Study LXXXVI - Legal Nature of Voluntary Carbon Credits

The concept of carbon credit was introduced in the Kyoto Protocol of 1997 with the purpose of reducing the emission of greenhouse gases into the atmosphere. Since then, a number of international treaties and domestic laws have introduced related regulations seeking to fight global warming. Special reference is due to the Paris Agreement of 2015, which provides for carbon trading as a key means of reducing carbon emissions globally.

Instruments such as the Kyoto Protocol and Paris Agreement have encouraged the development of an international market for the creation and trading of carbon certificates. In parallel with the development of compliance carbon schemes, demand for carbon credits from entities that are not under an obligation to participate in carbon markets has also grown. Voluntary carbon credits (“VCCs”) represent a certification stating that the holder, either directly or indirectly, has reduced or removed from the atmosphere one metric ton of carbon dioxide equivalent in line with applicable rules and requirements. VCCs typically are constituted outside of any regulatory or compliance framework and are generally chosen by the relevant stakeholders as a means to offset emissions and help meet net-zero goals.

Investment and transactions concerning this type of complex asset require legal certainty, something which cannot be taken for granted in unregulated and unsupervised markets. As voluntary carbon markets grow in size and complexity, the trading in VCCs would be significantly enhanced if steps were taken, both nationally and internationally, to better understand the legal nature of VCCs.

The main objective of the UNIDROIT Project on the Legal Nature of Carbon Credits (the “VCCs Project” or “Project”) is thus to provide guidance on private law issues so as to enhance confidence in VCC transactions and support the development of a well-functioning market which could play a central role in fighting climate change, achieving the goals of the United Nations Framework Convention on Climate Change (“UNFCCC”), in particular the Paris Agreement, and facilitate the fulfilment of the UN Sustainable Development Goals. Given that a significant share of the projects that generate VCCs are located in developing economies, a reliable carbon credit market also provides an opportunity to increase capital flow to emerging markets and provide funding to projects that may not otherwise receive adequate support.

On 24 January 2022, the International Swaps and Derivatives Association (“ISDA”) submitted a proposal to UNIDROIT recommending that UNIDROIT consider a project to analyse the legal nature of VCCs. ISDA’s proposal was expressly supported by the Government of Paraguay in a letter received by the UNIDROIT Secretariat on 9 May 2022.

At its 101st Session (Rome, 8-10 June 2022), the UNIDROIT Governing Council unanimously recommended the inclusion of the VCCs Project in Unidroit’s 2023-2025 Work Programme, with high priority (see paras 50-60, UNIDROIT 2022 – C.D. (101) 4 rev). While the Governing Council recognised the similarities of the VCCs Project to the UNIDROIT Project on Digital Assets and Private Law (the “DAPL Project”), it identified sufficient distinct features of VCCs to recommend that a separate Working Group be established for the VCCs Project. The Governing Council’s recommendation was unanimously endorsed by the UNIDROIT General Assembly at its 81st session (Rome, 15 December 2022) (see paras 75-78, UNIDROIT 2022 – A.G. (81) 3).

Following receipt of the mandate, the UNIDROIT Secretariat organised a First Exploratory Consultative Workshop (the “First Exploratory Workshop”) in collaboration with the World Bank Group and ISDA, held at ISDA headquarters in London on 27 March 2023. The purpose of the First Exploratory Workshop was that of identifying current issues in the VCC field and delineating the scope of the Project. A preliminary discussion paper was prepared by the Secretariat to guide the discussion. The First Exploratory Workshop was attended by twenty-four participants, including representatives from international organisations, industry and academia, as well as practitioners and members of the UNIDROIT Secretariat. The First Exploratory Workshop sought to consider, among other matters, the following items:

(a) Key concepts;

(b) Key considerations regarding the legal nature of VCCs;

(c) Ownership, creation, and transferability of VCCs;

(d) Secured transactions involving VCCs, including collateralisation;

(e) Custodians/intermediaries;

(f) Applicable law issues;

(g) Treatment in case of insolvency; and

(h) Local market regulatory oversight.

An update on the status of the VCCs Project, drawing on the conclusions of the First Exploratory Workshop as well as on the Secretariat’s own research, was presented to the UNIDROIT Governing Council at its 102nd session (Rome, 10-12 May 2023). On this occasion, the Governing Council confirmed the authorisation to establish a Working Group, in collaboration with the World Bank Group, tasked with developing an international law instrument to provide guidance on the legal nature and other private law aspects of VCCs (the “VCCs Working Group”).

A Second Exploratory Consultative Workshop was held at the World Bank Group offices in Vienna on 11 July 2023 (the “Second Exploratory Workshop”). The Second Exploratory Workshop was attended by twenty-eight participants, including experts from international organisations, development banks, academia and the private sector, as well as representatives from the UNIDROIT Secretariat. The Second Exploratory Workshop built on the work of the First Exploratory Workshop and discussed, among other things, the following items:

(a) Key concepts;

(b) Main actors involved in the VCC life cycle;

(c) Key considerations regarding the legal nature of VCCs;

(d) Ownership of VCCs;

(e) Transferability of VCCs;

(f) Secured transactions and collateralisation of VCCs;

(g) Retirement of carbon credits;

(h) VCC price;

(i) VCC accounting;

(j) Treatment in case of insolvency;

(k) Local market regulator oversight;

(l) Applicable law issues;

(m) Sector-specific carbon credits; and

(n) Relevant issues not to be included in the Project’s scope.

The Second Exploratory Workshop closed with the participants noting that next steps would be delineated in coordination with UNIDROIT’s sister organizations, including with the UNCITRAL Secretariat in light of UNCITRAL’s 56th Commission Session held in Vienna on 3-21 July 2023, and with the Hague Conference on Private International Law (“HCCH”).