The Commodity Futures Trading Commission (CFTC) has issued a cautionary advisory to operators of prediction markets, known as designated contract markets (DCMs), regarding the self-certification process for event contracts. In a staff advisory released on July 24, the CFTC expressed concern that some licensees are packaging 014;potential contract variations into a single certification, which may overextend the current parameters of their self-certification process.
According to the CFTC, these "broad template certifications" can impede its ability to assess whether a DCM has provided all necessary information under existing regulations. The advisory raises doubts about whether DCMs have sufficiently evaluated the settlement methodologies, data sources, and compliance with core principles related to every variation of the contracts they wish to list.
This advisory comes from the CFTC's Division of Market Oversight, which is overseen by acting director Duncan Hennes. While the advisory is not binding, it reflects the Division's views rather than the commission's overarching stance.
Self-certification is a hallmark of CFTC-regulated markets, contrasting sharply with state-regulated sportsbooks that require prior approval for new betting types. In the CFTC framework, prediction markets can act as self-regulatory entities, certifying their contracts as long as they meet required standards.
However, the Commodity Exchange Act mandates that DCMs adhere to 23 core principles, including one that ensures listed contracts are not easily subject to manipulation. This principle has garnered significant media scrutiny lately. CFTC-registered exchanges must comply with these principles to retain their registration.
The advisory identifies two predominant concerns in prediction markets: rapid contract expansion and ambiguous contract terms. In the past 18 months, the emergence of various contract types, alongside controversies over contract resolutions such as the removal of Venezuelan President Nicolas Maduro and the death of Iranian leader Ayatollah Ali Khamenei, has generated considerable attention and legal disputes.
Hennes noted in his communication to licensees that the current regulations permitting bulk self-certification were established in 2011, when interest rate swaps made up a dominant portion of the trading landscape. He explained that back then, obtaining approval for multiple contract types was feasible since they relied on similar pricing sources. However, evolving contract types linked to elections, politics, sports, and pop culture necessitate more tailored submissions today.
For a broad self-certification to be valid, the advisory outlines specific criteria: each contract must relate to a valid commodity, operate on the same currency, and utilize identical pricing sources and methodologies to approved contracts.
Hennes illustrated this process using soccer match contracts. For World Cup games, a DCM might certify a broad template based on a single game as a representative scenario. However, for contracts related to the MLS Leagues Cup, a different basis would be required due to differing tournament rules, as the World Cup allows for the possibility of a draw, which would not apply in MLS matches.
The advisory on self-certification is part of ongoing regulatory discussions regarding prediction markets. In June, the CFTC released an initial draft of a rulemaking proposal aimed at clarifying important terminologies and addressing discrepancies within the types of contracts eligible for listing.
This forthcoming rulemaking, particularly regarding sports contracts, seeks to establish a structured framework to evaluate contracts involving excluded activities and those that may contravene public interests.
For instance, Kalshi, a prediction market, self-certified contracts related to college athletes transferring schools using broad templates last December, framing questions like: "Will <player> enter/withdraw from the transfer portal in <time period>?" The CFTC's recent advisory seems aimed at tempering the rapid development that self-certification permits, which stands in contrast to the ongoing support demonstrated by the regulator under Chairman Michael Selig.
Under Selig's leadership, the CFTC has taken legal action against nine states to assert its jurisdiction over event contracts in response to attempts by certain states to regulate or ban sports contracts altogether. Selig has repeatedly stated that sports events present genuine economic hedging opportunities that prediction markets can enhance.
