credits markets creates conditions ripe for this sort of malfeasance. Ideally, carbon credits are a way for a carbon emitter to invest in a green initiative or project intended to reduce carbon emissions. In theory, encouraging greater investment in these beneficial projects will push the world toward carbon neutrality.

In reality, however, too many of these carbon offset projects offer no environmental benefits at all. A recent study out of the University of Cambridge and ETH Zurich (still in preprint) estimates that “88% of the total credit volume across the[] four sectors [of renewable energy, cookstoves, forestry, and chemical processes] in the voluntary carbon market does not constitute real emissions reductions.”[4]  Greening claims made in connection with carbon offsets are, for now, unverifiable. Even putting aside cases where an offset might be an outright scam, it is incredibly difficult to know whether a given project actually results in reduced carbon emissions or promised carbon sequestration.

Increasingly, investors and courts are concluding that corporations have also engaged in greenclaiming by making difficult-to-verify corporate pledges to achieve “net zero emissions.”

While, in theory, a corporate pledge would mean that the company engaged in extensive efforts to ensure that their operations minimized carbon emissions, recent evidence suggests that making such claims without sufficient verification may be all too easy and may create the potential for legal liability. 

In September of 2022 at the first MRAC meeting under my sponsor, we invited leading voices from the Integrity Council on Voluntary Carbon Markets (ICVCM) an international standard-setting body that has engaged in a thoughtful deliberation on how to establish a common understanding of the attributes of a high-quality carbon credit.

To this end, ICVCM released Core Carbon Principles, but has not yet finalized an assessment framework for identifying credits “that create real, additional and verifiable climate impact with high environmental and social integrity.”[5] 

Sonja Gibbs led the discussion that afternoon, and a few months later I had the benefit of joining a roundtable hosted by Chris Hayward, Policy Chairman for the City of London Corporation.

The International Organization of Securities Commissions (IOSCO) has started taking steps to address these concerns. Last September, IOSCO issued a statement encouraging international audit and assurance standards boards to develop high quality standards for sustainability-related reporting.[6] Last March, the Securities and Exchange Commission (SEC) proposed a series of rules for registrants to include climate-related risks and their greenhouse gas emissions in their disclosures.[7]

Independent auditing of carbon offsets and disclosure of green projects and initiatives is a critical first step in reducing greenwashing and ensuring that carbon offsets are reliable, verifiable, and designed to actually achieve their stated goals. But it is only a first step. Regulators need to step in to define standards, create intermediaries, and facilitate markets.

With the current absence of regulation directly addressing greenwashing, I encourage the EFTF to step up enforcement efforts in the meantime. Carbon offsets are viewed as contracts of sale of a commodity in interstate commerce, and thus within the anti-fraud jurisdiction of the CFTC pursuant to Section 6(c)(1) and Regulation 180.1(a).[8] The CME Group lists voluntary carbon emissions offset futures on its exchange, further bringing these products within the ambit of our anti-fraud jurisdiction.[9] The CFTC can and will devote appropriate resources to punishing fraud carried out in these new marketplaces.

Carbonized Tokens

The carbon economy has spawned a mirror crypto-economy, in the form of carbonized tokens. And as is the case with much of the crypto-economy, the theoretical goal of carbonized tokens is to make trading of carbon offsets simpler, more transparent, and cheaper, which will enable creators of carbon-reducing projects to access financing more easily. But I have deep concerns that taking one unregulated market—carbon offsets—and layering it on top of another unregulated market—cryptocurrency—will serve only to compound the risks and vulnerabilities inherent in both.

Crypto-based technology solutions provide the promise of increased transparency and the elimination of expenses related to intermediaries and middlemen. By having all transactions publicly accessible via blockchain ledgers, one would be able to see the entire lifecycle of a carbon offset, from its initial purpose of financing a carbon-reduction project through the entire secondary market.

But this purported advantage of crypto technology does nothing to address the root issues of carbon offsets. As I discussed, more needs to be done to verify whether particular offsets actually contribute toward carbon neutrality. For example, an offset might be created as an investment in the protection of existing rainforests. But a project like that adds little to carbon resiliency if those rainforests were never in danger of logging in the first place.

The sheen of new technology-based solutions might entice new and unsuspecting investors hoping to do their part in reducing carbon emissions. With clear guidance on disclosures, governance, auditing, anti-money laundering, data reporting, to name a few issues, there may be hope for offsets to contribute to positive environmental changes.

Recent DeFi Cases

There is broad consensus among regulators, policymakers, and market participants that digital asset markets would benefit from Congressional action and regulatory intervention. On multiple occasions in recent months I have advocated for the CFTC to take steps to regulate these products and protect vulnerable retail customers. I do so again today.

In the interim, however, the CFTC continues to be at the vanguard in the oversight of crypto-economy. Three recent cases—against Opyn, Inc., Deridex, Inc., and ZeroEx, Inc.—demonstrate how the agency is operating at the cutting edge to address this clear need.[10]

Some background first. Each of the companies that were the subject of these cases created decentralized finance (DeFi) trading protocols that allowed the public to invest in derivatives with digital asset underliers. Deridex offered what are called perpetual contracts that provided for the exchange of payments between counterparties depending on the relative value of two virtual currencies. Opyn created a token called oSQTH, whose value was based on an index, Squeeth, that tracked the relative value of ether, squared, compared to the stablecoin USDC. ZeroEx allowed for the trading of tokens that provided investors 2:1 leveraged positions in preexisting digital assets like ether and bitcoin.

Each of these companies allowed investors to take on exposure to the value of certain digital assets without needing to actually invest in the digital assets themselves. And because of the leverage built into the structure of the derivatives, the value of the derivative assets is inherently more volatile than the digital assets themselves. Each of the companies also operated a website that offered these derivatives to the general investing public.

If these derivatives had been based on underlying assets in the traditional economy, existing CFTC regulations would impose a host of obligations—registration, disclosure, clearing, risk management, know your customer and anti-money laundering—before they could be accessed by the public.

The procedures and obligations that our regulations impose are critical for protecting customers. They allow us to surveil transactions across markets, identify the existence, nature, and extent of wrongdoing, and balance the inherent asymmetries of information in these complex financial markets. The orders issued against these three companies variously charge them with failing to register as a swap execution facility (SEF), designated contract market (DCM), and futures commission merchant (FCM); failing to adopt know your customer (KYC) procedures or a customer identification program (CIP) as required by the Bank Secrecy Act; and unlawfully offering leveraged and margined retail commodity transactions in digital assets. In other words, these three companies were acting as registrants without registering.

As I have said before:

Since the foundation of our nation, platforms that offer trading services have played a vital role in our markets, in price discovery, price accuracy, and facilitating greater efficiency and introducing economies of scale in secondary trading markets.  In addition, these platforms perform critical risk mitigation functions.  For two hundred years, these platforms have been responsible for participating in policing our markets.  They have served as a first-line-of-defense in our financial markets.  This incredible responsibility is part of the privilege of operating as a secondary market trading platform.[11]

The Environmental Impact of Crypto

Finally, my time today will not allow me to address, but it merits raising: In a number of states, including here in Texas, the community is investigating the energy consumption associated with mining cryptocurrency. We must carefully evaluate the demands that crypto-industry infrastructure creates for our electrical power grids.

President Biden has made this a “principal policy objective of the United States,” directing interagency coordination on a report studying “the connections between distributed ledger technology and short-, medium-, and long-term economic and energy transitions; the potential for these technologies to impede or advance efforts to tackle climate change at home and abroad; and the impacts these technologies have on the environment.”[12]

That report found: “As of August 2022, published estimates of the total global electricity usage for crypto-assets are between 120 and 240 billion kilowatt-hours per year, a range that exceeds the total annual electricity usage of many individual countries, such as Argentina or Australia.”[13] The report also estimated that all crypto-asset operations in the United States consumes as much electricity as “all home computers or residential lighting in the United States,” and results in carbon emissions “similar to emissions from diesel fuel used in railroads in the United States.”[14]

As we begin to work on policy solutions to these challenging issues, I welcome all of your contributions. I am grateful to many of you here at the Baker Institute for your continued work in these and any number of cutting-edge policy issues. Thank you again for allowing me to join you today.

[2]  Christy Goldsmith Romero, Commissioner, CFTC, Keynote Address at the ISDA ESG Forum on Promoting Market Resilience, A Thoughtful Approach to the Daunting Challenge of Climate Financial Risk (Mar. 7, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero7.

[3]  Press Release No. 8736-23, CFTC, CFTC Division of Enforcement Creates Two New Task Forces (June 29, 2023), https://www.cftc.gov/PressRoom/PressReleases/8736-23.

[5]  See The Integrity Council for the Voluntary Carbon Market, Core Carbon Principles, Assessment Framework and Assessment Procedure, Draft for public consultation (July 2022), https://icvcm.org/the-core-carbon-principles/ (The Core Carbon Principles include Additionality, Mitigation activity information, No double counting, Permanence, Program governance, Registry, Robust independent third-party validation and verification, Robust quantification of emissions reductions and removals, Sustainable development impacts and safeguards, and Transition towards net-zero emissions).

[6]  Int’l Org. of Sec. Comm’ns Bd., IOSCO Encourages Standard-Setters’ Work on Assurance of Sustainability-Related Corporate Reporting  2–3 (2022), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD713.pdf.

[7]  Press Release No. 2022-46, SEC, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors (Mar. 21, 2022), https://www.sec.gov/news/press-release/2022-46.

[8]  7 U.S.C. § 9(1); 17 C.F.R. § 180.1(a); (2022); 7 U.S.C. § 1a(9) (The definition of the term “commodity” includes “all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.”).

[9]  See, e.g., 7 U.S.C. § 9(1) (making unlawful the use of manipulative or deceptive devices “in connection with . . . [a commodity] for future delivery on or subject to the rules of any registered entity”).

[10]  Press Release No. 8774-23, CFTC, CFTC Issues Orders Against Operators of Three DeFi Protocols for Offering Illegal Digital Asset Derivatives Trading (Sept. 7, 2023), https://www.cftc.gov/PressRoom/PressReleases/8774-23.

[11]  Kristin N. Johnson, Commissioner, CFTC, Statement Regarding CFTC Resolving Charges Against Three Decentralized Finance Companies: The Need for Oversight (Sept. 7, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement090723b.

[12]  Executive Order 14067, Ensuring Responsible Development of Digital Assets, 87 Fed. Reg. 14143, 14148 (Mar. 14, 2022).

[13]  The White House, Fact Sheet: Climate and Energy Implications of Crypto-Assets in the United States (Sept. 8, 2022), https://www.whitehouse.gov/ostp/news-updates/2022/09/08/fact-sheet-climate-and-energy-implications-of-crypto-assets-in-the-united-states/.

[14]  Id.