Executive Summary:  The Commission should permit a designated contract market (DCM) to list contracts on sporting events that are designed to hedge the risks of commercial activity related to those events, including legalized sports bookmaking.  However, the proposal (withdrawn) by Eris Exchange (ErisX) to list contracts based on the outcome of football games was deficient because: (1) ErisX did not provide sufficient evidence of hedging utility; and (2) ErisX’s proposed exclusion of the general public from trading the contract on the DCM would violate DCM Core Principles and CFTC regulations regarding impartial access (Core Principle 2) and antitrust considerations (Core Principle 19).  A DCM cannot exclude retail participants.  Core Principle 2 prohibits a DCM from imposing discriminatory access criteria on the basis of net worth, as ErisX has proposed.  Core Principle 19 requires a DCM to not impose any material anticompetitive burden on trading.  ErisX’s proposed sporting event contracts are functionally identical to the sports bets offered by bookmakers to the general public, and are designed so that sports bookmakers may use the exchange to hedge the risks arising from selling those contracts to the public.  It would be anticompetitive to allow bookmakers to trade these contracts on the exchange so they can sell them to the public at casinos, racetracks, and other betting establishments, while at the same time prohibiting the public from obtaining those contracts through open, transparent, competitive trading on the exchange.  Although contracts involving gaming should be permitted to be traded on a DCM if they have an economic purpose, which may include hedging by sports bookmakers, gaming contracts without any such economic purpose should not be permitted on a DCM.

1. The ErisX Petition.

On December 15, 2020, the CFTC received a self-certification filed by ErisX under Regulation 40.2 for the listing of three financially settled contracts that it called “RSBIX NFL Futures Contracts” (NFL Contracts).[1]  The ErisX certification included the following assertions:

The contracts are futures contracts.  According to ErisX, “[t]he proposed Contracts will be structured as a futures contract for each sports event outcome.”[2]

The contracts mirror common sports bets.  ErisX’s certification stated that the NFL Contracts “will be listed for individual sporting events, and will include contracts based on the moneyline,[3] the point spread,[4] and the total points for each game.”[5]  ErisX’s description of the NFL Contracts employs the same terminology and indicates that the contracts would function in the same manner as the moneyline, point spread, and total points sports bets offered by sports bookmakers to the general public.[6]

Hedging utility.  According to ErisX, the NFL Contracts would “permit Licensed Sportsbooks to manage commercial risk by hedging their exposure [to imbalances in their books],” and are “tailored to address the unique risks of Licensed Sportsbooks.”[7]  ErisX claimed that contracts with alternative specifications “would create a disparity between the commercial risks faced by Licensed Sportsbooks and the hedge used to mitigate the commercial risk.”[8]  ErisX also asserted that the NFL Contracts could be used by vendors and stadium owners to hedge their commercial risks that depend on attendance at football games because teams that win more games have better attendance and are more likely to make the playoffs and host additional games.

Compliance with DCM Core Principles.  The ErisX Certification included explanations of how it believed the NFL Contracts complied with the relevant DCM core principles and CFTC regulations.

Exclusion of retail customers.  ErisX proposed to limit trading in the NFL Contracts to “eligible contract participants (ECPs) that fall into one of the following categories: (1) commercial market participants seeking to hedge their cash market exposure; or (2) designated market makers.”[9]  These limitations “mean that retail (non-ECP) persons and persons seeking to profit based upon the outcome of particular sporting events will not be eligible to trade the Contracts.”[10]

On December 23, 2020, the CFTC informed ErisX that it had determined that the NFL Contracts “may involve, relate to, or reference . . . gaming” under CFTC Regulation 40.11.  The CFTC requested that ErisX suspend any listing and trading of the contracts during the pendency of a 90-day review period beginning on that date.[11]  The CFTC sought public comments on a number of questions related to the certification, and received 25 comment letters in response.[12]  On March 22, 2021, one day before the expiration of the 90-day review period, ErisX withdrew its certification.

ErisX officials have been quoted as stating that they may re-file another certification.[13]  In light of the public comments received on the initial filing, and the potential for a subsequent filing, I believe that it may be helpful to provide my views on the now-withdrawn ErisX certification and some of the issues it presented.[14]

2. Standard of Review.

As enacted by Congress in the Dodd-Frank Act, CEA Section 5c(C)(5)(C) (the CEA gaming provision) prohibits the listing of agreements, contracts, transactions or swaps in an excluded commodity[15] that involve (i) activity that is unlawful under any federal or state law, (ii) terrorism, (iii) assassination, (iv) war, or (vi) gaming, if the Commission determines such agreements, contracts, or transactions are “contrary to the public interest.”[16]  The CEA gaming provision thus requires a two-part test for the Commission to prohibit a contract that involves gaming.  First, the Commission must find that a contract “involves” gaming.  Second, it must determine that the contract involving gaming is “contrary to the public interest.”

The Commission has interpreted the “public interest” test in the CEA gaming provision as a restoration of the “economic purpose” test that was eliminated in the Commodity Futures Modernization Act of 2000 (CFMA).[17]  The referenced economic purpose test included a requirement that an application for the listing of a contract demonstrate that the contract “reasonably can be expected to be, or has been, used for hedging and/or price basing on more than an occasional basis.”[18]  The Commission also has concluded it has “discretion to consider other factors in addition to the economic purpose test in determining whether an event contract is contrary to the public interest.”[19]

During the Senate’s consideration of the CEA gaming provision, Senator Lincoln, then-Chair of the Senate Committee on Agriculture, Nutrition and Forestry, stated that this provision was intended to enable the CFTC to prohibit the trading of derivative contracts based on sporting events:

Mrs. Feinstein: . . . Will the CFTC have the power to determine that a contract is a gaming contract if the predominant use of the contract is speculative as opposed to hedging or economic use?

Mrs. Lincoln: That is our intent.  The Commission needs the power to, and should, prevent derivatives contracts that are contrary to the public interest because they exist predominantly to enable gambling through supposed event contracts.  It would be quite easy to construct an “event contract” around sporting events such as the Super Bowl, the Kentucky Derby, and Masters Golf Tournament.  These types of contracts would not serve any real commercial purpose. Rather, they would be used solely for gambling.[20]

In 2011, the Commission promulgated Regulation 40.11 to implement the CEA gaming provision.[21]  Regulation 40.11(a) prohibits the listing of an agreement, contract, or transaction “that involves, relates to, or references terrorism, assassination, war, gaming, or an activity that is unlawful under any State of Federal law . . . .”[22]  Regulation 40.11(c) provides for a 90-day review period for any such contract that the Commission determines may involve gaming or any of the other activities referenced in Regulation 40.11(a).

During the 40.11 rulemaking comment period, the Commission was urged to further define the term “gaming” to avoid market uncertainty as to the scope of the prohibition.[23]  In the final rulemaking, the Commission stated it “agrees that the term ‘gaming’ requires further clarification and that the term is not susceptible to easy definition.”[24]  The Commission declined, however, to provide such further definition, stating instead that it would “consider individual product submissions on a case-by-case basis.”[25]  The ErisX certification presented such a product for the Commission’s consideration.

With respect to product certifications submitted under Regulation 40.2 that may involve gaming, the Commission also reviews the certifications under the same standards that apply to all other product certifications submitted under Regulation 40.2.  These include whether the proposed product complies with “applicable provisions of the Act, including core principles, and the Commission’s regulations thereunder.”[26]

3. Review of the NFL Contracts.

1. The NFL Contracts involve gaming.

Football is a game.  Betting on the outcome of games is “gaming.”  The American Gaming Association (AGA) website provides a one-page summary of the business of sports betting.  Under the heading “The Basics of Sports Betting,” this AGA document identifies and explains key sports betting terms and concepts, including descriptions of the moneyline, point spread, and over/under bets.

The NFL Contracts are identified by the same labels and structured to match the basic types of sports bets described by the AGA.  The asserted economic purpose of the NFL Contracts—to enable sports bookmakers to hedge their gaming contracts with the public—does not undermine the conclusion that the NFL Contracts involve gaming.  To the contrary, it supports this conclusion: a contract that is structured identically to gaming contracts, labelled with the same terms as gaming contracts, and designed with a purpose to hedge gaming contracts “involves” gaming.[27]

2. Hedging utility.

The Commission has interpreted the public interest test in the CEA gaming provision to encompass the economic purpose test that the CFMA deleted from the CEA.  Notably, however, the CEA gaming provision does not require the Commission to prohibit contracts involving gaming or to prohibit a contract simply because it involves gaming; it provides the Commission with the discretion to prohibit them.  In my view, the Commission should recognize the significant growth of sports betting as a legalized activity in recent years with significant underlying commercial activity.  The Commission should permit a DCM to list contracts involving sports events where a DCM demonstrates that such contracts have an economic purpose and hedging utility related to such commercial activity.

In 2010, at the time the CEA gaming provision was enacted as part of the Dodd-Frank Act, sports betting was generally illegal in the United States, including under prohibitions on state-authorized sports betting in the Professional and Amateur Sports Protection Act (PASPA).  Sports betting was permitted only in Nevada casinos and three states hosted sports lotteries or permitted sports pools.[28]  In light of the widespread illegality of sports betting at the time, it is not surprising that sports betting contracts were held out in legislative discussions as a prime example of event contracts that would not have a legitimate economic purpose. [29]

The sports betting landscape today, however, is dramatically different from when Congress enacted the gaming provision and the Commission promulgated Regulation 40.11.  In the three years since the Supreme Court’s 2018 decision invalidating PASPA,[30] sports betting in the U.S. has expanded rapidly, both geographically and in the total dollar amount of betting annually.  Half of the states and the District of Columbia have legalized sports betting, and more are considering whether to do so.[31]  Morningstar projects that in 2024, the aggregate amount of legal sports betting in the U.S. will reach $81 billion.[32]

Because in many states sports betting is now legal under both state and federal law, it would not be “contrary to the public interest” for the Commission to permit the listing of sports event contracts if an exchange can demonstrate that the contracts will be used to hedge commercial risks arising from lawful commercial activity related to sports betting.[33]  In my view, however, ErisX did not provide sufficient evidence that the NFL Contracts would provide an effective and more-than-occasionally-used hedging mechanism for licensed sportsbooks, vendors, or stadium owners.  Among other issues, for example, the AGA, which represents licensed sportsbooks, cast doubt upon the utility of the contracts, stating that the proposed contracts “pose complex legal and policy questions,” and informing the Commission that “some AGA members also believe these proposed contracts will have limited utility for their individual operations.”[34]  Further, ErisX provided no evidence to support its claim that the NFL Contracts could be used to hedge the non-gaming economic consequences arising from the outcomes of NFL games, such as changes in revenue for in-stadium and other vendors.

If ErisX or any other applicant can demonstrate that sports event contracts such as the NFL Contracts can be used for an economic purpose other than for gaming itself, meaning they reasonably can be expected to be used for hedging and/or price basing on more than an occasional basis, then in my view it would not be contrary to the public interest to permit their listing.  To date, however, there has been no such demonstration.

3. Violations of Core Principles.

Even if a proposed contract passes muster under Regulation 40.11, it also must satisfy all the other requirements of Regulation 40.2, including compliance with the CEA core principles and CFTC regulations.  In my view, contracts that exclude retail participation on a DCM, such as the NFL Contracts, do not satisfy these requirements.

Excluding retail customers from trading the NFL Contracts would violate DCM Core Principle 2 (impartial access) and Core Principle 19 (antitrust considerations).  To the best of my knowledge, no DCM has ever prevented—and the CFTC has never previously permitted a DCM to prevent—retail customers from trading a contract competitively on a DCM.

1. Core Principle 2 (impartial access).

DCM Core Principle 2 requires a DCM to “enforce compliance with the rules of the contract market, including [] access requirements . . . .”[35]   In connection with Core Principle 2, CFTC Regulation 38.151 states:

A designated contract market must provide its members, persons with trading privileges, and independent software vendors with impartial access to its markets and services, including:

(1)  Access criteria that are impartial, transparent, and applied in a non-discriminatory manner . . .[36]

In the preamble to the final rule implementing Regulation 38.151, the Commission made clear its interpretation of Core Principle 2 as requiring DCMs to provide impartial, non-discriminatory access.  The Commission concluded that “impartial access rules are necessary in order to prevent the use of discriminatory access requirements as a competitive tool against certain participants.”[37]  The Commission stated that such impartial access “will likely enhance the DCM’s liquidity and the overall transparency of the swaps and futures markets.”[38]  The Commission emphasized that access criteria should be based only “on the financial and operational soundness of a participant, and not on factors that could bar access and result in discriminatory access or act as a barrier to entry.”[39]  In the notice of proposed rulemaking, the Commission specifically rejected as discriminatory any access criteria based on a person’s net worth (e.g., ECP status): “The Commission believes that the requirement to provide impartial access requires DCMs to avoid the creation of exclusive membership standards that focus on high net worth.”[40]

ErisX proposed to limit trading in the NFL Contracts to ECPs that are either (i) licensed sportsbooks, vendors, or stadium owners, or (ii) designated market makers.  Under ErisX rules, a market maker must (a) meet ErisX’s definition of a Professional Trading Firm; and (b) enter into a market making agreement with ErisX.  According to ErisX, “[t]he foregoing limitations on eligible participants mean that retail (non-ECP) persons and persons seeking to profit based on the outcome of particular sporting events will not be eligible to trade the Contracts.”[41]

ErisX’s exclusion of individuals who are not ECPs is the very kind of discrimination based on net worth that the Commission has prohibited.  It is blatantly discriminatory to bar retail customers with less than $10 million in discretionary investments from access to the DCM.   None of ErisX’s proposed access criteria relate to the permissible factors of financial or operational soundness.  Moreover, if ErisX applied its access criteria in a truly non-discriminatory manner, all other persons “seeking to profit based on the outcome of sporting events”—a category that includes licensed sportsbooks, in-stadium and other vendors, and stadium owners—also would not be able to trade the contracts, and there would be nobody left to trade.    

2. Core Principle 19 (antitrust considerations).

Core Principle 19 states:

(19)  Antitrust considerations.—Unless necessary or appropriate to achieve the purposes of this Act, the board of trade shall not—

(A) adopt any rule or taking [sic] any action that results in any unreasonable restraint of trade; or

(B) impose any material anticompetitive burden on trading on the contract market.[42]

In addition to a DCM’s antitrust obligations under Core Principle 19, the CEA imposes an obligation upon the Commission to foster competition.  CEA Section 15 requires that in issuing any order or approving any rule or regulation of a contract market, the Commission must “take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the objectives of the [CEA].”[43]  The Commission therefore has an obligation to ensure that the terms of contracts listed on exchanges do not impermissibly restrict competition.

The sports betting market as envisioned by ErisX would be anticompetitive—it would protect the bookmakers from competition by members of the public and non-market making ECPs.  The market structure that would have resulted from ErisX’s proposal would be one where sports bookmakers could trade amongst themselves to swap their risks and together balance their books, while preserving their exclusive ability to provide sports event contracts to the public.[44]  Members of the public would be prohibited from accessing the DCM to either post or accept bids or offers from other market participants.  The proposed restrictions on participation in the trading of the NFL Contracts thus would protect sports bookmakers from competition from retail traders and non-market making ECPs; retail customers would be required to obtain their sports betting contracts from bookmakers.

Prohibiting retail customers from accessing sports bet contracts offered on a DCM would harm the public.  On a DCM, retail participants would benefit from exchange-based prices that would more accurately reflect the market’s assessment of the probability of an event, rather than the odds dictated to the customer by a bookmaker.[45]  On the DCM, members of the public could make or take bids or offers placed by other market participants—including the bookmakers, market-makers, and other members of the public—rather than be consigned to take-it-or-leave-it odds offered by bookmakers.  The price discovery process on the exchange would be transparent, in contrast to the opaque price-setting process of a bookmaker or casino.  The bid/ask spread on the exchange likely would be smaller than the commission or “vig” charged by the bookmakers.[46]  The two-tier market structure that ErisX’s proposal would create—a non-public exchange designed to solely support the business of the dealers who would then have the exclusive ability to offer the same contracts at a mark-up to the public off-exchange—has been rejected in CFTC-regulated swaps markets[47] and is contrary to the public interest.[48]

The economic purpose test in the CEA gaming provision does not require that all market participants have an economic purpose in trading the contract—just that the contract “can be expected to be, or has been, used for hedging and/or price basing on more than an occasional basis.”  CFTC markets are composed of both hedgers and speculators.  Once hedgers are permitted in a market, speculators must be permitted as well.  Speculators have a variety of motivations, and neither the exchanges nor the CFTC has ever sought to limit speculation in DCM contracts based upon the net worth of a speculator, or to probe into the motives of speculators—other than to prohibit fraud or manipulation.[49]

The contracts proposed by ErisX would be a no-lose situation for the bookmakers, and a no-win situation for the public.[50]  ErisX’s proposed restrictions are both anticompetitive and harmful to retail market participants.[51]

4. Contracts involving gaming without an economic purpose should not be permitted on a DCM.

As described above, if sports event contracts involving gaming are found to have an economic purpose, they should be permitted to be listed on a DCM and retail customers cannot be prohibited from trading those contracts.  In my view, however, based upon the gaming provision and the general purposes of the CEA, it would be contrary to the public interest to permit the listing of contracts involving gaming that do not have an economic purpose.

In Section 3(a) of the CEA, Congress finds that the transactions subject to the CEA “are affected with a national public interest by providing a means for managing and assuming price risks, discovering prices, or disseminating pricing information through trading in liquid, fair and financially secure trading facilities.”[52]  In Section 3(b) Congress declares that the purpose of the Act is to further these interests “through a system of effective self-regulation of trading facilities, clearing systems, market participants and market professionals under the oversight of the Commission.”[53]  The CFTC describes its mission as to “promote the integrity, resilience, and vibrancy of the U.S. derivatives markets through sound regulation.”[54]

Contracts or transactions involving gaming that do not have any of the purposes described in CEA Section 3(a)—managing price risks or price-basing—are not the types of contracts contemplated by Congress to be within the public interests served by the CEA or the functions of the facilities regulated by the CFTC.[55]  It would be contrary to the public interests identified in the CEA to permit the use of CFTC-licensed facilities solely for non-economic purposes.

5. Conclusion.

If sporting event contracts with an economic purpose, such as hedging, are allowed to be traded on a DCM, the general public must be able to access and trade those contracts on the exchange.  The public cannot be barred from trading a contract listed on a DCM.  However, gaming contracts without any economic purpose should not be permitted on a DCM.