The Commodity Futures Trading Commission (CFTC) delivered the first piece of its promised new guidance on prediction markets on Thursday, and devoted a large chunk of its public notice to highlighting how sports event contracts could be cause for integrity concerns.
An advisory issued by the CFTC’s Division of Market Oversight (DMO) highlighted that one of the core principles that designated contract markets (DCMs) must adhere to – Core Principle 3 – mandates that platforms must only list contracts that “are not readily susceptible to manipulation”. This could impact prediction market platforms such as Kalshi, Polymarket and Crypto.com.
In particular, the federal derivatives regulator stressed that certain sports markets must be considered carefully as the explosion of sports event contracts continues across the U.S.
“As front-line regulators, DCMs should be proactive, ensuring proper surveillance and oversight of trading in all of the products that they list, accounting for the particular characteristics and attributes of each product,” stated the advisory.
Sports have ‘heightened potential’ of manipulation
Speaking on CNBC’s ‘Squawk Box’ on Thursday, CFTC Chair Michael Selig singled out some sports markets, such as contracts that may be listed on player injuries, as cause for concern.
“For example, an injury contract, that’s something that our guidance discusses,” Selig said. “It’s manipulable. There’s a real risk that a player could go out and try to injure another player to collect on an event contract. That sort of thing is the responsibility of the exchanges as the first line to evaluate. These are contracts that have real manipulation risk.”
As referenced by Selig, the CFTC’s written guidance specifically highlights the injury example, as well as others such as unsportsmanlike conduct and officiating decisions during games.
“Sports-related event contracts and event contracts more generally have often been shown to be consistent with DCM Core Principle 3 where the settlement outcome depends on the aggregate performance of multiple participants over an extended period of play,” reads a section of the advisory. “The breadth of the outcome, in the typical case, reduces the ability of any single actor to manipulate the settlement value without material cost or substantial risk of detection.”
However, it acknowledged that certain categories of contracts “create a heightened potential for manipulation or price distortion”.
“DMO staff encourages DCMs to engage with staff in the early phases of designing such contracts to determine if any heightened manipulation or price distortion risks exist, and, if so, whether they may be mitigated with appropriate controls,” it added.
Exchanges actively engaged with sports leagues
The CFTC’s current approach to prediction markets allows platforms to self-certify proposed new contracts by informing the agency of their intent to list the relevant market and providing some details of how the markets would be listed and resolved during trading. The CFTC has until the specified listing date to object if it feels there is cause to reject the listing. If that does not happen, the markets can go live.
DMO staff made several recommendations for prediction market operators to follow during and after this process, including:
- Engaging in pre-self-certification communications with relevant sports governing bodies or authorities when developing terms and conditions, compliance and market oversight programs.
- Including explanations of whether suggested self-certified sports contracts are consistent with the relevant league’s or governing body’s integrity standards.
- Establishing information-sharing and data arrangements with sports integrity monitoring firms.
- Using official league data as the metrics for settling sports contracts.
- Cooperating with any league-run investigations into potential manipulation or insider trading investigations.
In essence, the DMO urged prediction market platforms to directly engage with sports leagues and governing bodies, both at the pro and non-pro levels, to ensure that sporting and trading integrity are upheld. That engagement is already happening, it said.
“DMO staff recognizes that sports-related event contracts may implicate the involvement of professional sports leagues and their integrity units, as well as the governing bodies of non-professional sports organizations. DMO staff further understands that the Commission is actively discussing issues of settlement integrity with some relevant sports leagues and their governing bodies and foresees that appropriate information sharing by these entities with the CFTC may lead enhanced CFTC oversight capabilities.”
CFTC opens public comment
As well as publishing the advisory, the CFTC issued an “Advanced Notice of Proposed Rulemaking” for prediction markets that includes dozens upon dozens of questions that should be considered. The commission gave the public a 45-day window, starting March 12, to submit written comments.
Both the advisory and the advanced notice focus on much more than sports contracts, tying in recommendations for how to approach markets on other things such as politics and war as well as broader questions about event contracts at large. But the agency placed a major focus on gaming, sports and “responsible gaming”.
Some of the questions posed by the CFTC include:
- How should a determination of whether an event contract is “readily susceptible to manipulation” be made? What factors should be considered?
- CEA [Commodity Exchange Act] section 5c(c)(5)(C) lists five activities, and provides that if an event contract involves any such activity, the commission may determine that the event contract is contrary to the public interest … The fifth activity is gaming. What factors should the commission consider in determining the scope and public interest implications of this activity?
- What sources should inform the commission’s determination of the scope of the term “gaming”? For example, is gaming synonymous with, or more or less extensive than, the scope of activities covered by state and federal gambling statutes? Are there characteristics – such as an entertainment purpose, or an element of chance – that distinguish gaming from other activities?
- In this regard, how should the commission distinguish between various types of contests? For example, should a sports competition be treated differently than an award competition, and if so, what factors support this distinction? What other types of contests should or should not be considered to be gaming?
- What aspects of event contracts involving gaming should the commission consider in a public interest determination?
- What aspects of responsible gaming standards, such as self-exclusion programs, monetary or time limits, or advertising limits, disclaimers, or warnings, should the commission consider in its public interest determination?
While court battles continue to debate the fundamental issue of whether the CFTC’s regulation of sports event contracts superseded state gaming law, Selig labeled Thursday’s update as “an important step in the commission’s continued effort to promote responsible innovation in our derivatives markets”.
“This begins the process of new rulemaking grounded in a rational and coherent interpretation of the Commodity Exchange Act, while reassuring the American people that the CFTC will exercise its exclusive jurisdiction over prediction markets,” added the CFTC Chair.
