While the rules adopted were lauded as significant progress in creating globally linked carbon markets, enhancing the integrity of carbon markets, and further boosting carbon finance, critics argue that non-compliance with the Paris Agreement framework is not yet effectively prevented. These concerns are also echoed for other carbon markets. As carbon markets continue to gain importance, the challenge of participating in these markets while also avoiding so called “carbon fraud” has become more critical than ever.
On the flipside, current developments across the world demonstrate the willingness of regulators to combat irregularities in carbon markets. Recently, regulators in both the US and Germany have begun targeting potential carbon fraud. These allegations and investigations should serve as a reminder to companies and investors to act diligently when purchasing or using carbon credits.
What is carbon trading?
All carbon trading schemes operate on the same key principle: treating the reduction or removal of greenhouse gases (“GHG”) as fungible commodities. These reductions and removals can be expressed in individual carbon credits and then used by entities such as states, companies or individuals seeking to offset their emissions. Usually, one credit point represents the reduction or removal of one ton of carbon dioxide or its equivalent in other GHG from the atmosphere. There are numerous carbon markets, each with specific sets of rules. Generally, compliance markets can be distinguished from voluntary markets.
In compliance markets, international or national legislation requires entities to participate in carbon trading. Typically, energy-intensive emitters such as oil companies, coal and steel installations or airlines are obliged to purchase credits corresponding to their actual emissions and dependent on meeting emission efficiency goals. The legislative goal is to reduce the carbon footprint of these industries by using market-economy mechanisms instead of strict prohibitions. The most notable market-economy mechanisms for carbon trading are cap-and-trade programs, such as the EU Emissions Trading System (“EU ETS”).
An entity may also choose to reduce their carbon footprint to make a profit from reselling carbon credits to others or due to a discretionary policy requiring the entity to become carbon neutral. In this case, the entity could acquire reduction or removal certificates from a voluntary market. Voluntary carbon credits (“VCC”) are intangible instruments issued by private carbon credit programs. Due to their private nature, VCC are generally not subject to any control mechanisms set by a government. The private carbon crediting programs assess and certify projects aimed at reducing emissions, awarding VCC to those that meet the specified standards. The awarded VCC can then be traded on the voluntary markets. A variety of standards exist, with notable examples such as the Verified Carbon Standard and the Gold Standard.
What is carbon fraud?
Due to rising pressure to meet net-zero targets, both through legislation as well as through public opinion, carbon trading and carbon markets have grown significantly. At the same time, reports of non-compliant behavior have increased. There are numerous factors that make both compliance and voluntary markets particularly vulnerable to abuse.
Firstly, purchasers have limited insight into the reduction procedures and verification processes may be inadequate. Typical cases include “ghost credits”, which refer to carbon reductions that are entirely made up. Closely related to this are cases of overstated impact, where the amount of carbon offset by these projects is exaggerated. Another example is double counting, which occurs when a carbon reduction is claimed multiple times or by multiple parties, e.g. by using the same credit in different trading schemes and/or in different jurisdictions. A lack of safety precautions of the emissions registry itself, such as a lack of transaction monitoring, may also increase the risk of fraud. Other concerns revolve around a lack of additionality or permanence of the carbon credits. Accordingly, much of the criticism aimed at the newly adopted rules for carbon markets under Article 6.4 of the Paris Agreement pertains to a lack of transparency and oversight.
Carbon fraud in voluntary markets
Recent examples of carbon fraud exist both in voluntary as well as compliance markets. In the US, the Commodity Futures Trading Commission (“CFTC”) conducted its first actions for fraud in the voluntary market on October 2, 2024. The CFTC filed a complaint against the former CEO of a carbon credit project developer based in the US and issued orders filing and settling charges against the carbon credit project developer and its former COO, charging them with fraud relating to VCC.
The project developer sought and received issuances of carbon credits for purported carbon emission reduction activities by reporting these activities to a carbon credit registry. These carbon credits were then sold on a voluntary market. From 2019 to at least December 2023, the project developer allegedly engaged in a fraudulent scheme of reporting false and misleading data to at least one carbon credit registry to obtain carbon credits far beyond what the developer was entitled to based on its actual carbon emission reduction activities. In response to this, the CFTC required the project developer to pay a civil monetary penalty and to cancel or retire several VCC sufficient to address the violative conduct. Generally, purchasers of invalidated VCC who suffered damages may be entitled to bring civil action against the project developer to recover those damages.
This case might be just the tip of the iceberg. In an investigation by The Guardian, it was found that more than 90 per cent of the rainforest offset credits accreditations of Verra, one of the largest certifiers of VCC, were not matched by actual carbon reductions.
Carbon fraud in compliance markets
In Germany, regulators are investigating potential cases of carbon fraud. The GHG reduction quota, implemented under national legislation pursuant to the EU RED II Directive, requires companies selling fuel to offset the GHG emissions of their fuel by a set percentage. It is currently considered the most important instrument for reducing GHG in the transportation sector in Germany. Companies may achieve the GHG reduction quota, for example, by selling electricity-based fuels themselves. Alternatively, they may pay third parties to fulfill their GHG emission quota (in part), e.g. by selling biodiesel for them. This has led to a trade with GHG emission reduction options to achieve compliance with the GHG emission quota.
The price for GHG emission reduction options (“GHG quota price”) has plummeted in value, from over 450 euros per ton at the end of 2022 to around 80 euros per ton in January 2025, due to an oversupply of GHG emission reduction options. There have been allegations that the oversupply stems from an overflow of fraudulent emission reduction options concerning wrongly labeled biodiesel and purportedly noncompliant upstream emission reductions (“UER”) projects.
Regarding biodiesel imports, there are suspicions of false declarations of biodiesel imported from China. The EU Commission and German authorities are currently investigating whether palm oil from Southeast Asia was relabeled in China as biodiesel made from old cooking fat or wastewater from palm oil production for the German and European market. As early as the summer of 2023, several biofuel producers had their certification withdrawn.
A second investigation concerns UER projects. UER projects involve avoiding emissions that usually arise during oil production, most notably due to flaring, venting and leakages of associated gases. In practice, companies obliged under the GHG quota regulation contract local oil producing companies with the implementation of third-party validated UER projects. Pursuant to the amount of GHG reductions confirmed by verification bodies, the obliged companies can register a corresponding amount of UER certificates in the UER registry of the German Environment Agency (Umweltbundesamt). Then, they can use the UER certificates to either comply with their GHG reduction quota or sell them to other market participants. Since August 2023, allegations have surfaced that fraudulent UER projects were registered with the German Environment Agency. It is claimed that the projects either do not exist, have started their project activity too early, or have not been sufficiently supervised by validation and verification bodies. Consequently, authorities have begun investigating potential ways to combat the supposed fraud, e. g. by freezing UER accounts.
In reaction to the falling GHG quota price, the German legislator has refitted the national legislation. There are further plans of the German legislator to adjust the rules governing the GHG reduction quota to restore the GHG reduction quota market and ensure its functioning.
How companies can prepare
In conclusion, these investigations underscore the importance for companies trading carbon credits to ensure that the purchased carbon credits are of high quality and comply both with international and national regulatory requirements. Companies that inadvertently acquire carbon credits from fraudulent carbon projects risk significant financial losses due to the loss or devaluation of the carbon credits purchased.
Moreover, the current trend of introducing emission-related transparency, disclosure and reporting regulations increases the risk of reputational damage. In the EU, for instance, a significant number of companies will be required to disclose the purchase of VCC in accordance with the European Sustainability Reporting Standards pursuant to the Corporate Sustainability Reporting Directive. In the US, a significant number of companies will be required to disclose the purchase or sale of VCC in California pursuant to the California Voluntary Carbon Market Disclosures law. These disclosures increase the likelihood that the public will become aware of a company relying on fraudulent VCC to reduce its carbon footprint. They also increase the risk that carbon reduction disclosures are deemed misstatements that could be the subject of shareholder claims. Companies should scrutinize any VCC disclosures carefully and potentially add risk-factor language to apprise investors and other stakeholders of the risks of fraud inherent in purchasing VCC.
Additionally, a company might face a multitude of legal issues. Whilst legal actions based on fraud against purchasers seem unlikely, having relied on fraudulent carbon credits may necessitate efforts that extend beyond a regulatory framework focused on a single jurisdiction to a cross-border approach encompassing litigation, commercial, and white-collar investigations. A strategic approach for managing these legal issues may also have to include corporate considerations to protect against potential board member liability.
Unfortunately, validating the quality of carbon credits may prove difficult at times. Relying solely on accreditations, even from reputable standards like Verra, carries inherent risks. Companies can mitigate these risks by thoroughly understanding the underlying offset projects, assessing the integrity of the carbon credits, and evaluating their pricing. Safeguards recommended by public authorities, such as the security measures for the EU ETS registry suggested by the Dutch authorities, should be adhered to whenever available – e.g. Dutch Emissions Authority (Nederlandse Emissieautoriteit) guidance “Fraud prevention and security”.
Some certainty for companies using VCC in the EU could result from the Carbon Removal Certification Framework Regulation, which entered into force on December 26, 2024 and aims to complement the standards introduced by private bodies and to create a harmonized EU-wide certification framework for carbon removal projects. Steps to enhance the integrity of VCC markets in the US include the US SEC’s climate disclosure rules which include provisions relating to VCC (the rules are currently staid pending litigation), the CFTC’s proposed VCC trading guidelines, and the US Federal Trade Commission’s proposal to make VCC-specific clarifications to its Green Guides.
As the regulatory landscape continues to evolve rapidly, it is imperative for companies to vigilantly monitor changes in the legal framework that increase the integrity of carbon markets and to stay abreast of any changes that may introduce additional liability risks.