By Maria Cronin, Craig Hogg, and Kirsten Stewart
At the 27th United Nations Climate Change conference (COP 27), held in Egypt this month, attention has once again turned to carbon credit markets. Once presented as a panacea for corporations struggling to keep apace with net zero targets, awareness is growing on the extent to which carbon credit markets are open to abuse by fraudsters, and the need for tougher regulation.
Carbon credits – what are they?
Carbon credits assign value to the reduction of greenhouse emissions, permitting companies to emit a certain amount of carbon dioxide or other greenhouse gases. One credit permits the emission of one tonne of carbon dioxide or the equivalent in other greenhouse gases.
Under carbon credit mechanisms, which date back to the 1990s and the so-called ‘cap and trade’ Kyoto Protocol of 1999, polluting companies are awarded credits permitting them to pollute to a certain prescribed limit, and may sell unutilised credits to third party companies creating an incentivisation process and a commodification of the emissions reduction system.
Carbon credit markets
There are two primary types of carbon market: regulatory compliance and voluntary markets. The regulatory compliance market is used by companies who are required by law to account for greenhouse gas emissions, whereas the voluntary market (once described by Credit Suisse as a “wild west” on account of its self-regulation and poor transparency) facilitates the trade of carbon credits on a voluntary basis.
The carbon credit market is burgeoning: according to figures published by the International Organization of Securities Commissions (IOSCO), the global carbon market was worth €760 billion in 2021 (up from €288 billion in 2020), with the overwhelming majority of that activity taking place in European markets (valued at €683 billion in 2020).
Despite their popularity, carbon credit mechanisms are highly divisive: Greenpeace have called such carbon offset schemes a greenwashing ‘scam’, whereas the IOSCO has demanded tougher regulation in both markets.
Why are carbon credits open to abuse?
Carbon credit mechanisms often involve complex financial instruments and are poorly understood by sellers, buyers and traders alike, creating fertile ground for abuse. In particular, INTERPOL has highlighted how carbon markets are at risk of exploitation by criminals due to the large amount of money invested, the immaturity of the regulations governing the market and an overall lack of oversight and transparency.
Legal considerations: VAT fraud and boiler room schemes
Perhaps the most prominent example of abuse of the market has arisen through the use of carbon credits to facilitate missing trader intra-community (MTIC) or “carousel” VAT fraud: a complex form of VAT fraud in which criminals exploit cross-border rules to fraudulently reclaim VAT. In 2019, MTIC fraud was estimated to cost EU states a total of €150 billion (£133bn) a year, with the UK’s HM Revenue and Customs calling such schemes a “a serious and credible threat to the VAT system”.
In 2018, 36 people were convicted by a French court of their participation in a carbon credit VAT fraud scheme described as the ‘carbon tax fraud of the century’ which led to losses of €385 million to the French tax authorities. The main organiser of the scheme, Christiane Melgrani, was sentenced to nine years in prison and fined three million euros for fraud as part of a criminal enterprise, money laundering and criminal conspiracy.
Fraudulent trading and money laundering convictions have also resulted from carbon credit schemes involving the sale of carbon credits at inflated prices. Last year, Paul Seakens and Luke Ryan of the company, Enviro Associates, were convicted of running a £36 million ‘boiler room’ fraud in the UK involving the sale of so-called Voluntary Emission Reduction (VER) carbon credits with up to 1,000% markups to vulnerable individuals. Both men were sentenced to 13 years and six years’ imprisonment and disqualified from holding directorships for 12 and six years, respectively.
Regulatory shortcomings and the future
The IOSCO has sought to use COP27 as an opportunity to discuss regulatory shortcomings in the carbon credit markets, with the Chair, Jean-Paul Servais, issuing a statement calling for “appropriate frameworks for sound and well-functioning carbon markets” to ensure appropriate levels of “integrity and, transparency, and liquidity are maintained”.
The IOSCO has issued two consultation reports, in which the body has recommended increased transparency in compliance markets including the number of allowances given to companies for free, and advocating for more robust frameworks to monitor derivative carbon markets, with stronger enforcement mechanisms and greater clarity over what constitutes manipulative, abusive conduct or other prohibited conduct in the market.
On the voluntary market side, the IOSCO has identified weaknesses in emission measuring and the quality and practice of double counting credits and the absence of centralised registries, which creates the preconditions for fraudulent transactions (for example, the selling of credits that either do not exist or do not belong to the seller). The IOSCO has also underscored how the use of cross-border transactions makes it challenging to detect or prevent fraudulent behaviours in the voluntary market. The IOSCO has called for responses to its consultation, with a deadline set for February 2023.
Whilst green activists will continue to strongly question the ethical value of carbon credits in their entirety, tougher regulation seems inevitable to ensure carbon credits are not instrumentalised by fraudsters seeking to ensnare individuals, businesses and governments and make a quick financial gain.
About the Authors
Craig Hogg is an Associate at Peters & Peters. He specialises in a wide range of white collar crime matters, with particular experience acting for clients in complex cross-border criminal and regulatory investigations, internal investigations and corporate compliance.
Maria Cronin is a Partner at Peters & Peters. She has extensive experience of advising corporate and individual clients on all aspects of business crime, including corruption and money laundering. Her practice focuses on white-collar cases with a truly international dimension.