A burning desire

Author:Clifford Curtis Williams
Position:Thomas Jefferson School of Law, Cartersville, Georgia, USA

Purpose – This article purports to show that an adequate anti-money laundering (AML) regime must be integrated into the carbon emissions market industry in order for it to function effectively, meet its intended goals, and prevent criminals from developing innovative methods to take advantage of particular vulnerabilities this unique market type has created. Design/methodology/approach... (see full summary)


Carbon will be the world's biggest commodity market, and it could become the world's biggest market overall ( Kanter, 2007 , quoting Louis Redshaw, then head of environmental markets at Barclays Capital).

I Introduction

International recognition of the need to avert potentially devastating climate change, caused chiefly by the burning of fossil fuels, has resulted in global efforts to reduce overall greenhouse gas (GHG) emissions in order to stabilize or limit the concentration of carbon dioxide in the atmosphere ( Gilbertson and Reyes, 2009, pp. 8-9 ). These efforts have resulted in a carbon emissions trading industry: a system used by countries, organizations, and individuals to offset carbon emissions from one activity with another, whereby those who desire to or must exceed pre-determined emissions requirements set by regulating bodies may purchase credits from those who have produced carbon emissions below their allocated levels ( Cleveland Carbon Fund, 2012 ). These emissions trading schemes limit the amount of GHG pollution which entities can produce, requiring heavy polluters to buy credits from companies or countries that pollute less – thereby purporting to create financial incentives to fight global warming ( Goldemberg et al., 1995, p. 30 ).

The first international carbon market was created by the United Nations Framework Convention on Climate Change (UNFCCC) and its issuance of the Kyoto Protocols. It was soon followed by the establishment of the European Union's Emissions Trading Scheme (EU ETS). What has evolved is a global push toward controlling emissions output with the establishment of new and integration of existing carbon emissions trading markets. As these markets have matured, so to have criminals in their efforts to exploit vulnerabilities that exist in these venues, particularly in their use of these instruments and the financial intermediaries on which these markets rely, to commit frauds and launder money.

Generally, money is laundered to conceal or disguise that its source is from illicit or criminal means. “In most cases, the money involved is earned from an illegal enterprise and the goal is to give that money the appearance of coming from a legitimate source” ( IRS, 2012 ). This is typically accomplished through a three-stage process:

  • placement, the initial movement of money into the financial system;
  • layering, the process of distancing criminal proceeds from their source through the movement of funds through accounts, financial systems, and institutions; and
  • integration, the movement of layered funds, no longer traceable to their criminal origin, into legitimate accounts or back to the criminal.
  • Because criminal elements must at some point attempt to turn illicit proceeds into “clean” funds, effective anti-money laundering (“AML”) regimes are integral to detecting and preventing overall criminality in carbon emission trading markets, regardless of whether the criminal act begins with fraud and then entails money laundering or vice versa.

    Though initially formed by international governmental efforts, rather than traditional market forces, the similarities in primary and secondary carbon emissions trading schemes to traditional securities or financial markets are obvious and cannot be ignored. This realization leads to the inescapable conclusion that these markets are as susceptible to money laundering threats as traditional financial markets, abuses of which are potentially just as prevalent. Because of this, effective AML objectives must be examined within these similarly-situated markets.

    This article purports to show that an adequate AML regime must be integrated into the carbon emissions market industry in order for it to function effectively, meet its intended goals, and prevent criminals from developing innovative methods to take advantage of particular vulnerabilities this unique market type has created. Lack of AML safeguards during the initial implementation and formation of these markets can have severe consequences to primary and secondary market operation and subsequent attempts to overlay an AML regime to solve obvious problems can be problematic. Part II discusses the formation of the international carbon emissions trading marketplace, including examination of primary and secondary markets, relevant stakeholders, market makers, and market instruments. Part III, using the EU ETS experience as a model, examines market implementing regulations and whether the lack of an AML framework existed to deter or detect criminal activity. It posits that it did not and that critical to the formation and effective operation of any carbon emissions trading market is the simultaneous coexistence of an AML regime to prevent criminals from taking advantage of legislative deficiencies. Part IV formulates and analyzes emerging criminal typology threats to which current, developing, and future carbon emissions markets are and will be subject.

    II Development of a carbon emissions trading marketplace

    International carbon emissions trading essentially began ( UNFCCC, 2012a ) with the ratification of the Kyoto Protocol in 19971, the first legally binding international document requiring member countries to meet emission reduction targets ( UNFCCC, 2012a ). The Protocol established three mechanisms parties can use to meet emissions commitments: emissions trading, also known as the “carbon market”; the Clean Development Mechanism (CDM); and Joint Implementation (“JI”) ( UNFCCC, 2012e ).

    Parties committed to reducing emissions under the Kyoto Protocol are required to meet specific targets, divided into units called “assigned amount units” (“AAUs”) ( UNFCCC, 2012c ). If a country has excess units to spare, meaning it has produced emissions under a pre-determined threshold, it can sell these excess AAUs to countries that have produced over their allowable emission level ( UNFCCC, 2012c ). In this way art. 17 of the Kyoto Protocol establishes a new carbon emissions trading market whereby AAU units can be publicly sold on an international level between participating countries and parties2.

    The CDM, created by art. 12 of the Kyoto Protocol, allows a country with an emission-reduction target to meet this obligation by implementing an emission-reduction project in certain developing countries2. These projects create certified emission reduction (CER) credits which can be used to meet emissions targets by offsetting production from another source ( UNFCCC, 2012b ). A CDM project must undergo an extensive registration and issuance process and produce credits that are “additional to what otherwise would have occurred” ( UNFCCC, 2012b ). These can also be sold in the carbon market ( UNFCCC, 2012b ).

    Article 6 of the Kyoto Protocol created JI, a program similar to CDM, whereby a country with an emissions limitation obligation can meet its commitment by instituting an emission-reduction or removal project in certain member countries ( UNFCCC, 2012d ). JI projects must provide reductions by source or enhance removals by sinks ( UNFCCC, 2012d ), processes or activities which remove GHGs from the atmosphere ( UNFCCC, 2012f ). The resulting reduction is called an emission reduction unit (ERU) and can be used to reduce the level of emissions counted towards the financing country's emission target ( UNFCCC, 2012d ). Additionally, activities such as reforestation can produce a fourth unit, called a removal unit (RMU), which will further reduce a country's measured emissions.

    All units created under the Kyoto scheme, and in trading systems developed since ( UNFCCC, 2012c ), are measured in tons of carbon dioxide since it is the principal GHG ( UNFCCC, 2012c ). Thus, one ton of carbon dioxide is one AAU, CER, ERU, or RMU unit, all of which can be traded in the international market created by the Kyoto Protocol ( UNFCCC, 2012c ). These single units are also used as a measure of a comparable amount of other regulated materials or GHGs ( Gilbertson and Reyes, 2009, p. 9 ), which are also traded.

    Though the continuation of the Kyoto Protocol's programs are in doubt3, of fundamental importance is its development of a foundational carbon market which has been a model and the basis for the creation of other emissions trading schemes on national and regional levels, the largest of which is the EU ETS ( UNFCCC, 2012c ). The purpose of establishing these carbon trading systems is to provide financial incentives and make it cheaper for organizations, companies, and governments to meet global emissions reduction requirements ( UNFCCC, 2012c ).

    Primary markets

    Essentially, two types of carbon trading systems have developed from the foundation provided by the Kyoto Protocol: cap and trade programs and carbon offset arrangements. Cap and trade systems set a maximum allowable amount of emissions, divided into increments, for a given area or set of participants who trade permits or allowances, thereby creating a market in which exchanges allow each member to meet individual requirements and the overall collective to meet the aggregate allowable levels of emissions ( EPA, 2012 ).

    Carbon offsetting arrangements occur when, instead of capping GHG emission at the source, entities finance emissions-savings projects elsewhere, purportedly reducing overall emissions since they are reduced at the project location at...

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