{"id":3939,"date":"2015-01-10T14:25:57","date_gmt":"2015-01-10T19:25:57","guid":{"rendered":"http:\/\/journals.law.harvard.edu\/hblr\/?p=3939"},"modified":"2016-07-04T22:37:25","modified_gmt":"2016-07-05T02:37:25","slug":"the-status-of-environmental-commodities-under-the-commodity-exchange-act","status":"publish","type":"post","link":"https:\/\/journals.law.harvard.edu\/hblr\/the-status-of-environmental-commodities-under-the-commodity-exchange-act\/","title":{"rendered":"The Status of Environmental Commodities Under the Commodity Exchange Act"},"content":{"rendered":"

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Matthew F. Kluchenek*<\/a><\/p>\n

This article examines the role of the Commodity Futures Trading Commission (\u201cCFTC\u201d) in regulating transactions in environmental commodities, such as renewable energy certificates (\u201cRECs\u201d), emissions allowances, carbon offsets and carbon credits. The article examines the general role of the CFTC, the types of products subject to the CFTC\u2019s jurisdiction, the basis for and scope of exclusions to the CFTC\u2019s jurisdiction, and how commodity option transactions could be converted into swaps subject to the CFTC\u2019s jurisdiction.<\/p>\n

Ultimately, transactions in environmental commodities may qualify for the forward exclusion from the definition of \u201cswap\u201d under the Commodity Exchange Act[1]<\/sup><\/sup><\/a> (\u201cCEA\u201d)\u2014and thus not<\/em> be subject to CFTC regulation\u2014if the transactions satisfy certain requirements, the most important of which is the parties\u2019 intent to physically settle each transaction. Such an exemption, however, is relatively narrow, and the active \u201ctrading\u201d of an environmental commodity may jeopardize the use of the exemption.<\/p>\n

I.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 The Role of the Commodity Futures Trading Commission<\/strong><\/p>\n

A.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Jurisdiction and Mission of the CFTC<\/strong><\/p>\n

When Congress created the CFTC in 1974, it conferred upon the CFTC \u201cexclusive jurisdiction\u201d over commodity futures and options thereon.[2]<\/sup><\/sup><\/a> Unless exempted, futures contracts and options thereon must trade on a commodity exchange that has been designated as a contract market\u2014that is, an exchange or market\u2014by the CFTC in order to be legal and enforceable.[3]<\/sup><\/sup><\/a> By contrast, spot and forward transactions\u2014in which the parties intend to make or take delivery of a commodity\u2014are not generally subject to CFTC jurisdiction.[4]<\/sup><\/sup><\/a><\/p>\n

Historically, the CFTC\u2019s regulation of trading in environmental commodities has been relatively limited, but the agency has explored the scope of its boundaries with respect to such commodities. For example, while recognizing that other federal agencies may be better equipped to regulate allocation and recordkeeping requirements associated with the trading of such products, former CFTC Chairman Gary Gensler asserted that oversight by the CFTC of environmental commodities would give it additional experience regulating cash emissions contracts, and claimed that, should Congress seek to regulate cash markets for emission instruments, the CFTC would be well suited to carry out that function. According to Chairman Gensler:<\/p>\n

In most respects, emissions contract markets operate no differently than the other commodity markets the CFTC regulates. While each contract \u2013 such as sulfur dioxide, soybeans, treasury bills or natural gas \u2013 presents its own unique challenges, the regulatory scheme is essentially the same. Carbon markets have similarities to several different markets that fall within our regulatory authority. For example, carbon allowances and offsets are similar to agriculture commodities in that there is a yearly \u201ccrop\u201d and important programmatic regulations governing the nature of the product. At the same time, carbon contracts have similarities to financial products. For example, government-issued allowances and offset credits would be similar to Treasury-issued debt instruments. Futures contracts on Treasury debt are among the most actively traded CFTC-regulated products.[5]<\/sup><\/sup><\/a><\/p>\n

Ultimately, Congress did not accept Chairman Gensler\u2019s invitation, but did mandate the formation, via the Dodd-Frank Wall Street Reform and Consumer Protection Act[6]<\/sup><\/sup><\/a> (\u201cDodd-Frank Act\u201d), of an inter-agency working group to study the oversight of existing and prospective carbon markets.[7]<\/sup><\/sup><\/a><\/p>\n

B.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Dodd-Frank Act<\/strong><\/p>\n

In 2010, Congress enacted the Dodd-Frank Act, which adopted sweeping changes to how the markets in the U.S. for over-the-counter derivatives, and the participants in those markets, are regulated. Many of those changes were implemented by amending the CEA. Through the Dodd-Frank Act, Congress issued a general directive to the CFTC of having as many \u201cswaps\u201d as possible cleared by regulated clearing entities in order to reduce \u201csystemic risk\u201d to the financial markets, and as many \u201cswaps\u201d as possible traded on regulated exchanges, or on or through other regulated entities, in order to increase transparency in the markets.[8]<\/sup><\/sup><\/a> The Dodd-Frank Act thus makes it unlawful for a person[9]<\/sup><\/sup><\/a> to enter into a \u201cswap\u201d without complying with the CEA and the numerous rules promulgated by the CFTC.[10]<\/sup><\/sup><\/a><\/p>\n

The Dodd-Frank Act was important to the environmental commodity market in two respects, both of which are discussed more fully below: 1) it provided and confirmed the basis for excluding environmental commodities from the definition of \u201cswap\u201d and thus from regulation by the CFTC; and 2) it created the inter-agency working group to study the markets.<\/p>\n

C.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 The Definition of \u201cSwap\u201d <\/strong><\/p>\n

1.\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Dodd-Frank Act<\/em><\/p>\n

The cornerstone of commodity futures trading regulations under the Dodd-Frank Act is the definition of \u201cswap.\u201d Generally, if a transaction involves a swap, regulation follows. The Dodd-Frank Act contains a broad definition of \u201cswap\u201d that encompasses most transactions that transfer financial risk<\/em> from one party to the other party.[11]<\/sup><\/sup><\/a> The definition of swap specifies several categories, including:<\/p>\n