CFTC Issues Proposed Rules on Event Contracts

The CFTC’s proposed rules specify that certain event contracts involving gaming (such as political contests, awards contests, and sports games), war, terrorism, assassination, and unlawful activities under federal or state law are all contrary to the public interest and are, therefore, not permitted to be traded or cleared on CFTC registered entities.

On May 10, 2024, the Commodity Futures Trading Commission (CFTC) issued a notice of proposed rulemaking in which the CFTC set out a series of amendments to its existing rules governing the use of event contracts (the “Proposed Rules”).[1] According to the CFTC, the aim of the Proposed Rules is to build on the existing event contract rules by further specifying the types of event contracts that are contrary to the public interest and therefore not permitted to be traded or cleared on CFTC registered entities. The CFTC has invited public comments on the Proposed Rules, which must be received on or before July 9, 2024.

1. Background

The CFTC’s existing rules on event contracts, as set out in Section 5c(c)(5)(C) of the Commodity Exchange Act (CEA) and CFTC Rule 40.11, prohibit event contracts that involve, relate to, or reference (i) terrorism, assassination, war, gaming, and other activities that are unlawful under any federal or state laws (the “Enumerated Activities”) or (ii) activities similar to the Enumerated Activities (the “Prescribed Similar Activities”) that, in the case of each of the activities set forth in prongs (i) and (ii), the CFTC determines to be contrary to the public interest. Event contracts are generally types of derivatives that are structured as binary options based on the outcome of an event.

To date, the CFTC has not sought to codify definitions for any of the specifically listed Enumerated Activities nor has it made a determination identifying of any Prescribed Similar Activities. Instead, the CFTC has established a 90-day review and approval process whereby the CFTC reviews the terms and conditions of a particular contract to determine whether it is a prohibited event contract.[2]

2. Out-of-Scope Event Contracts

The Proposed Rules include amendments clarifying that event contracts based on a change in the price, rate, value, or levels of the applicable underlying commodity fall outside the scope of Section 5c(c)(5)(C) of the CEA and, therefore, CFTC Rule 40.11. According to the CFTC, event contracts based on a change in the price, rate, value, or level of the following would generally be considered out of scope:

• Economic indicators (e.g., consumer price index and other price indices, U.S. trade deficits with other countries, GDP measures, jobless claims and the unemployment rate, and new U.S. home sales);
• Financial Indicators (e.g., federal funds rate, U.S. credit card debt, fixed-rate mortgage averages, and certain values for broad-based stock indexes); and
• Foreign exchange rates or currencies.

3. Enumerated Activities

Under the Proposed Rules, the CFTC provided definitions and examples of some of the Enumerated Activities and also set forth certain other amendments to align CFTC Rule 40.11 with the statutory text of Section 5c(c)(5)(C) of the CEA.

Terrorism, Assassination, and War

The Proposed Rules state that event contracts involving terrorism, assassination, or war are contrary to the public interest and are, therefore, prohibited from being traded or cleared on a CFTC registered entity. The CFTC’s rationale is that such event contracts could potentially incentivize harmful activities by providing a financial reward for acts that threaten national and international security. The CFTC emphasized the importance of not allowing the derivatives markets to be used in ways that could potentially finance or otherwise support such activities.

The CFTC noted that it was not necessary to define “terrorism,” “assassination,” or “war” at this time, but did define “gaming” (as further described below).

Gaming

A significant aspect of the Proposed Rules is the inclusion of a new definition of “gaming,” and the accompanying statement that that event contracts involving gaming (as defined) are contrary to the public interest and are, therefore, prohibited from being traded or cleared on a CFTC registered entity.

The CFTC is proposing to define “gaming” as:

[T]he staking or risking by any person of something of value upon: (i) the outcome of a contest of others, (ii) the outcome of a game involving skill or chance, (iii) the performance of one or more competitors in one or more contests or games, or (iv) any other occurrence or non-occurrence in connection with one or more contests or games.

The CFTC also provided a non-exhaustive list of examples of activities that would fall within the proposed definition of “gaming”:

• Political contests: This would include, without limitation, the staking or risking of something of value upon a federal, state, or municipal election or primary contest, for any political office, as well as any political contest in a foreign jurisdiction, including any political subdivision, or in a supranational organization.
• Award contests: This would include, without limitation, the staking or risking of something of value upon an entertainment award contest (e.g., the Emmys, the Oscars, or the Grammys), an athletics award contest (e.g., the Heisman Trophy), and achievement award contests (e.g., the Nobel Prize or the Pulitzer Prize).
• Sports games:  This would include, without limitation, the staking or risking of something of value upon a professional or amateur (including scholastic) sports game.

In addition, the CFTC stated that an example of “gaming” would also include an occurrence or non-occurrence in connection with any of the above examples of contests or games. That is, the definition of “gaming” does not just include the outcome of a contest or game or the performance of a competitor in such a game or contest, but also includes any other occurrence or non-occurrence in connection with such a contest or game. The CFTC said this would include, for example, (i) whether a particular candidate enters or withdraws from a political contest, or polls above or below a certain threshold; (ii) whether a particular individual is nominated for an award or attends an award ceremony; and (iii) in the context of an athletic game, the score or individual player or team statistics at given intervals during the game, whether a particular player will participate in a game, and whether a particular individual will attend a game.

Unlawful Activities Under Federal and State Law

The Proposed Rules also include a determination that event contracts involving activities that are unlawful under federal or state law are contrary to the public interest and are, therefore, prohibited from being traded or cleared on CFTC registered entities.

3. Prescribed Similar Activities

The CFTC reiterated that it retains the authority to determine that an event contract is contrary to the public interest if the event contract involves activities similar to the Enumerated Activities. Such a determination would prohibit such an event contract from being traded or cleared on CFTC registered entities. As of the date of this client alert, the CFTC has not exercised this authority.

4. Implementation Period

Under the Proposed Rules, the CFTC stated that the final amendments, if adopted, would become effective 30 days after publication in the Federal Register. However, solely with respect to event contracts that are listed for trading as of the date of publication of the final rule, the CFTC proposed an additional 30-day implementation period after this effective date (i.e., a total of 60 days) for those event contracts affected by the final rule.

[1] Commodity Futures Trading Commission, Notice of Proposed Rulemaking. As of the date of this client alert, the Proposed Rule had not yet been published in the Federal Register.

[2] As of the date of this client alert, the CFTC has issued two such determinations: (i) the Nadex Order, and (ii) the KalshiEX LLC Order.