Voluntary Carbon Credits: A regulatory grey area in the EU? (Part II)

This part continues our blog on Voluntary Carbon Credits: A regulatory grey area in the EU? (Part I). It discusses (IV) the applicability of supply chain due diligence requirements for financial institutions; (V) the greenwashing risks that the public advertising of supposed CO2 neutrality achieved with carbon credits can entail and that is becoming increasingly apparent from recent court rulings.

IV: Supply chain due diligence requirements

Carbon credits might also be considered products within the scope of supply chain regulation, such as the newly published EU directive on corporate sustainability due diligence (CSDDD), as well as national laws, such as in Germany, France, Norway, Switzerland. For the German Act on Corporate Due Diligence Obligations in Supply Chains (Gesetz über die unternehmerischen Sorgfaltspflichten in Lieferketten, LkSG), the national supervisory authority has published an application guidance (in German) specifically for the financial and insurance industry. According to these guidelines, the decisive differentiation criterion is whether or not the products or services establish a characteristic supplier-manufacturer relationship.  While the obligations under the European CSDDD only apply to upstream supply chains for regulated financial undertakings following lengthy discussions in the legislative process, this is sometimes more differentiated under national laws. In these jurisdictions, customer relationships must at least partially be considered.

While voluntary carbon credits do not have to be traded in regulated marketplaces, they share similarities to mutual financial transactions, such as the numerous intermediaries connecting buyers with credit issuers and institutionalised exchanges that have emerged for carbon credits over the past years. However, there is a risk that the relationship between the company buying the credits and the provider of the credits (often a project operator or a broker) will be considered more akin to a supplier relationship by the competent German authority. If voluntary carbon credits were not primarily treated as financial transactions but as an integral part of the corporate environmental responsibility and the associated supply chain, their purchase would trigger the (due diligence) obligations set out in the LkSG. However, the extent to which these principles can be transferred to the European CSDDD is also unclear.

V. Carbon credits as a source of greenwashing risk

The purchase of carbon credits itself does not generally constitute greenwashing, as carbon credits are part of a widely recognised system for reducing greenhouse gas emissions. However, the growth of the VCM market does not necessarily indicate that companies are actually making genuine efforts to reduce their emissions. For example, claims can be deemed misleading when the activity leading to emissions reduction is legally mandated or when they assert immediate offsetting of emissions that will actually occur years later. Thus, they can easily be misunderstood and/or misused when combined with other measures or without accompanying emissions reductions, creating a positive image that does not align with actual environmental impact. In fact, a consumer testing exercise by the ESAs showed that particularly the non-professional audience was not familiar with the concept of carbon credits. This opens the door to greenwashing (accusations). 

Greenwashing accusations can lead to considerable litigation and reputation risks, which are steadily increasing due to progressive and complex regulation, the increasingly professional claimant industry associations, and the increased public attention in relation to ESG issues. For an overview on greenwashing risks in the financial services sector in Germany, see our separate client briefing. Respective market practices are increasingly under scrutiny of and subject to regulatory oversight, as shown by current initiatives of the EU supervisory authorities, as shown by the very recent ESAs Reports on Greenwashing, ESAs’ Call for Action on Greenwashing, ESMAs 2023 Common Supervisory Action, but also national supervisory authorities like the BaFin’s Sustainable Finance Strategy – just to name a few.

How present these greenwashing risks are is demonstrated by a recent judgement by the German Federal Court of Justice (Bundesgerichtshof, BGH). Here, the BGH prohibited advertising with the statement "climate neutral" as misleading if no explanation is provided as to whether the advertised climate neutrality is achieved through actual CO2 savings in the manufacture of the product or merely through offsetting (see our blogpost). The court held that ambiguous environmental terms such as “climate-neutral” must therefore regularly be explained in the advertising itself in order to avoid misleading claims. Companies relying on carbon credits for the “reduction” of their CO2 emissions will need to take these rules into account. While it remains to be seen whether the judgement will have an impact on the carbon credit market as well, it certainly shows that relevant stakeholders need to be aware of greenwashing risks in this context as well.

Importantly, greenwashing may also give rise to reputational risks, even if technically speaking no laws or voluntary obligations were violated. In the context of using carbon credits for the offsetting of GHG emissions, reputational damage may, for example, already occur where information is euphemised or concealed, as may be the case where CO2 reductions are not actually achieved but emissions are ‘merely’ offset by way of purchasing carbon credits.

Outlook

The thriving market for carbon credits not only offers a promising approach to combat greenhouse gas emissions but also brings with it various regulatory touchpoints to navigate. At the same time, it poses considerable greenwashing risks. In this evolving landscape, striking the right balance between fostering innovation and ensuring accountability will be essential for a sustainable and transparent carbon market of the future.