Custody, Clearing, and Settlement

Before an institution can buy a carbon credit, it needs to answer three questions: (1) If the firm holding my asset fails, do I still own it? (2) Between agreeing a trade and receiving it, who carries the risk that the other side disappears? And (3) at what moment does the transfer become final, with payment moving against it rather than after it?

Securities markets have dedicated institutions for each. A custodian holds the asset, segregates it from its own balance sheet, is capitalized and supervised for that role, and is liable when it fails. A clearing house steps into the middle of the trade and becomes the counterparty to both sides, so if one party disappears before delivery, the other is still made whole. Settlement fixes the moment ownership changes, delivery against payment, final under law rather than by agreement.

The carbon market only has the registry, which does all three jobs by default. The consumption frame produced a market that only ever needed a record keeper, so the industry built one.

The registries are candid about the consequences of this choice, right in their own terms of use. On custody: no guarantee of legal title, no obligation to inquire into it, no fiduciary relationship with the account holder, and total liability capped at the fees paid over the past year. On clearing: no responsibility for the performance or settlement of any transaction, and none for the acts of your counterparty. Nothing stands between the two sides of a trade.

On settlement, sharper still. Transfers are settled by the parties themselves under separate agreements; payment never moves on the registry, so one side goes first and hopes. And the transfer is not final: the registry reserves discretion to reverse a movement of credits, and the account holder agrees in advance to no remedy if it does. A book entry that can be undone is not settlement.

Institutions cannot waive these protections; their own rules require them. Wrapping the credit, as the last post described, is what lets those securities market protections attach to it. The credit stays in the registry, in an account controlled by a regulated custodian, and the custodian makes the representations the registry declines: that the asset is there, that it is segregated, that it is unencumbered, and that the custodian answers if any of that proves untrue. Entitlements to it are cleared and settled on securities rails, delivery against payment, final at a defined moment under law.

Proper capital market formation in carbon requires that registries be strictly limited to the one job they are built for, and that custody, clearing, and settlement pass to the institutions built to perform them, under supervision, with capital behind them and liability that cannot be disclaimed.

Next up: What a Carbon Registry Is Actually For.

Part of No New Parts, a sixteen-part series by Andrew Gilmour.