On May 10, 2024, the Commodity Futures Trading Commission (CFTC or Commission) proposed amendments to CFTC Regulation 40.11 (the Proposed Rule) that further define "gaming" contracts considered "contrary to the public interest" under section 5c(c)(5)(C) of the Commodity Exchange Act (CEA).1
This is the latest development in the Commission's long-standing effort to address event contracts that are based on political and economic indicators, and other event contracts considered "gaming." We have previously written about the Fifth Circuit litigation involving PredictIt and the CFTC's order related to political event contracts of KalshiEX LLC (access our prior alert here).
While litigations related to PredictIt and KalshiEX LLC make their way through the courts,2 the Commission's vote to approve the proposal demonstrates its ongoing interest in codifying its views around what event contracts may be impermissible gaming under the CEA. The Proposed Rule, if adopted, will limit the types of event contracts that can be listed for trading on CFTC-registered trading platforms. Depending on its implementation timeline, the Proposed Rule would also negatively impact the permissibility of certain currently outstanding event contracts with open interests—forcing them to be wound down and open interests to be liquidated. Finally, and importantly, the Proposed Rule would allow the Commission to establish a categorical ban on certain types of contracts in one fell swoop that would otherwise be evaluated by the Commission on a contract-by-contract basis.
This alert provides a preliminary analysis of the CFTC's Proposed Rule issued late last week, and a redline of how the Proposed Rule would amend CFTC Regulation 40.11 is posted here. Comments on the Proposed Rule are due on or before July 9, 2024. The WilmerHale Futures & Derivatives Group continues to review the text of the proposal and related materials closely, and we are happy to answer any questions you may have.
Overview of the Proposal
Section 5c(c)(5)(C) of the CEA provides that the CFTC may determine that contracts based on the occurrence of an event are contrary to the public interest if the contracts involve (i) activity that is unlawful under any federal or state law, (ii) terrorism, (iii) assassination, (iv) war, (v) gaming, or (vi) other similar activity determined by the Commission, by rule or regulation, to be contrary to the public interest. A contract that "involves, relates to, or references" one of these enumerated activities and is determined by the CFTC to be contrary to the public interest may not be listed or made available for clearing or trading.
The Proposed Rule would further define the enumerated activity of "gaming" to include the staking or risking by any person of something of value on (i) the outcome of a political contest, including an election or elections; (ii) the outcome of an awards contest; (iii) the outcome of a game in which one or more athletes compete; or (iv) an occurrence or non-occurrence in connection with such a contest or game, regardless of whether it directly affects the outcome.
The CFTC interprets CEA section 5c(c)(5)(C) here to authorize categorical public interest determinations if the Commission determines that contracts involving an enumerated activity or prescribed similar activity are, as a category, contrary to the public interest, as opposed to a determination on a contract-by-contract basis. Therefore, the CFTC also proposes to amend Regulation 40.11(a)(1) to include a determination that event contracts involving each of the enumerated activities are, as a category, contrary to the public interest and therefore may not be listed for trading or accepted for clearing on or through a registered entity.
Proposed Amendments to CFTC Regulation 40.11
The Commission states that it interprets CEA section 5c(c)(5)(C) to contemplate a two-step inquiry. First, the Commission must assess whether a contract in a specified excluded commodity "involve[s]" an activity enumerated in CEA section 5c(c)(5)(C)(i)(I) – (V) (each, an "Enumerated Activity") or other similar activity as determined by the Commission by rule or regulation ("prescribed similar activity"). Then, if the Commission determines that the contract involves such activity, the Commission must assess whether the contract is contrary to the public interest.
The Commission aims to enhance clarity of the two-step inquiry for event contracts by proposing amendments to Regulation 40.11 that would (1) provide descriptions of excluded commodities and contracts that involve an enumerated activity, (2) define gaming as an enumerated activity, and (3) detail the public interest considerations.
1. Description of Excluded Commodity
The CFTC proposes to amend Regulation 40.11(a)(1)-(2) and 40.11(c) to refer to "agreements, contracts, transactions, or swaps in excluded commodities based on the occurrence, extent of an occurrence, or contingency (other than a change in the price, rate, value, or levels of a commodity described in section 1a(19)(i) of the Act)." The amendment aims to more precisely track the text of CEA section 5c(c)(5)(C) and to clarify the CFTC's interpretation that the reference to "section 1a(2)(i)"3 in section 5c(c)(5)(C) was intended by Congress to refer to the excluded commodities described in section 1a(19)(i) and thereby carve out from the scope of section 5c(c)(5)(C) event contracts based on a change in the price, rate, value or levels of the measures, indices and instruments described in 1a(19)(i).4 The CFTC acknowledges that historically, it has not recognized these types of event contracts as falling within the scope of CEA section 5c(c)(5)(C).
The CFTC requests comment on its interpretation that the reference to "section 1a(2)(i)" was intended to refer to excluded commodities described in CEA section 1a(19)(i) and on the examples of event contracts that the CFTC believes would fall outside the scope of CEA section 5c(c)(5)(C) and Regulation 40.11. The Commission specifically asks commenters whether there are additional types of event contracts that should be identified in the nonexclusive list of contracts and what indices or measures are "other macroeconomic index[es] or measure[s]" for purposes of CEA section 1a(19)(i).
The CFTC proposes to amend Regulation 40.11 by removing the terms "relate to" and "reference" wherever they appear and to simply refer to event contracts that "involve" an enumerated activity. The Commission notes in the Proposed Rule that this change would be consistent with the Nadex5 and Kalshi6 orders, both of which focused on whether the event contract "involved" an enumerated activity. The CFTC states that a contract may "involve" an enumerated activity, or prescribed similar activity, in circumstances where such activity is not, itself, the underlier of the contract.
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Footnotes
1. https://www.cftc.gov/PressRoom/PressReleases/8907-24.
2. The PredictIt litigation was moved to the DC federal court earlier this year. See In re: Kevin Clarke, case number 24-50079, in the US Court of Appeals for the Fifth Circuit and Clark et al. v. CFTC, case number 1:24-cv-00167, in the US District Court for the District of Columbia; see also KalshiEX LLC v. Commodity Futures Trading Commission, case number 1:23-cv-03257, in the US District Court for the District of Columbia.
3. The CFTC notes in the proposal that there is no "section 1a(2)(i)" in the CEA.
4. The Proposed Rule provides examples of these types of contracts, including (i) economic indicators, including the CPI and other price indices, the US trade deficit with another country, measures related to gross domestic product, jobless claims or the unemployment rate, and US new home sales; (ii) financial indicators, including the federal funds rate, total US credit card debt, fixed-rate mortgage averages (e.g., the 30-year fixed-rate mortgage interest rate), and end-of-day,- week or -month values for broad-based stock indexes; and (iii) foreign exchange rates or currencies.
5. On January 3, 2012, the CFTC commenced a 90-day review under Regulation 40.11(c) of binary option contracts that paid out based on the results of various US federal elections in 2012. On April 2, 2012, the CFTC issued an order prohibiting the contracts from being made available for clearing or trading. See https://www.cftc.gov/PressRoom/PressReleases/6224-12.
6. On June 23, 2023, the CFTC commenced a 90-day review under Regulation 40.11(c) of event contracts that were based on which political party will be in control of each chamber of Congress. On September 22, 2023, the CFTC issued an order prohibiting the contracts from being made available for clearing or trading on or through Kalshi. See https://www.cftc.gov/PressRoom/PressReleases/8780-23.
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