^{Chapter 5:}
Legal nature
of carbon

^{Chapter 5:}

Legal nature of carbon

Despite their widespread use, and the need for increased use to finance carbon abatement activities, the legal rights associated with carbon projects and resulting carbon units remain ambiguous. These units (today treated as “credits”) are often defined differently in different jurisdictions, creating uncertainty for issuers, investors and buyers. Furthermore, there are significant questions as to: legal title when carbon units are bought; the consequent ability for investors to take security over assets; performance of other custodial services; the prospect of governments ‘rescinding’ rights to carbon (particularly where it is transferred internationally); the operationalisation of Article 6 of the Paris Agreement.

To overcome these challenges, carbon should follow legal patterns long established and tested in other commodities markets, principally by clearly defining carbon as property. Market infrastructure, notably ‘registries’, need to be set up to facilitate the taking of security of these assets – and the United Nations Article 6 structures should be built, to avoid falling into the same legal gaps and issues in today’s voluntary carbon markets.

5.1. The need for legal clarity

Legal clarity is critical for markets to function. Investors struggle to operate in markets without clear legal frameworks, definitions and recourse. Market participants are largely unlikely to trade carbon without legal certainty over their rights and obligations within the market. This, in turn, severely inhibits market growth and restricts capital flowing into underlying projects.

Carbon markets, therefore, require legal clarity on the nature of the asset, and legal frameworks that can form a basis for investment and trading. This chapter articulates the legal rights associated with carbon projects and the legal rights to carbon units. Such clarity allows the market to apply tried and tested legal concepts and frameworks from comparable commodity markets, and helps remove a key barrier to unlocking market activity and investment.

5.2. Carbon (mineral) rights

For any commodity market, parties require legal certainty that carbon ‘owners’ have the legal rights to the carbon as a mineral, and that this right can be transferred. This refers to the rights to the ‘physical’ carbon (rather than the tradeable carbon units, which are dealt with in subsequent sections. A number of steps should be taken to secure and evidence these legal rights.

In many jurisdictions, while private actors can own land, there are certain minerals associated with that land that are initially excluded from private ownership. In these cases, those seeking to own and extract these minerals should apply for a license from the state, to transfer ownership for extraction and then sale or use.

More specifically:

UK: By law, the Crown owns all petroleum (oil and natural gas), coal and precious metals (gold and silver).⁴⁴Generally, other minerals are owned by private actors, tied to the landholding. This information is freely available on the Land Registry.⁴⁵ Where the Crown owns minerals, the UK government licenses the rights to extract and own the minerals. Where mineral rights are not owned by the Crown, the landowner may need to seek planning permission and other specific regulatory permissions (e.g. environmental permits) associated with the activity in question.⁴⁶
USA: Private landowners initially own rights to minerals, unless the rights have otherwise been severed by sale or reservation (creating a “split estate”).⁴⁷ Where split estates exist, the mineral estate is commonly treated as the dominant estate, meaning that the mineral rights owner has authority to use the land surface as reasonably necessary to extract the minerals.⁴⁸ On private land, there is no federal licensing regime; rather state permits need to be obtained for development, construction and access, and other permissions (e.g. environmental).
Australia: By law, each state and territory owns virtually all minerals within its jurisdiction. Hence title to land typically does not include ownership of underlying minerals. Each state and territory has its own licensing statute and regulatory frameworks, which provide licensing systems for exploration and extraction (often these are separate licenses/leases). Mining titles are recorded in public registers. If rights to the minerals are granted to a private entity, then these mineral rights are dominant to the land surface rights, but compensation often needs to be paid to the landowner. Ownership of the mineral legally passes to the extractor at the point of extraction and until that point remain property of the Crown.⁴⁹

_⁴⁴_{UK mineral ownership - MineralsUK}_⁴⁵_{UK mineral ownership - MineralsUK}_⁴⁶_{Carbon Capture, Usage, and Storage: UK Regulatory Regime – Publications}_⁴⁷_{What are Mineral Rights? & What You Need to Know | Hall & Hall}

_⁴⁸_{What are Mineral Rights? & What You Need to Know | Hall & Hall}_⁴⁹_{Dentons - Dentons Global Mining Guide: Australia}

Rights to carbon – i.e., the rights to sequester and store – are largely silent in law in a number of these jurisdictions, notably in the USA and UK. These jurisdictions do not recognise a ‘carbon right’ in law. Australia does, however, at the state level. A number of states have enacted statutes to codify rights to carbon. For example, Western Australia’s Carbon Rights Act 2003 creates a “carbon right”, defined as the exclusive legal right to benefits from carbon sequestration (and liability for carbon release) on a parcel of land.⁵⁰ This right can be granted separately to the land title.⁵¹ New South Wales, Victoria, Queensland, Tasmania and South Australia each adapted legislation (such as forestry rights acts or amendments to property laws) so that the sequestered carbon in forests or soils can be owned/traded independently of the land.⁵²

Governments should take steps to clarify carbon rights, and where carbon has not been explicitly named in law as amongst the minerals which sovereigns own, then landowners should have the right to the carbon that is sequestered (i.e., ‘extracted’ and stored) on their land. Sovereigns should clarify the requirements for a licence to ‘extract’ carbon. This would be project type dependent and in line with planning regimes that govern these projects – rather than requiring a new licencing regime for carbon. This should not require new statutes; however, statutes should be pursued where needed, to provide legal clarity.

Recommendation

Governments should clarify the initial owner of carbon associated with land rights, whether the default position is that the private landowner has rights over the carbon attributes, or, in the case of Crown land, government has rights to the carbon.

Governments should clarify the permissions needed to sequester carbon, leveraging existing planning regimes, rather than requiring new licensing regimes.

_⁵⁰_{CAR-01 Carbon Rights and Carbon Covenants | Landgate}_⁵¹_{CAR-01 Carbon Rights and Carbon Covenants | Landgate}_⁵²_{https://www.unswlawjournal.unsw.edu.au/wp-content/uploads/2017/09/31-3-5.pdf}

Some carbon sequestration projects also need legal clarity over the physical storage of the carbon sequestered. As governments have looked to support the creation of carbon capture, utilisation and storage (CCUS) infrastructure and markets, legal frameworks have been created. For example, in the UK, the Energy Act 2008 set up a licensing regime for the offshore storage of carbon, similar to oil and gas licence.⁵³ Some states in the US have provided legal clarity (through statute) that the surface landowner owns subsurface spaces for carbon storage, subject to any specific existing rights of mineral owners.⁵⁴ Clarity over who owns the subsurface space for the purpose of storing carbon is critical, not least given different jurisdictional approaches to land and mineral ownership in the first instance. An analogy here could be groundwater, for which subsurface rights regimes exist.

Recommendation

Governments should provide legal clarity as to who owns the subsurface property used for carbon storage and, where appropriate, establish licensing regimes for physically storing carbon. This should also include the storage of carbon in physical products such as biochar and enhanced rock weathering projects.

_⁵³_{Carbon Capture, Usage, and Storage: UK Regulatory Regime – Publications}_⁵⁴_{Who Owns Pore Space for Carbon Capture and Storage?}

5.3. Legal definition of carbon units (tCO₂e)

There are a range of legal definitions of carbon credits. They are often seen as personal property rights under common law jurisdictions such as Hong Kong, Singapore and Australia, and range in definitions across the US.

More specifically:

England and Wales: There is no statutory or common law definition of the legal nature of carbon credits. A 2023 paper by Ben Mcuhae & Co argues that carbon credits “broadly meet” the requirements for property and that “assuming a VCC [voluntary carbon credit] falls within the definition of personal property, the next step is to determine the applicable category of personal property – such as chattels personal (for example tangible goods or choses in possession, choses in action, or other intangible property) or a form of documentary intangible.”⁵⁵
Australia: Carbon credits are defined in statute as personal property. However, the type of personal property is not specified. And this definition is expressly applied to the carbon credits issued under the 2011 Act, namely Australian Carbon Credit Units (ACCUs).⁵⁶
Singapore: Singapore case law, according to Ben McQuhae & Co, suggests that carbon credits can be defined as intangible property, if specific tests are met. There are statutory definitions of carbon credits in the Carbon Pricing Act 2018, and property is defined under the Conveyancing and Law of Property Act 1886.¹⁵
USA: There has been some variance at a state level as to the legal definition of carbon credits. For example, if they are issued by the state for use in California’s compliance regime, then they might not be subject to property rights. A federal District Court in Louisiana suggested the right to report, sell or transfer carbon credits is included in a land owner’s real property “bundle of rights”.⁵⁷ This conclusion flows from the view that a landowner’s simple absolute estate includes “the soil, vegetation growing in the soil and underlying minerals.”⁵⁸ The Uniform Law Commission has recently formed a committee on carbon credits to develop a model law for states to adopt, which could help provide consistent definitions going forward.⁵⁹

_⁵⁵_{The Legal Nature of Carbon Credits – Ben McQuhae & Co}_⁵⁶_{Australian Government Clean Energy Regulator;}_{Legal characteristics of Australian carbon credit units}_⁵⁷_{The Legal Nature of Carbon Credits – Ben McQuhae & Co}

_{⁵⁸ Steven A. Kennett, Arlene J. Kwasniak & Alastair R. Lucas, Property Rights and the Legal Framework for Carbon Sequestration on Agricultural Land, 37 OTTAWA L. REV. 171, 180 (2005)
⁵⁹}_{Commercial Law Framework for Voluntary Carbon Credits Committee - Uniform Law Commission}

The market would benefit from jurisdictions clarifying the legal definition of carbon as property rights, and within this, clarifying which kind of property carbon would fall under. Market participants need legal certainty over their rights, security, trading position – as well as tax regulatory and accounting positions. Such certainty is commonly the case for commodities traded across jurisdictions.

Ideally this would result in consistent legal definitions across jurisdictions, and should be encouraged through legal advice and statutory and regulatory frameworks. These should be embedded into a commodity regulatory framework, as is the case with electricity. As Chapter 6 notes, by defining carbon as a commodity, market makers (such as financial institutions) can avoid significant capital charges for holding these assets on their balance sheet.

One characteristic of assets subject to proprietary rights is individuation, or the ability to distinguish one thing from another. This can be accomplished through serialisation of carbon units, or the assignment of specific, unique naming practices. Standard practice in registries is to issue credits in blocks, particularly at the initial issuance. The blocks are typically divided as necessary to facilitate transactions but may or may not represent a single unit – and rarely represent a single credit representing a single metric tonne of carbon. This individuation by block can accommodate proprietary rights if appropriately specific but may have accounting consequences.

Recommendation

The definition of carbon credits/units as property should be made explicit and consistent in law within – and ideally across – jurisdictions. By serialising carbon units, registries can distinguish individual carbon units, to determine property rights.

5.3.1 Carbon as an intangible asset: UK digital assets definition of property

Commodities are typically physical items, in gaseous, liquid or solid states. Carbon units however, while linked to underlying physical projects are intangible representations to the right to carbon that has been sequestered and which, in many cases, cannot be identified physically, only calculated using methodologies and formulas based on the physical presence of the project.

In the UK, the Law Commission has provided a new type of property right, which can be applied here. It has sought to define the legal rights to intangible digital assets, such as crypto-tokens and crypto assets. It finds that English and Welsh common law with respect to personal property rights “is well placed to provide a coherent and globally relevant regime for existing and new types of digital asset.”⁶⁰

This provides a helpful starting point to define the characteristics of a carbon unit, and to map it against widely used legal frameworks and definitions. The Law Commission proposed that the UK Government legislates to remove all ambiguity on this point, and the UK Government has introduced the Property (Digital Assets etc) Bill in order to do so.⁶¹ The UK could use this legislation to clarify that carbon units would be covered by this new definition of property, to provide clarity over legal rights associated with the units.

Recommendation

The UK Government should extend the Digital Assets Bill to cover carbon units.⁶²

_⁶⁰_{Digital assets – Law Commission}_⁶¹_{Property (Digital Assets Etc.) Bill - GOV.UK}_⁶²_{Property (Digital Assets Etc.) Bill - GOV.UK}

5.4. Standardised contracts

Whether or not the market coalesces around consistent legal definitions of carbon, it should benefit from standardised contracts for carbon spot and future transactions. This is the case in all tradeable and liquid markets, clarifying the rights and obligations of parties in the transaction, which should be recognisable and consistent, to support efficient trading environments.

This is happening in part for carbon markets. The International Swaps and Derivatives Association (ISDA) has started to provide standardised documents for secondary market trading for verified carbon credits.⁶³ These include provisions which: govern the delivery and payment obligations of parties; allow for retirement as a way of delivery; address mutual discharge; introduce additional representations and warranties; incorporate disruption events; provide a set of definitions that may be specified in the confirmation of the transaction.⁶⁴

Standardised primary contracts have been drawn up by exchanges. These tend to draw on standard terms from ISDA or elsewhere, and then add their own specific terms and conditions, depending on their market regulations and structures.

Standardised contracts can support the codification of these rights, and delivery and recourse for failure, but rely on other parties to evidence legal rights.

_⁶³_{Overview of the 2022 ISDA Verified Carbon Credit Transactions Definitions | Global law firm | Norton Rose Fulbright}_⁶⁴_{Overview of the 2022 ISDA Verified Carbon Credit Transactions Definitions | Global law firm | Norton Rose Fulbright}

5.5. Transfer of asset

Once rights to carbon have been established, it is necessary to legally clarify the transfer of ownership of the carbon between parties. There are a number of established legal frameworks for the transfer of commodities via a transaction. English and Welsh law provides the basis for international transactions of commodities, with a legal framework derived through statute.

Domestically, the transfer of commodities is governed by the Sale of Goods Act 1979⁶⁵, which sets out provisions on when ownership and risk pass from seller to buyer, typically depending on the parties’ intentions or, if not specified, on default statutory rules.

Commodities can be transferred through physical delivery or by transferring documents of title, such as bills of lading or warehouse receipts. In such cases, the Carriage of Goods by Sea Act 1992 may apply, particularly in international trade contexts.⁶⁶

These statutes provide the basis for contracts to be drawn up to cover this transfer of ownership. They therefore provide a recognised and precedented basis to transfer the rights to carbon between parties when transacting.

In international and large-scale commodity trades, standardised contracts issued by trade associations such as the Grain and Feed Trade Association (GAFTA), the Federation of Oil, Seeds and Fats Associations (FOSFA), or the London Metal Exchange (LME) are frequently used. These contracts streamline terms relating to delivery, quality and dispute resolution. When commodities are used as collateral in financing arrangements, UK law provides mechanisms for creating and registering security interests under legislation like the Companies Act 2006.⁶⁷

Recommendation

English and Welsh law provides a strong basis for the legal framework to govern the transfer of carbon as an asset and the market should seek to use these laws to underpin contracts transferring the ownership of carbon.

_⁶⁵_{Sale of Goods Act 1979}_⁶⁶_{Carriage of Goods by Sea Act 1992}_⁶⁷_{Companies Act 2006}

5.6. Security

To facilitate finance into carbon reduction and removal projects, and to scale carbon markets at pace, financiers and buyers of emissions reductions and removals, resulting from such carbon projects, should each be able to establish legally valid, binding and enforceable security interests in carbon reductions and removals generated from financed projects.

Contracts should clarify who owns the carbon abatement, as well as how security is enforceable across jurisdictions. This is dependent on laws in different jurisdictions, assets used as collateral and other factors.

The contractual agreements of many carbon credit registries prohibit the taking of security over reductions and removals, undermining investment (debt and forward purchase commitments) in projects that seek to deliver these benefits. This is distinct from other markets, where market infrastructure allows financiers to take security in law and in practice over borrowers’ assets.⁶⁸ Carbon registries, which register and create frameworks for the recognition and issuance of carbon credits, should provide this function. This should also be the case for the UN Article 6 registry (under Article 6.4).⁶⁹

_{⁶⁸ See Philip Lee, Skylight Law, SDFM, Emral Carbon, Letter to Chair of the Article 6.4 Supervisory Body, RE A6.4-SB011-AA-A11 – Draft Procedure relating to the Article 6.4 Mechanism Registry, 25 April 2024
⁶⁹}_{Registry | UNFCCC}

If carbon registries fail to provide infrastructure to facilitate the taking of security over assets, then this task should fall to another market participant. In commodity and financial markets, depositories provide this function. These house trillions of dollars of securities, commodities and other instruments, and have clear frameworks to facilitate legal processes and requirements, such as the ability for financiers to take security over assets. Given the maturity of these institutions and their familiarity to market participants, both as a counterparty and as an operator, there is a strong case for these entities to provide the core depository function for carbon units.

Recommendation

Carbon depositories (whether registries as recognised today or as a carbon depository) should affirm the validity of legal title to carbon credits held in registry accounts. These entities should furthermore provide the processes and infrastructure to give access to information necessary to facilitate the securitisation of assets. Such information could include relevant land title documents, carbon sequestration rights or licensing and any such other evidence commonly used to establish security interests.

This function should be provided by robust market infrastructure, either run by governments or attached to exchanges, that can facilitate finance, securitisation and enforcement of legal rights.

5.7. Article 6

The UN Article 6 Framework (the Paris Agreement Crediting Mechanism, “PACM”) should seek to avoid the legal ambiguity of today’s VCMs, and build it around recognisable and necessary legal rights and frameworks, based on ownership of carbon units as a commodity extracted from a reserve. This should operate as a record of title for parties, to execute security interests, assuming legal liability.

5.7.1. Letter of authorisation for transfer of carbon ownership

Project developers, investors and buyers should seek assurances from host jurisdictions to clarify ownership, and to claim and use potential for carbon credits. Necessary assurances may include acknowledging the carbon crediting project and establishing the jurisdiction’s recognition of a project’s legal right to conduct operations in specific activities or sectors. Letters of acknowledgement can be used, for example, to help establish ownership and title to carbon credits financed by third parties but intended to be counted towards the host jurisdiction’s nationally determined contributions (NDC).

Letters of authorisation (LoAs) are formal, binding commitments, issued by host countries, that allow credits to be eligible for transfer out of the country, and be potentially used towards another jurisdiction’s NDC, or other international mitigation purpose such as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). LoAs can similarly provide some evidence of legal title and ownership, but primarily serve accounting purposes, confirming that credits are not double counted or used against the host country’s NDC.

Due to their intangible nature, carbon rights could be rescinded by sovereign governments, who may: nationalise credits; or renege on NDC accounting commitments, so that credits intended to be put towards another NDC – or eligible compliance schemes such as CORSIA – can no longer be used this way.

This is not, of course, a specific issue related to the Article 6 carbon markets; countries could rescind any carbon transactions. Therefore, in any event, these LoAs – and other methods to provide evidence of ownership and permitted use – should be clear and legally robust, to provide confidence for investors, carbon owners and buyers that governments of host countries will not count the associated emissions reductions against its own targets. Article 6 and Article 13, the establishment of an enhanced transparency framework,⁷⁰ specify measures governments should take, to establish appropriate infrastructure to issue and track these LoAs, to support market activity, and ensure that carbon credits are appropriately rivalrous, and have been tracked and accounted for in ‘export’ terms.

Recommendation

Host governments should continue to provide Letters of authorisation (LoAs) or other methods, to legally clarify that carbon can be transferred internationally. These letters should present an unambiguous legal position as to the host government’s position, as well as the legal rights and responsibilities of parties.

_⁷⁰_{parisagreement_publication.pdf}