Overview of the 2022 ISDA Verified Carbon Credit Transactions Definitions

Introduction

On 13 December 2022, ISDA published the 2022 ISDA Verified Carbon Credit Transactions Definitions (the VCC Definitions) together with forms of Confirmations for use with certain VCC derivative transactions, as set out in the Exhibits to the 2022 ISDA Verified Carbon Credit Transactions Definitions (the Forms of VCC Confirmations). The launch of the VCC Definitions and Forms of VCC Confirmations is an important step towards a liquid voluntary carbon market and represents an important milestone in the development of standard OTC derivatives documentation for secondary market trading in voluntary carbon credits. This briefing provides an overview of the recently published VCC Definitions and Forms of VCC Confirmations.

What are VCCs?

A Verified Carbon Credit (VCC) is a unit measured in tCO2e, representing the removal, reduction, avoidance, sequestration or mitigation of emissions of greenhouse gasses (including, carbon dioxide, methane and nitrous oxide) from the atmosphere, which is capable of being represented in a unit of measurement pursuant to the relevant carbon standard rules under which it is issued. 

VCCs differ from “voluntary carbon credits” because the program or standard in which they are issued may be either a mandatory or voluntary domestic or intentional greenhouse gas program, certification, scheme or protocol (a Carbon Standard). A VCC has a unique serial number and is issued by the relevant Carbon Standard into its registry pursuant to which they can be held, delivered, retired or cancelled. 

What is the background to publication of the VCC Definitions and Forms of VCC Confirmations?

In its paper “Role of Derivatives in Carbon Markets” of September 2021, ISDA highlighted the role of the derivatives markets in the transition to a low carbon economy. Subsequently, in December 2021, ISDA published its paper “Legal Implications of Voluntary Carbon Credits” highlighting the need for increased legal certainty and liquidity in the carbon markets as an enabler for the development of a clear price signal for carbon and to achieve more efficient funding of low-carbon and carbon-reducing or emission-reducing projects. 

Carbon markets have developed alongside technology-based methods to reduce carbon emissions and work towards international, national and regional net-zero targets. An important element of the carbon market is secondary carbon trading (meaning all subsequent transactions of carbon credits, following the initial distribution of emission allowances in the primary markets) which allows for a greater participation and involvement in the carbon markets across industry sectors and jurisdictions. 

The carbon markets are fast growing and as a result there has been an exponentially increasing entry into VCC derivative transactions. The VCC Definitions and Forms of VCC Confirmations are the first standardised OTC derivatives documentation for secondary market trading in VCCs. The VCC Definitions and Forms of VCC Confirmations are intended for use across markets, jurisdictions and the breadth of Carbon Standards globally. 

What do the VCC Definitions and Forms of VCC Confirmations aim to achieve?

The purpose of the VCC Definitions and Forms of VCC Confirmations is to provide standardised documentation to allow market participants to document physically settled spot, forward or option transactions in VCCs (VCC Transactions) under the ISDA Master Agreement framework. The aim is to bring standardisation to the secondary trading of VCCs which, in turn, will help increase liquidity in the market. 

This standardised documentation is an integral part of the development of safe and efficient derivatives markets for secondary trading in VCCs which will (a) allow market participants to transact with confidence, using clearly defined provisions for execution and settlement and (b) promote greater liquidity and efficiency in the market.

How do the VCC Definitions interact with the ISDA Master Agreement?

The VCC Definitions are a definitional booklet published through ISDA's online 'MyLibrary' platform. As provided in the VCC Definitions, any or all of the provisions set out therein may be incorporated into a document (such as a Confirmation) by including wording in such document indicating that, or the extent to which, the document is subject to the VCC Definitions. 

Unless otherwise agreed between the parties, the latest version of the VCC Definitions available on the trade date of a VCC Transaction will apply to such VCC Transaction, and the terms of that VCC Transaction will not be affected by any further updates in a later dated version of the VCC Definitions. 

The VCC Definitions were initially conceived as an additional Part to be incorporated in to the Schedule to the ISDA Master Agreement (like the ISDA EU and UK Emissions Allowance Transaction Documents). However, a standalone set of VCC Transaction provisions and definitions to be applied as a definitional booklet were eventually developed, which allows the flexibility if, as is expected to the case, the provisions and concepts are updated over time, for parties to apply the latest version of the VCC Definitions to their VCC Transactions without the need to amend their ISDA Master Agreement.

What do the VCC Definitions contain?

The VCC Definitions contain provisions which, amongst other things:

• govern the delivery and payment obligations for business-as-usual trading in VCC Transactions. Broadly speaking, and subject to the retirement process discussed below, the VCC Definitions provide that the delivering party is required to do everything required under the relevant Carbon Standard rules and registry rules to deliver the relevant VCCs to the receiving party’s registry account on the delivery date (subject to the receiving party having done all that is required of the receiving party to allow for receipt of the relevant VCCs). If the relevant VCCs are delivered on the delivery date, the receiving party shall pay an amount calculated pursuant to, and in accordance with, the VCC Definitions to the delivering party on the payment date. As the different Carbon Standard rules and registry rules each have their own requirements and terminology, the concepts of “deliver” and “receive” have deliberately been drafted broadly in order to allow the provisions to work with different rules. 
• address mutual discharge across VCC Transactions. If “VCC Netting” applies, on any date VCCs of the same agreed specification are deliverable in respect of two or more VCC Transactions by each party to the other between the same pair of registry accounts of the parties, then such delivery obligations will be mutually discharged with the party with the larger aggregate number of VCCs to deliver, being required to deliver the excess only. Payment netting with respect to VCC Transactions will apply pursuant to, and in accordance with, Section 2(c) of the ISDA Master Agreement.
• introduce additional representations and warranties. Pursuant to the VCC Definitions, each party represents and warrants to the other party as at the trade date and on each delivery date that it has at all times fully complied with the relevant Carbon Standard rules and registry rules to the extent necessary to permit the delivery contemplated by the relevant VCC Transaction. In addition, the delivering party makes several additional representations to the receiving party on each delivery date regarding, amongst other things, its legal and beneficial ownership of the relevant VCC, the relevant VCC satisfying the agreed specifications and confirmation that the relevant VCC has not been previously retired or otherwise cancelled for use. 
• allow for retirement as a way of delivery. Retirement of a VCC is the permanent removal of the VCC from circulation in the relevant registry in accordance with the relevant Carbon Standard rules and the relevant registry rules. Some market participants may purchase VCCs intending to retire them in order to offset their own emissions. Once retired, a VCC is permanently removed from circulation and cannot be traded anymore or used to offset further emissions. The VCC Definitions allow for the delivering party to retire VCCs on behalf of the receiving party, following the receiving party’s instructions, and that constitutes effective delivery.
• incorporate VCC Disruption Events. The VCC Definitions contain various disruption mechanics covering the occurrence of external events that cause a failure to deliver VCCs by a transaction party, a failure to receive VCCs by a transaction party or other settlement disruption events. Generally speaking, upon the occurrence of such events, the delivery and payment obligations of the parties are deferred and the relevant party is required to try and overcome the relevant event by a cut-off date. If the relevant party is unable to overcome the relevant event by the relevant cut-off date, then the VCC Definitions include bespoke termination provisions for each disruption event. The termination provisions in the VCC Definitions are supplemental to the Events of Default and Termination Events in the ISDA Master Agreement.  For example, the VCC Settlement Disruption Event is drafted as an additional type of force majeure event and does not override or disapply Section 5(b)(ii) (Force Majeure Event) of the ISDA 2002 Master Agreement. In addition, the consequences of a failure to deliver and a failure to receive under the VCC Definitions are different to the standard consequences flowing from an Event of Default or Termination Event under the ISDA Master Agreement.
• introduce a set of definitions relating to VCC specifications which may be specified in the Confirmation for a VCC Transaction.  These relate, inter alia, to different Carbon Standards, registries, VCC types and Carbon Standard labels.

Commentary

The market has been in need of standardised documentation to enable trading VCCs to be developed. The development of standardised documentation which is Carbon Standard agnostic, and is intended to work with the differing rules and delivery and retirement methodologies of differing Carbon Standards provides a strong base for the further evolution of the market, and represents a significant step towards building the common foundations that will underpin liquidity in the VCC derivatives markets.