An interim final rule explicitly excludes casino-style gambling products from the definition of a swap, while a proposed rule expressly includes event contracts within this definition.
The CFTC makes clear that both changes are simply intended to codify the regulator’s longstanding positions on these topics.
The regulatory thrust here is to resolve the uncertainty that has been created by conflicting court decisions and various enforcement actions, particularly those at the state level, on the question of what constitutes a swap.
Interestingly the CFTC has invoked the good cause exception in order not to engage in notice-and-comment rulemaking in connection with this amendment.
It cites state and court action threatening “to expose large areas of hitherto uncontroversial CFTC jurisdiction to incursion by certain of the States.” It singles out a decision by the Ninth Circuit panel as potentially depriving the CFTC “of exclusive jurisdiction over most event contracts” and threatening “to wreak havoc on the operation of [designated contract markets (DCMs)] nationwide.” The CFTC’s action here addresses that split among federal appeals courts (the Third and Ninth Circuit courts) and even pending petitions before the US Supreme Court regarding state authority here, such as the one New Jersey has filed.
Furthermore, the state-level actions, according to the CFTC, “imperil a nascent industry that Congress has entrusted to the ‘exclusive jurisdiction’” of the CFTC.
The interim final rule
The interim final rule adds a new paragraph (7) to the swap definition in the Commodity Exchange Act (7 USC 1a(47)).
The rule excludes a product from the definition of a swap if it satisfies two tests:
- a provider test, which looks at the person, duly licensed or authorized to offer gambling products acting within the scope of the license; and
- a product test, which seeks to ensure that the product is not traded on a board of trade, an organized exchange, swap execution facility, or any other market in which trades are executed multilaterally or subject to individual negotiation.
Sports wagers, casino games, and other licensed games of changes (including bingo, pool, lotteries, and raffles) are also expressly listed as excluded from the swap definition.
The CFTC’s rationale is that such gambling products “do not bear the structural characteristics” of regulated derivatives because they are not inherently tradeable – they are bilateral, priced by the “house,” not centrally cleared, and have a history of State and Tribal regulation.
An important footnote explains that the exclusion “is non-exclusive”; in other words, there may be “other gambling-style transactions that are not swaps given how those transactions are structured and whether they are tradeable.” Examples of these include “a casual bet between friends or a casino-style sportsbook illegally operating in a State that prohibits gambling.”
The regulator is seeking feedback from stakeholders on whether the provider test should cover additional categories of providers and whether there is a better way for the product test to “draw an objective, functional distinction between swaps” and “traditional gambling products.”
The proposed rule would add a new paragraph ((2)(i)(G)) to section 1.3 explicitly pulling event contracts, “including those based on sports, politics, cultural, and weather-related events,” into the definition of a swap.
The CFTC views events contracts as swaps because they “are implicated” by four key clauses of the statutory definition of a swap:
- inclusion in the definition of any agreement, contract, or transaction that is dependent on the “’occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence’”;
- explicit inclusion of binary options and other commodity options in the definition;
- explicit inclusion of contracts “commonly known to the trade as a swap” in the definition; and
- inclusion in the definition of “’any combination or permutation of, or option on, any agreement, contract, or transaction described’” in any clauses of the definition.
The regulator is also drawing attention to the fact that it has express statutory authority to amend and expand the definition of a swap.
While the proposed amendment does not “change the legal rights or obligations of market participants,” the added certainty that events contracts are swaps and are subject to the exclusive jurisdiction of the CFTC is a key benefit. Market participants “may benefit by spending less time and fewer resources determining which regulatory regime applies and by saving the costs of complying with various State regulatory regimes.”
To put things rather bluntly, the CFTC is clearly staking out its regulatory turf with these proposals in an attempt to provide some clarity to what is a burgeoning industry in the United States. Put another way, it wants to ensure its oversight of incredibly popular platforms like Kalshi and Polymarket and not wait for a Congress that has dallied on comprehensive virtual currency legislation and may see potential leadership changes following midterm elections.
The CFTC chair Michael Selig does not mince words, stating that “casino-style gambling products are not derivatives” while event contracts “are commodity derivatives squarely within the CFTC’s regulatory remit under the Commodity Exchange Act and are within the agency’s exclusive jurisdiction.”