Overview of Carbon Credits (Part 2) – Legal Framework and Key Considerations –

Legal Framework Governing Carbon Credit Transactions

As of now, there is no comprehensive legislation in Japan that specifically regulates carbon credit transactions. In principle, carbon credits can be freely traded within Japan.

However, exceptions may arise under certain laws, such as the Banking Act, Financial Instruments and Exchange Act (FIEA), and the Insurance Business Act. Below, we focus on the FIEA as an illustrative example.

Article 35(2) of the FIEA

Article 35(2) of the FIEA

Financial Instruments Business Operators may engage in the following businesses in addition to those stipulated in the preceding paragraph:
(omitted)
(vii) Other business activities as specified by a Cabinet Office Ordinance

Article 68 of the Cabinet Office Ordinance on Financial Instruments Business
(16) Contracting, brokering, intermediary, or agency services related to the acquisition or transfer of "Assigned Emission Allowances" (as defined in Article 2, Paragraph 7 of the Act on Promotion of Global Warming Countermeasures, and similar instruments)
(17) Transactions (or brokering, intermediary, or agency thereof) between parties agreeing to settle based on the market value of a specified number of such allowances
(omitted)

Under the FIEA, Type I Financial Instruments Business Operators and Investment Management Business Operators are subject to restrictions on the scope of their permitted business activities. In contrast, those engaged only in Type II Financial Instruments Business or Investment Advisory/Agency Business are not subject to the same scope limitations but may still need to file certain notifications.

If the carbon credit in question is deemed similar to the “Assigned Emission Allowance” as defined in the Act on Promotion of Global Warming Countermeasures (Article 2, Paragraph 7), it may fall under the "Assigned Emission Allowance" category defined in Article 68(16) and (17) of the Cabinet Office Ordinance. In such cases, Financial Instruments Business Operators may conduct relevant transactions without violating business scope restrictions.

According to the Financial Services Agency's Q&A on the treatment of carbon credits  (Japanese only), the categorization is as follows:

• J-Credits and JCM (Joint Crediting Mechanism) Credits are generally considered to fall under "Assigned Emission Allowance."
• As for voluntary credits as well, although individual and specific assessments are required, those that, like the Verified Carbon Standard (VCS), involve rigorous review and approval procedures and are managed through a registry, thereby ensuring clear ownership, are highly likely to fall under the category of “Assigned Emission Allowance.”

Therefore, as to voluntary credits like VCS as well as J-Credits and JCM Credits, Type I Financial Instruments Business Operators and Investment Management Business Operators may legally:

• Enter into, broker, intermediate, or act as an agent for contracts involving the acquisition or transfer of these credits (Art. 68(16) of the Cabinet Office Ordinance)
• Conduct or facilitate derivative transactions related to such credits (Art. 68(17) of the Cabinet Office Ordinance)

A similar approach applies to banks and insurance companies.

Key Considerations in Carbon Credit Transactions

With the launch of the Tokyo Stock Exchange's carbon credit market (as mentioned in Part 1) and the emergence of private platforms, carbon credit transactions in Japan are expected to increase. Some compare the current state of the carbon credit market to the early stages of cryptocurrency, suggesting that close attention should be paid to regulatory developments.　

Even if no legal reforms occur, carbon credit transactions require careful consideration of the risks inherent to the specific credits involved.
Most carbon credits are managed via registries, with proper recording often being a prerequisite for the transfer of rights. Given the legal ambiguity around carbon credits, contracts should ensure effective and valid transfer mechanisms.
In some cases, instead of transferring registry ownership from seller to buyer, the credits are retired or canceled on behalf of the buyer. In such cases, contractual provisions should guarantee cancellation and the issuance of proof.
Further, issuance of credits may be suspended if human rights violations are reported at the project site by third-party organizations. Contracts should address the risk that some or all of the credits may not be issued or obtained.

Use of Carbon Credits

As discussed in Part 1, there are several recognized uses for carbon credits:

Act on Promotion of Global Warming Countermeasures (APGWC):

J-Credits and JCM Credits can be used to report adjusted emissions under the SHK System (emission calculation, reporting, and publication).

Energy Conservation Act:

J-Credits can be used to report non-fossil energy usage and joint energy-saving initiatives. However, not all J-Credits are equally eligible, and careful attention must be paid to the credit type.

GX League:

 J-Credits and JCM Credits certified as eligible can be used for emission reporting under the GX-ETS. Other credits may also be recognized in the future.

Voluntary Offsetting:

For corporate branding and environmental responsibility initiatives, voluntary credits (e.g., VCS) can also be used in addition to J-Credits.

Points to Consider When Using Carbon Credits

When using carbon credits for voluntary offsetting, companies must be mindful of "greenwashing"—giving a misleading impression of environmental friendliness.

In March 2024, the Ministry of the Environment revised and published two key documents:

• Guidelines on Carbon Offsetting in Japan (Japanese only)
• Carbon Offset Guidelines Ver. 3.0 (Japanese only)

These documents emphasize the importance of accurate and transparent information to ensure credibility and prevent consumer misunderstanding. They recommend referencing the Environmental Labeling Guidelines (Japanese only), and outline the need to disclose:

• Offset activities and scope
• Emission calculations
• Reduction methods
• Offset volumes and ratios
• Project names, credit types, years of issuance and reductions
• Retirement details

As a related development, in December 2022, the Consumer Affairs Agency issued cease and desist orders based on misleading representations of superior quality (Article 5, Item 1 of the Act against Unjustifiable Premiums and Misleading Representations) to ten companies that sold biodegradable plastic products (five business operators selling airsoft BB bullets, two business operators selling garbage bags and shopping bags, one business operator selling fishing gear, and two business operators selling cutlery, straws, cups, and similar items).

These cases involved representations by the respective companies suggesting that their products possessed biodegradability—such that even if discarded or landfilled, they would be decomposed into water and carbon dioxide by microorganisms in the natural environment—despite lacking evidentiary materials that could reasonably substantiate such claims (Article 7, Paragraph 2 of the same Act). These orders can be evaluated as having been issued in response to representations that falsely suggested environmental friendliness.

Taking into account both the growing adoption of carbon offset initiatives and the recent issuance of cease and desist orders related to environmental representations, it can be said that, for example, if a fee is collected from consumers separately from the product price for the purpose of offsetting, but the breakdown of such fees is unclear to the consumer, or if abstract expressions such as “environmentally friendly” are used based on the carbon offset, there is a possibility that a cease and desist order may be issued under the Act against Unjustifiable Premiums and Misleading Representations.

In Europe, in February 2024, the Council of the European Union adopted the “Directive on empowering consumers for the green transition through better protection against unfair practices and better information”, which amended the “Unfair Commercial Practices Directive” and the “Consumer Rights Directive”, and the directive came into effect on March 27 of the same year.
This directive is noteworthy as being in line with trends in Japan, in that it prohibits general environmental claims such as “environmentally friendly” unless they can be substantiated, and also prohibits claims such as “neutral,” “reduced,” or “positive” with regard to environmental impact based solely on carbon offsets.

Consult a Lawyer Regarding Carbon Credit Matters

The legal treatment of carbon credits remains uncertain. Companies should take care when designing services or engaging in transactions involving carbon credits.

ZeLo provides legal support not only in traditional corporate matters like litigation and dispute resolution but also in emerging areas such as Web3, AI, and innovative business models. We support carbon credit developers and trading platform operators, including regulatory advocacy via our Public Affairs team.

We also assist with fundraising for new ventures and provide legal support for investments or acquisitions involving carbon credit businesses.

We offer tailored legal advice aligned with your business model and goals. Please feel free to reach out to us.

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The information provided in this article does not, and is not intended to, constitute legal advice and is for general informational purposes only. Readers of this article should contact an attorney to obtain advice with respect to any particular legal matter.