Voluntary carbon trading markets are growing as emissions-producing businesses formulate plans to reach net zero. The legal and regulatory infrastructure is not yet mature across a range of jurisdictions, but ISDA has been keen to be at the forefront of documentation for secondary market trading, whether on a spot or derivative basis – culminating in the 2022 ISDA Verified Carbon Credit Transactions Definitions (the VCC Definitions).
At the end of 2022, ISDA launched the new VCC Definitions to facilitate the trading of verified carbon credits (VCCs). As the global legal and regulatory landscape remains uncertain, the VCC Definitions are necessarily flexible and open-ended. The VCC Definitions provide for spot, forward and option trades, all physically-settled, referencing VCCs. VCCs cater for both voluntary and mandatory greenhouse gas schemes, but will not cover mandatory emissions allowance schemes such as the EU and UK emission trading scheme. The scope of trades matches those catered for under ISDA’s standard EU / UK emissions allowance transaction terms (the Emissions Allowance Terms) which have become standard for use in ISDAs between parties wishing to trade transactions referencing emissions allowances, but with spot trades being expressly catered for.
As with other recent definitions booklets including the 2021 ISDA Interest Rate Derivatives Definitions, the VCC Definitions are only available on ISDA’s subscription-based MyLibrary website (https://mylibrary.isda.org/bookstore). Future updates to the definitions will therefore be made by restating the entire definitions booklet (so-called “re-versioning”).
The booklet also takes the form of a conventional definitions booklet (albeit on MyLibrary), rather than (as was the case for the Emissions Allowance Terms) a form of Part 7 to the Schedule to the ISDA Master Agreement (the ISDA MA). Taking this form should provide several advantages for users, including: (i) following a form of document more familiar to users of ISDA materials; (ii) providing a more efficient process for incorporating future updates to the terms in new trades (i.e. the most recent version will be incorporated into a new trade, rather than (as was the case with the Emissions Allowance Terms) parties having to amend their Schedule to the ISDA MA to update for the latest form of terms; (iii) ISDA MAs will be shorter, since the definitions booklet is incorporated by reference into a trade confirmation rather than being set out in full in the Schedule to the ISDA MA; and (iv) negotiation should be simpler, as it is clearer that the standard terms in the definitions booklet should not typically be amended, other than where they expressly provide for elections. ISDA has also published template confirmations for each product type, to accompany the definitions booklet.
Readers will certainly see the debt that the VCC Definitions owe to the Emissions Allowance Terms, in their substance. The new definitions, however, adopt a more user-friendly and logical layout and format, in line with the style of other recent definitions booklets.
Key terms include a settlement mechanism in which payment follows delivery, and the parties can elect how they allocate risk of cancellation of a VCC post-delivery. The VCC Definitions also provide various other elections the parties can make in the relevant trade confirmation, including as to the standard to which certain representation are made. This is important given the uncertainty in some jurisdictions as to the nature of a VCC and the sort of property it might constitute. Notably, the definitions provide the option for the party buying VCCs to elect for the VCC to be retired upon settlement of a trade (rather than simply delivered to the buyer’s registry account) – upon retirement, the VCC can no longer be sold on. This function will be useful for parties that intend to use VCCs to offset their emissions where they don’t have direct access to the registry (in contrast to parties whose use of the definitions will simply be for trading in the secondary market).
The approach taken to dealing with settlement disruption and failure to deliver / receive VCCs is very similar to the Emissions Allowance Terms, which notably provide bespoke consequences, including the compensation process for failure to delivery / receive, rather than relying on a close-out amount calculation under Section 6(e) of the ISDA MA, given the bespoke (and illiquid) nature of the underlying VCC. However, there are some differences, including the removal of some optionality as to the replacement value calculation.
While the Emissions Allowance Terms catered for a more limited potential user base (i.e. parties in the market for mandatory emissions allowances), the VCC Definitions have a potentially unlimited user base. The form of the VCC Definitions should help users who have ISDA MAs in place (e.g. for treasury hedging) get up-and-running quickly. However, it’s fair to say that the market for secondary trading in VCCs is still in its infancy, and so it remains to be seen how widely used the VCC Definitions will be in the near future. Parties may also prefer to use alternative documentation published by the International Emissions Trading Association (IETA). However, parties that are used to ISDA documentation and appreciate the certainty it provides, and the ability to net across different products, may prefer the ISDA-based approach.
The VCC Definitions will no doubt be here to stay, and will form an important part of the transition to net zero, as they are future-proofed to be able to accommodate carbon standards which have not yet been created (in contrast to the Emissions Allowance Terms, which hard-wired the relevant emissions trading scheme and compliance period). It may of course be the case that developing carbon standards necessitate changes and additions to the VCC Definitions, but ISDA’s digital format is flexible enough to permit that.