Just as with any other type of transaction, carbon trading can also be subject to fraud – carbon credit fraud. Similarly to other economic areas, fraudsters are taking advantage of the existing weaknesses, loopholes and security shortcomings in carbon trading systems to put their respective schemes in place. Most commented are the instances of fraud with regards to the EU Emissions Trading System (EU ETS). Even though it is currently the most developed carbon credit market mechanism, it has nevertheless been successfully exploited for different types of fraud.
Among the most common types of fraud with regards to carbon credits are VAT frauds. In principle, a VAT fraud is committed when the customer is charged with VAT, which later on is not accounted for to the tax authorities by the respective supplier. A type of VAT fraud is carousel fraud, which traditionally involves small goods of high value such as computer chips. In addition, there is also the missing trader intra-community (MTIC) fraud, which Europol defines as a VAT theft “from a government by organised crime groups who exploit the way VAT is treated within EU Member States”. Both carousel and MTIC fraud have over the past couple of years had instances of perpetration within the emissions trading sector.
VAT fraud was detected with regards to the EU ETS carbon market in the summer of 2009, as reported by the European Commission. However, according to Europol, indications of suspicious trading activities were noted in late 2008. An estimation made by Europol in 2009 showed that VAT fraud in the EU ETS had already cost EUR 5 billion worth of damage to European taxpayers.
Carbon credit fraud is also possible through cyber attacks, such as hacking and phishing attacks. So far, the most serious reported case of fraud is the notorious theft of EUR 45 million worth of EU allowances, which took place in January 2011 and resulted in the temporary closure of national registries and suspension of spot trading. In addition, according to the World Bank report “State and Trends of the Carbon Market 2011″, in November 2010, there was an incident of unauthorised access to EU ETS registry accounts in Romania, which led to the theft of 1.6 million EU allowances.
Phishing scams are also common with regards to carbon trading, and similarly to online banking frauds, an e-mail directs the user to a page, which is a copy of the bank webpage, or in this case, a copy of a registry website, where the user is prompted to provide registration details. Therefore, while carousel and MTIC frauds usually occur due to the existing different VAT regulations in the EU Member States, this type of fraud can easily take place wherever web-based carbon credit registries are involved.
Another type of fraud in relation to the carbon market is reselling already “used” carbon credits. The World Bank’s report also mentions a case when in March 2010, Hungary sold Certified Emission Reductions (CERs) that had already been surrendered to it under the EU ETS. The EU therefore amended the registry regulations accordingly in order to prevent this “CER recycling”.
Carbon credit fraud is a rather serious issue since it has a negative impact on the carbon market. According to the World Bank report, the different types of fraud lead to a loss of confidence and liquidity in the spot markets. Therefore, the EU which apparently faces most cases of fraud with regards to its emissions trading system has decided to switch to a new Single Registry. The European Commission expects that the new “state-of-the-art” security measures as well as preventive measures will significantly reduce the cases of fraud and in addition, will help law enforcement authorities to detect fraud more easily. As for VAT fraud, the most efficient way to deal with it is the implementation of a reverse charge mechanism. However, in order to effectively prevent VAT fraud, the reverse charge mechanism needs to be adopted with regards to the EU ETS in all of the EU Member States.
It is obvious that the existing levels of development of the carbon market present a variety of opportunities for fraudsters. Therefore, the appropriate measures should be taken in order to reduce the instances of carbon credit fraud. Furthermore, countries such as Australia, which have already outlined the launch of an emissions trading system, should take notice of the European experience in the field so as to minimise the potential risks for fraud.