^{Chapter 6:}
Regulatory treatment

^{Chapter 6:}

Regulatory treatment

This chapter outlines how existing regulatory frameworks can be applied to carbon markets, focusing on financial regulators and policy tools in major jurisdictions (UK, EU and US). A phased approach is recommended, utilising a principles-based strategy that includes: (1) clearly defining the legal status of carbon credits; (2) establishing regulatory perimeters based on carbon market functions; (3) introducing conduct, transparency and disclosure standards for market players; (4) supporting market innovation via regulatory sandboxes and pilot programs; and (5) helping to ensure international alignment to avoid fragmentation. These measures, discussed in this chapter, aim to help enhance market integrity and investor protection in carbon trading, while supporting the growth of high-quality carbon markets worldwide.

6.1. A principles-based approach akin to the UK’s digital assets framework

VCMs provide a mechanism for channelling capital towards the energy transition. But their effectiveness is undermined by lack of transparency in how organisations use credits, and uncertainty over the quality of the credits, which erodes trust. Unlike legally established compliance markets, such as emissions trading schemes (ETS), VCMs have developed in a fragmented, largely unregulated fashion akin to the early days of cryptocurrency markets. This has led to potential vulnerabilities including inconsistent standards, information gaps and opportunities for fraud. In the absence of clear regulatory oversight, anyone can issue or sell carbon credit and authorities have “no way of controlling their quality or validity”, as the UK’s Financial Services Authority warned over a decade ago.⁷¹

A phased and principles-based regulatory approach, inspired by the UK’s model for digital assets, offers a promising path to bring carbon credits within the formal oversight of financial regulators – without stifling innovation. The UK’s response to regulating crypto assets evolved gradually – initially through guidance on how existing laws apply, then requiring registration and anti-money laundering (AML) controls, then introducing conduct rules (e.g., fair marketing), and now moving toward a comprehensive regime. In October 2023, the government and regulators announced a ‘phased approach’ to make crypto a fully regulated asset class by 2026. This deliberate sequencing balanced innovation with market integrity, allowing the sector to mature under increasing oversight. The VCM shares parallels with early crypto markets: it is fast evolving, largely outside traditional regulation and marked by diverse new participants and technologies. By applying lessons from digital asset regulation, policymakers can integrate carbon trading into the financial regulatory perimeter in a flexible yet robust manner.

Recommendation

Adopt a phased, principles-based regulatory framework for VCMs, modelled on the UK’s digital assets regime.

_{⁷¹ FSA:}_{FSA warning over carbon credit trading schemes | Scams | The Guardian}

6.2. Defining the legal status of carbon credits within regulatory frameworks

A foundational step is to clarify the legal nature and classification of carbon credits within existing regulatory frameworks. Today, voluntary carbon credits occupy a grey area; they are typically treated as intangible commodities or environmental assets, rather than traditional financial instruments. The International Organisation of Securities Commissions (IOSCO), highlighted in 2024 that “clarity is needed [on] the legal nature and regulatory classification of carbon credits” as a prerequisite for effective oversight.⁷²In practice, this means legislators and regulators should determine whether carbon credits fall under definitions of commodities, securities, derivatives or a new sui generis asset class, as this status dictates which laws and agencies oversee their trade.

In the UK, regulators could draw on the approach taken for crypto tokens by the Financial Conduct Authority (FCA). The FCA’s guidance on crypto assets categorises tokens into existing regulatory buckets (e.g. security tokens, e-money tokens or unregulated utility tokens). Similarly, carbon credits could be explicitly classified – for instance, as regulated commodities or contracts – through amendments to the Financial Services and Markets Act 2000 (FSMA) and the Regulated Activities Order (RAO). This would bring certain carbon market activities firmly under the FCA’s jurisdiction. Clear classification would also help resolve whether dealing in carbon credits constitutes a regulated investment activity requiring authorisation. Establishing credits as regulated instruments would close this loophole and empower the FCA to police promoters and intermediaries.

In the EU, lessons can be drawn from the treatment of compliance carbon allowances. Since 2018, EU Emission Allowances (EUAs) under the EU Emissions Trading System have been legally defined as financial instruments under Markets in Financial Instruments Directive II (MiFID II). This move subjected allowances and their derivatives to the full suite of EU financial market rules, including transparency, reporting, and the Market Abuse Regulation (MAR). Unlike unregulated spot commodities, EUAs are now directly subject to market abuse prohibitions, such as insider trading and manipulation, under MAR. The result is a carbon allowance market with stronger safeguards for integrity and investor confidence.

_{⁷² IOSCO:}_{FR/08/2024 Voluntary Carbon Markets}

By contrast, voluntary carbon credits in the EU are generally not covered by MiFID II if traded spot and over-the-counter (OTC), as they sit outside the compliance scheme (although discussions are underway on linking the two). They remain largely in the realm of private contract law. European policymakers could consider expanding the regulatory definition of allowable instruments (or creating a new category) to encompass high-quality voluntary credits, especially as standardised credit trading platforms emerge. This should help ensure that key protections, such as surveillance for fraud and manipulation, apply in the voluntary arena as well.

In the US, carbon credits are not explicitly defined as securities or commodities by statute, but regulators have found ways to exert oversight. The Commodity Futures Trading Commission (CFTC) has stated that carbon credits (being interchangeable offset units) fall under the broad definition of ‘commodity’ in US law. Consequently, the CFTC asserts anti-fraud and anti-manipulation jurisdiction over the cash market for carbon credits, and oversees any derivatives (futures, options, swaps) on carbon credits, through its authority on designated contract markets.

The Securities and Exchange Commission (SEC), on the other hand, generally does not treat standalone carbon credits as securities unless they are packaged in an investment scheme that meets the Howey test (e.g. certain carbon investment trusts).⁷³ To date, US federal policy has not created a bespoke legal status for voluntary offsets, leaving a patchwork of oversight. Here too there are calls for clarity: for instance, a joint study by legal experts under the International Institute for the Unification of Private Law (UNIDROIT) and the United Nations Commission on International Trade Law (UNCITRAL) is examining the legal nature of voluntary credits to aid domestic law development. A clear legal classification in each jurisdiction – whether through legislative amendment or regulatory guidance – is a precondition for consistent regulation, providing the basis on which agencies can extend their rules to carbon trading.

Recommendation

Establish a clear and harmonised legal classification for carbon credits within financial and environmental regulatory frameworks.

_⁷³_{Framework for “Investment Contract” Analysis of Digital Assets}

6.3. Establishing regulatory perimeters based on use case for carbon units

Once carbon credits are defined within the legal framework, regulators should establish which activities in the carbon market fall inside the regulatory perimeter and which can remain outside. Not every use of a carbon credit needs financial regulation; for example, a company retiring credits to offset its emissions for sustainability goals is primarily an environmental claim issue. But many market-facing functions associated with carbon credits mirror those in traditional financial markets, and thus merit similar oversight. Key areas to consider include trading venues, investment products and derivatives trading.

6.3.1. Trading platforms and exchanges

Several online marketplaces and broker platforms facilitate the buying and selling of carbon credits between project developers, investors and corporates. These platforms often operate outside the regulated exchange or trading facility framework. Going forward, regulators should decide which types of carbon trading venues require authorisation – for instance, a platform dealing in standardised carbon contracts to multiple investors might be deemed a multilateral trading facility (MTF) or equivalent, thus needing to meet requirements on transparency, fair access and orderly trading.

In the EU, if a platform lists carbon derivatives or EUAs, it is already under MiFID II/Markets in Financial Instruments Regulation (MiFIR) rules by virtue of those instruments being regulated. The UK could similarly require that any organised secondary trading of carbon credits (e.g., above a certain volume or involving retail participants) be conducted on authorised venues. This could bring oversight to pricing and prevent market fragmentation, much as moving crypto trading onto regulated venues is expected to improve consumer protection.

6.3.2. Funds and investment products

As carbon is increasingly treated as an asset class, it is seen that the emergence of carbon credit funds, exchange-traded products, such as exchange traded funds (ETFs) or notes tracking carbon prices, and structured products (e.g. bonds linked to carbon offset projects). Regulators should clarify that when carbon credits are pooled or securitised into an investment product offered to others, the usual securities/fund regulations apply. For instance, an investment fund that buys and holds carbon credits for profit should be managed by a regulated asset manager and provide prospectus disclosures – like any commodity fund. Indeed, classifying carbon credits as financial instruments would automatically fold such products into existing anti-market abuse and disclosure regimes, which is a key advantage.

In Europe, trading in carbon derivatives or allowances already triggers obligations under market abuse law and position reporting. Extending that perimeter to popular voluntary carbon instruments (or futures on them) should similarly guard against cornering the market or insider dealing on non-public information (for example, a project developer knowing a batch of credits will be invalidated would constitute inside information, if the credits were regulated). Regulators can also specify that certain corporate uses of carbon credits – for instance, if companies trade credits for profit or use them to back green financial products – may bring those activities under oversight for fraud or misrepresentation.

In delineating the perimeter, regulators should adopt a functions-based approach. This means focusing on the economic function and risks of an activity, rather than its label. The aim is to capture activities that pose systemic risks to investor protection or market integrity. Buying a carbon credit to make a one-time offset claim might remain outside financial regulation (handled by consumer protection or advertising standards), whereas speculative trading, or dealing on behalf of clients, would be inside. As IOSCO noted in its work on carbon markets, some of its members already view certain voluntary market activities as falling under securities law. A careful mapping of carbon market functions against regulatory objectives should ensure that important areas (trading, intermediation, fund management) are subject to oversight, while not unnecessarily burdening pure climate or philanthropic uses of credits.

Recommendation

Adopt a functions-based regulatory framework that distinguishes between environmental use cases (e.g., offsetting emissions) and financial market activities (e.g., trading, investing, securitising carbon credits).

This approach should help ensure that activities posing financial risk or requiring investor protection are brought under appropriate oversight, while avoiding unnecessary regulation of purely environmental or philanthropic uses.

Require authorisation and oversight for carbon trading platforms and investment products that resemble traditional financial market infrastructure. This includes:

Classifying high-volume or investor-facing carbon trading platforms as regulated venues (e.g., MTFs).
Applying securities/fund regulations to carbon credit funds, ETFs and structured products.
Extending market abuse and disclosure rules to voluntary carbon instruments when pooled or traded for profit.

6.3. Imposing conduct, transparency and disclosure standards

In tandem with bringing carbon market players within the regulatory perimeter, authorities should introduce conduct and disclosure standards tailored to the carbon market’s unique characteristics. These standards should be principles-based and address the current information asymmetries and trust deficits in carbon trading. The goal is to help ensure that market participants behave honestly and transparently, and that buyers have reliable information about what they are purchasing.

6.3.1. Anti-fraud and market integrity rules

Financial regulators can extend existing anti-fraud provisions to explicitly cover carbon credits. In the US, for example, the CFTC has made clear that it will aggressively enforce anti-fraud and anti-manipulation laws in the carbon markets, pursuing cases of false reporting or deceptive practices in credit issuance and trading. In 2024 the CFTC brought its first fraud charges in the voluntary carbon market, signalling a “commitment to vigorously fight fraud” in both new and established markets.⁷⁴

Likewise, the UK’s fraud and market abuse laws (which already cover carbon allowances as financial instruments) could be explicitly applied to voluntary carbon credits if they become regulated. This means anyone knowingly selling ‘ghost’ credits (non-existent or double-counted offsets) or manipulating carbon prices would face severe penalties. Importantly, applying the Market Abuse Regulation (MAR) framework to carbon would outlaw insider trading on material non-public information about carbon projects and prohibit collusive schemes to distort carbon prices.

These measures protect honest market participants and help ensure that carbon prices reflect genuine supply-demand dynamics and quality differentials, not manipulation.

_⁷⁴_{CFTC Charges Former CEO of Carbon Credit Project Developer with Fraud Involving Voluntary Carbon Credits | CFTC}

6.3.2. Conduct and competency requirements

Regulators can require firms active in carbon trading to meet baseline standards of conduct. IOSCO’s recent guidance includes promoting “participants’ skill and competence” in carbon markets, recognising that inexperienced actors may otherwise cut corners.⁷⁵ Licensing regimes could impose fitness criteria and training for carbon market dealers, so that they understand both financial and environmental aspects of the products they handle.

Given the technical complexity in assessing carbon projects, regulators might also consider accrediting or overseeing third-party verifiers and ratings agencies that evaluate credit quality, analogous to how credit rating agencies are regulated for financial debt instruments.

_⁷⁵_{FR/08/2024 Voluntary Carbon Markets}

6.3.3. Transparency and disclosure for buyers

Authorities can mandate disclosure requirements for any regulated offering of carbon credits. For example, a platform listing credits for sale could be required to provide standardised product information documents detailing the project type (forestry, renewable energy, etc.), verification standard, vintage year, methodology for calculating emissions reduced and any risks to permanence or additionality. This parallels disclosures in securities offering documents, should help enable buyers to compare credits.

Regulators might leverage industry initiatives here – for instance, credits that meet the Core Carbon Principles (CCP) set by the Integrity Council for Voluntary Carbon Markets (ICVCM) could be labelled as such, and sellers would have to disclose if a credit does not meet an established quality benchmark.

Additionally, rules could require disclosure of any conflicts of interest (if, say, the seller has a financial stake in the project) and the use of proceeds (if relevant, for project developers selling forward credits). Enhanced transparency should help mitigate the information imbalance, where buyers currently rely on claims by sellers that may be exaggerated.

6.3.4. Truthful marketing and environmental, social and governance (ESG) claims

Many participants in carbon markets are also making public claims about climate neutrality or offering carbon-inclusive financial products. Financial regulators are increasingly cracking down on greenwashing: misleading claims about sustainability.

In the UK, the FCA’s new anti-greenwashing rule requires that any sustainability-related claims by regulated firms be “fair, clear and not misleading” and backed by evidence.⁷⁶ This would cover claims about carbon credits or offsetting. For instance, if an investment fund advertises itself as carbon-neutral through offsets, the firm must have data to substantiate that those offsets are legitimate and sufficient.

Similarly, in the EU, the upcoming Green Claims Directive and existing consumer protection laws will penalise unsubstantiated carbon neutrality claims. By enforcing truth-in-advertising standards, regulators will help to ensure that companies cannot overstate the impact of credits or mislead stakeholders about their climate performance. Carbon credit vendors should also only market credits for what they truly deliver; e.g. not selling a cheap avoided-deforestation credit as if it were equivalent to a high-quality removal credit. Clear guidelines on marketing communications (as the FCA introduced for crypto assets promotions) should help standardise how carbon credits can be presented to consumers and investors, with appropriate risk warnings about price volatility or project risks.

_⁷⁶_{PS23/16: Sustainability Disclosure Requirements (SDR) and investment labels}

6.3.5. Anti-money laundering (AML) and know-your-customer (KYC)

Given the growing financial value of carbon credits, and the potential for cross-border transactions, it is prudent to apply AML/KYC requirements to this sector. Illicit actors could seek to launder money via obscure carbon credit trades or use proceeds from environmental crime. Under a regulated regime, carbon credit exchanges and brokers should implement customer due diligence, report suspicious transactions, and adhere to financial crime controls, like crypto exchanges.

The EU’s AML regulations already cover commodity derivatives and allowances; extending them to cover voluntary credits (if not already implicitly covered as ‘property of value’) should close any gaps. The UK could include carbon market intermediaries in its AML supervision framework (e.g. treating them akin to dealers in high-value commodities). This should prevent the integrity of carbon markets being undermined by criminal abuse, further building trust for legitimate participants.

Recommendation

Apply existing anti-fraud and market abuse regulations (e.g., Market Abuse Regulation in the UK) explicitly to voluntary carbon credits. This includes prohibiting deceptive practices, insider trading and price manipulation.

Apply anti-greenwashing rules to carbon credit marketing and ESG claims. Require that claims (e.g., carbon neutrality) be substantiated with verifiable data and that marketing communications follow clear guidelines.

Extend AML/KYC obligations to carbon credit exchanges, brokers, and intermediaries. Require customer due diligence, suspicious activity reporting and financial crime controls.

6.4. International alignment and cooperation

Carbon markets are inherently global; a credit generated in one country may be sold to an investor in another and used by a company in a third. This global nature means that a purely domestic regulatory approach could lead to arbitrage and inconsistency. International alignment of regulatory frameworks is therefore crucial, to avoid fragmenting the market and to uphold high standards across borders.

If one jurisdiction imposes strict rules on carbon credit trading (for example, requiring licensing and disclosures) while another remains laissez-faire, bad actors are likely to gravitate to what they consider the weakest link. In lightly regulated markets, credits or trading platforms could be deliberately domiciled to escape oversight, undercutting the integrity efforts of stricter jurisdictions. To prevent this, major markets should coordinate, with regulatory requirements for carbon credits interoperable – or at least mutually recognised across borders. For instance, if the UK classifies voluntary credits as regulated assets, it could work with the EU and US so that similar definitions are adopted, or foreign regulated status is acknowledged. Harmonising basic standards – such as what constitutes a high-quality credit, or a consensus on disclosure items – should allow credits to trade globally without losing the confidence of buyers. Conversely, a patchwork of rules could increase compliance costs and complexity, potentially stifling legitimate market development.

Fortunately, a number of international bodies and initiatives are already laying the groundwork for common standards. IOSCO’s work on carbon markets has resulted in a set of Good Practices for regulators that emphasise consistency and cooperation.⁷⁹ One principle explicitly calls for “domestic and international consistency and cooperation” – urging regulators to consult peers when developing their approach and to strive for aligned frameworks.⁸⁰ In practice, this could mean joint regulatory forums on carbon (similar to IOSCO’s task forces) or bilateral agreements for information sharing about market misconduct.

_⁷⁹_{FR/08/2024 Voluntary Carbon Markets}_⁸⁰_{FR/08/2024 Voluntary Carbon Markets}

The ICVCM has introduced CCPs for credit quality; regulators can incorporate these by reference, so that a credit which meets ICVCM criteria is accepted broadly. The VCMI is developing guidance on how companies should use and report offsets; securities regulators could echo VCMI’s guidelines in their disclosure rules for public companies (for example, requiring companies to follow VCMI’s claim code if they assert carbon neutrality in annual reports). Additionally, international accounting standards are evolving (the International Sustainability Standards Board (ISSB) is working on climate disclosure standards that include carbon credit usage) and alignment with these should help ensure companies around the world report carbon credit information in a comparable way.

Coordinated regulation also enables better enforcement against misconduct. Carbon credit frauds or manipulative schemes often span multiple jurisdictions; credits might be sold in Country A for a project in Country B by a company registered in Country C. Regulators should establish channels for cross-border cooperation, such as agreements to share data on suspicious transactions, or to undertake joint investigations. IOSCO encourages regulators to use “cross-border enforcement” and to collaborate with counterparts overseeing different parts of the carbon market (from issuance to trading to retirement). A concrete example is the collaboration between the CFTC, Department of Justice (DOJ) and foreign authorities in recent US enforcement actions, which unravelled transnational fraud in carbon credit schemes. Going forward, one could envision an international network of carbon market regulators, analogous to arrangements in AML or bribery, where information on bad actors and best practices is regularly exchanged.

Another aspect of international alignment is to help ensure that the growth of voluntary markets complements formal climate agreements like the Paris Agreement. Article 6 of the Paris framework governs international transfer of mitigation outcomes (ITMOs) between countries. Regulators should be mindful that any credits approved as ITMOs (with corresponding adjustments to national emissions) have a different status than regular voluntary credits. Coordination between financial regulators and environmental authorities is needed, to avoid double counting and to help ensure that credits are not used improperly in both compliance and voluntary contexts.

Some countries are already exploring domestic regulation of carbon credits in line with Article 6; for example, Singapore allows certain international credits for compliance use up to 5% of emissions and has set criteria for those credits. Aligning such policies with financial market oversight (e.g. requiring the same transparency from an Article 6 credit as a voluntary one) should create a more unified carbon market, rather than two siloed systems.