A new report from INTERPOL describes the crimes that have already taken place in global carbon markets and warns that “The intangible nature of the global carbon trading markets puts them at risk for exploitation by criminal networks”.
The INTERPOL Guide to Carbon Trading Crime looks at the ways in which criminals can exploit carbon markets, it does not take a position on carbon trading but aims to provide the information needed to police carbon markets.
The report lists five categories of illegal activities in carbon markets:
(i) Fraudulent manipulation of measurements to claim more carbon credits from a project than were actually obtained;
(ii) Sale of carbon credits that either do not exist or belong to someone else;
(iii) False or misleading claims with respect to the environmental or financial benefits of carbon market investments;
(iv) Exploitation of weak regulations in the carbon market to commit financial crimes, such as money laundering, securities fraud or tax fraud; and
(v) Computer hacking/ phishing to steal carbon credits and theft of personal information
Of course, any market is susceptible to crime, but INTERPOL points out some of the structural problems with carbon markets: “The noteworthy potential for the carbon market to be exploited rests on a single significant vulnerability that distinguishes it from other markets – the intangible nature of carbon itself.”
Unlike traditional commodities, which at some time during the course of their market exchange must be physically delivered to someone, carbon credits do not represent a physical commodity but instead have been described as a legal fiction that is poorly understood by many sellers, buyers and traders. This lack of understanding makes carbon trading particularly vulnerable to fraud and other illegal activity. Carbon markets, like other financial markets, are also at risk of exploitation by criminals due to the large amount of money invested, the immaturity of the regulations and lack of oversight and transparency.
The report points out the conflict of interest in the clean development mechanism. CDM projects are validated and verified by Designated Operation Entities (DOEs) that are certified by the CDM Executive Board. But the DOE is usually paid by the project developer after the project has been approved by the CDM Executive Board. “This raises an inherent conflict of interest,” INTERPOL notes, “in which DOEs are incentivised to facilitate the project’s approval rather than to ensure accuracy of the validation process.”
INTERPOL raises the problem of additionality and points out that additionality “can only be assessed theoretically, as it is not possible to prove with certainty what could or would have happened in the absence of a project’s implementation”.
The difficulty in assessing additionality provides ample opportunity to manipulate the process and make false claims over the environmental integrity of the project. Under these circumstances, companies can ensure their projects receive carbon credits in circumstances where they should not have received any at all.
The report gives examples of fraud in the carbon markets. In one case, that has been under investigation for more than two years, people bought areas of remote forest with either non-existent or poorly marked boundaries. INTERPOL has found evidence that documents were forged, and bribes were paid to obtain the documents. The land was sold to other companies and carbon credits sold to the provincial agency responsible for offering carbon credits to industrialised countries. The US$80 million fraud was uncovered when the real owners of the land contacted the authorities. INTERPOL points out that this sort of fraud “can be expected to rise” if the value of carbon markets increases.
INTERPOL describes another case in which Anne Scholtz, a carbon trader who set up a Ponzi scheme using the Californian pollution trading programme, “Regional Clean Air Incentives Market” (RECLAIM). Scholtz paid old investors by recruiting new investors, creating a façade of high returns. In 2004, Scholtz was indicted on six counts of wire fraud. Investors filed claims for US$50-80 million during bankruptcy proceedings. Scholtz was sentenced to one year house arrest.
Then there’s VAT fraud which Europol estimates cost European taxpayers more than €5 billion. INTERPOL points out that carbon credits are particularly well suited to this type of fraud:
Prior to exploiting the carbon market, this form of tax fraud had been widely used by criminals for items that are of high value but small and easily shipped across borders (such as mobile phones or computer chips). With carbon credits, however, such fraud is even more attractive as there is no product to physically ship across jurisdictions, since the credits are transferred electronically.
INTERPOL’s report only briefly mentions the biggest, most influential and probably the most dangerous network working in the carbon markets – the banks and financial companies that are responsible for the global financial crisis and that also helped design the carbon markets:
Carbon markets involve more than just direct trading in carbon credits, they also include trading its derivatives and other financial instruments. As carbon markets develop, so too does the complexity of the financial instruments that can be traded. The recent global financial crisis has illustrated difficulties in regulating financial markets when financial instruments become too complex to properly disaggregate and assess for compliance. Many of the same derivatives traders responsible for developing these complex financial instruments are also actively engaged in investing in the carbon market. The financial crisis demonstrated the lack of technical and enforcement capacity among financial regulators to deal with complex financial instruments. The carbon market is at risk, therefore, of following the same path unless its regulators are able to properly manage these complex financial instruments.