The Commodity Futures Trading Commission (CFTC) has issued a cautionary advisory to operators of prediction markets, warning that the practice of self-certifying event contracts is becoming overly broad. The advisory highlights concerns that some designated contract markets (DCMs) are merging various potential contract variations into a single certification.
Dated July 24, the advisory indicates that such "broad template certifications" might hinder the CFTC's capacity to ascertain whether a DCM has provided all necessary information, analyses, and explanations as mandated by existing regulations. The language used in these broad certifications raises questions about whether DCMs have properly evaluated all aspects of the contracts they intend to list, including settlement methodologies and data sources.
This advisory, led by Duncan Hennes, acting director of the CFTC's Division of Market Oversight, is non-binding and reflects only the views of the DMO, not the entire commission. Self-certification is a key feature of CFTC-regulated exchanges, contrasting sharply with state-regulated sportsbooks, as the latter require prior approval for any new wager types. In contrast, CFTC-licensed prediction markets operate as self-regulatory entities that can certify their contracts as long as they meet CFTC requirements.
However, the Commodity Exchange Act imposes 23 core principles that DCMs must adhere to. For example, Core Principle 3 prohibits DCMs from listing contracts easily subject to manipulation, a concern that has gained considerable media attention lately. Maintaining compliance with these principles is essential for CFTC-registered exchanges.
The advisory addresses two major issues central to prediction markets: rapid contract expansion and unclear terms. The past 18 months have seen a surge in various contract types, alongside controversies over contract outcomes, most notably involving the Venezuelan President Nicolas Maduro and Iranian Ayatollah Ali Khamenei.
Hennes observed that the current rules around bulk self-certification were established in 2011, during a time when interest rate swaps dominated the market. Certifying multiple contract types in one filing was manageable then, as they relied on similar pricing sources and methodologies. Presently, however, the emergence of new contract types surrounding elections, politics, sports, and popular culture necessitates more tailored submissions.
For a broad template self-certification to be deemed valid, individual contracts must meet several criteria. These include: they must revolve around a valid commodity; be denominated in the same currency; and have identical pricing methodologies.
Using soccer match contracts as an example, Hennes illustrated that while a DCM could certify a representative game for World Cup matches, a distinct representative would be necessary for contracts regarding the MLS Leagues Cup due to differences in rules and formats.
The advisory comes amid ongoing regulatory discussions related to prediction markets. Earlier in June, the CFTC introduced its first draft of a rulemaking proposal aimed at clarifying key terms and addressing discrepancies regarding contract listings.
This proposal seeks to establish a structured framework to assess if certain contracts involve excluded activities or operate against public interest, potentially impacting self-certification processes. For instance, Kalshi's self-certification of contracts for college athletes transferring schools employed broadly drafted templates, raising similar concerns about clarity and compliance.
Ultimately, the recent advisory appears to be a response by the CFTC to regulate the rapid expansion of self-certification practices, which contrasts with the support shown under Chairman Michael Selig's leadership. Under Selig, the CFTC has taken legal action against nine states to assert its authority over event contracts, as several states have attempted to ban sports contracts or initiate state-level legislation regarding prediction markets. Selig has consistently emphasized that prediction markets can facilitate legitimate economic hedging opportunities in sports events.
