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This will be my last post on the CFTC and prediction markets.

Thank you to those who e-mailed me with comments and left comments on my posts. As I hoped, it helped clarify my own thinking, particularly on how public event markets can and should work. While I still believe that the CFTC should make public, real-money event markets work, the reality that this will need strong regulation from the CFTC is reflected in my draft response. My final draft is attached below, and will be submitted to the CFTC later this week.

What do I expect to happen?

I expect that the CFTC will choose to provide a “safe harbor” for academic, corporate and low-stakes prediction markets. There is very strong (I would venture unanimous) support for this, and it is sorely needed.

I sincerely doubt that the CFTC will take the steps necessary to allow public real-money prediction markets at this point. It is simply a very significant change, and I doubt that it would happen before a major election. That said, I am quite hopeful that the CFTC will sketch out a roadmap as to how this can or should happen in the coming months and years. Knowing that governmental bodies are quite risk-averse, there is really no way that we will go from the current state to a position where real-money prediction markets are completely legal in one stroke of the CFTC’s regulatory pen. But I believe that the current environment is positive for change and that if enough interest is shown in this comment period the right steps will be taken to make “event markets” legal in the United States.

This really will have little to no effect on most corporations and prediction market projects. Companies will be able to run them just as easily in the coming years as they can now. However, once real-money prediction markets are legal, there should be much more familiarity and acceptance of the concept, and thus greater acceptance at the corporate level. When that happens I will be very happy!

CFTC-DraftResponse.pdf

This is part 5 in a five-part series where I present first drafts of what I intend to send to the CFTC in response to their request for input on prediction markets or “event markets.” More background can be found in my first post here.

This post deals with questions of Market Participants.

Market Participants

20. Would it be appropriate to allow market participants, and in particular, retail customers, to trade on Commission-regulated event markets with the knowledge that the Commission may not be able to effectively monitor the measures or events that underlie certain event contracts?

Absolutely. If retail customers are fully aware of this fact, it is completely appropriate to allow them to trade.

I expect that event markets will compete to be known for the protection of their customers’ interests. Those that don’t do so will not attract customers and fail as an exchange. If, after a period of time, the CFTC feels that consumers are not being protected sufficiently by the marketplaces own actions, they can then step in to make further adjustments to any regulations.

21. What unique protections and prophylactic measures are appropriate or necessary for the protection of retail users of event contracts and markets?

Retail traders of event contracts on event markets need to be provided with clear rules as to how the event will be judged, and a dispute resolution procedure for when those rules are unclear or interpreted differently.

Both of these can be done by the marketplace itself, though I would suggest that the CFTC not issue any “no-action relief” letter or similar mechanism until the marketplace has self-certified that they have these two measures in place.

This is part 4 in a five-part series where I present first drafts of what I intend to send to the CFTC in response to their request for input on prediction markets or “event markets.” More background can be found in my first post here.

This post deals with questions of Legal Implementation.

Legal Implementation

16. Is it appropriate for the Commission to direct certain or all event contracts onto markets that are regulated differently from and perhaps less stringently than DCMs? For example, it may be warranted or necessary to treat event markets that aggregate information solely for academic or research purposes, event markets set-up for internal corporate purposes, or event markets that offer exceedingly low notional value contracts to traders differently than markets that possess the attributes of traditional DCMs.

Event markets established for academic, research, internal corporate purposes, or low-notional-value should be treated under the “safe harbour” provisions that have been put forward by a number of esteemed academics. Experimentation is essential to allow these unique tools to grow, and a safe harbour for these purposes ensures that the public will not suffer any harm.

However, to only allow event contracts to be traded on such markets is a very poor idea. Event markets should be allowed to be traded as other commodity futures, on regulated exchanges. The amount of regulation should be sufficient to protect the retail traders on these exchanges, but should not be so excessive to never allow event markets to flourish. Striking this balance is likely subject to much further discussion and general comment.

17. Is it appropriate for the Commission to use the Section 4(c) exemptive authority of the Act for implementing a regulatory scheme for event contracts and markets? In this regard, the Commission notes that it has the discretion to grant an exemption under Section 4(c) to certain classes of transactions without having to make a determination as to whether such transactions are subject to the Act in the first instance.

It is absolutely appropriate for the Commission to use the Section 4(c) authority to exempt event contracts and event markets from regulation. While retail customers should be protected in a marketplace, it would be more appropriate to ensure that little (or no) regulation of event markets exists, even in retail event markets. The only way these marketplaces will survive is to treat retail customers appropriately. After a certain period of time, this issue can be reviewed to determine if any regulation may be needed, and if so what the purpose of that regulation would be.

18. Is the issuance of staff no-action relief, such as the relief issued to the IEM, an appropriate or preferable means for establishing regulatory certainty for event contracts and markets? Is a policy statement appropriate or preferable?

The no-action relief, similar to the relief issued to the IEM, would be a suitable regulatory scheme for most markets. If this letter could also be issued to larger commercial exchanges, the situation would be even better.

A policy statement would also be appropriate, but I believe a no-action relief letter would be the best solution for any event marketplace that has retail traders. For academic and internal corporate markets, the policy statement would be sufficient and preferable.

This is part 3 in a five-part series where I present first drafts of what I intend to send to the CFTC in response to their request for input on prediction markets or “event markets.” More background can be found in my first post here.

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This post deals with questions of Jurisdictional Determination.

Jurisdictional Determination

4. What characteristics or traits are common to or should be used to identify event contracts and event markets?

Event contracts are futures contracts contingent upon the binary result or value of a future event, such as an election, scientific discovery, business development or news item. The event contract serves to aggregate the public opinion on the likelihood of that event occurring, or the value of an event when it occurs.

Each contract has a specific criterion for judgement, which is written into the rules of the contract. Each contract also has a specific date by which the contract is judged.

12. What objective and readily identifiable factors, statutorily based or otherwise, could be used to distinguish event contracts that could appropriately be traded under Commission oversight from transactions that may be viewed as the functional equivalent of gambling?

Event contracts on the outcome of sporting events and the outcome of a random event (spin of a roulette wheel or roll of dice) could certainly be considered gambling by societal consensus. Virtually every other event contract would serve the purpose of information aggregation and not be viewed widely as gambling.

As described in part 1, where most people and institutions try and distinguish between what is gambling and what is not comes down to what is being traded. In the two examples above there is a clear consensus in American society that trading in those event outcomes would be gambling. The same statement would not be true for other events contracts.

14. Should certain underlying events or measures - such as those based on assassinations or terrorist activities - be prohibited altogether due to the social perception and impact of such events? What statutory or other legal basis would support this treatment?

Any event contract that is contingent on a law being broken should be prohibited. This would include any contract on assassinations, terrorist activities or similar events. There should never be any incentive to break a law, so there should never be any contracts that would pay someone if a law was broken.

15. Are there event contracts, such as political event contracts, that should be prohibited from trading under the Act, or that deserve separate treatment or consideration, due to the nature and importance of their outcomes? What statutory or other legal basis would support this treatment?

Event contracts on the outcome of a sporting event or the outcome of a random event should be prohibited as they are too akin to gambling.

Event contracts that would require breaking a law in order to be judged successful should be prohibited to eliminate any incentive for criminal activity.

All other contracts should be treated equally. Though some may seem deserving of separate treatment, such as political event contracts, that special treatment is simply unnecessary. Any attempt at manipulation simply becomes an opportunity for other traders to correct the market price. Even political event contracts can serve as hedging tools, as companies or industries that would be favourable to one political party over the other could hedge the risk of the unfavourable candidate being elected.

This is part 2 in a five-part series where I present first drafts of what I intend to send to the CFTC in response to their request for input on prediction markets or “event markets.” More background can be found in my first post here.

This post deals with questions of Public Interest.

Public Interest

1. What public interests are served by event contracts that are designed and will principally be traded for information aggregation purposes and not for commercial risk management or pricing purposes?

Event contracts do serve the public interest, by providing the public unbiased information on events of concern to society. The public wants to understand what is likely to take place in the future, whether that is the results of a political event, scientific discovery, or even the status of traffic in a major city. Though the event contract is designed for information aggregation, the information revealed can also cause people to change their behaviour.

Additional information, particularly unbiased market-based information, helps individuals and organisations make better decisions by more accurately planning for the future. If an event is important enough that people will trade on the results, it is important enough to at least some sections of society to have that information.

The news media serves to evaluate masses of information and news and filter it so that the public gets the pieces of news or information that are critical to them. However, this process is frought with difficulty and bias. Problems with corporate ownership, political bias and lack of deep understanding in technical issues means that media coverage is frequently criticised for being inaccurate. Event contracts can serve the public interest by removing that “filter” and allowing society as a whole to judge the potential that a particular event would occur. This serves the public as providing a meaningful check and balance against potentially incorrect or sensational news coverage.

Fundamentally, I believe that more information provided to the public about events that concern society is a public interest, and event contracts serve this purpose well.

3. What calculations, analyses, variables, and factors could be used to objectively determine the social value of information to the general public that may be discovered through trading in event contracts? Should this be a factor in determining whether the Commission plays a role in regulating these markets?

I don’t think that any calculation, analysis, variable or factor should be used in determining whether the Commission plays a role in market regulation. The key to the growth and social value of event contracts is precisely that they are flexible to respond to the needs of the traders that participate in the marketplace.