Jason Ruspini:

Unfortunately, election contracts and ALL event contracts appear to be prohibited by CFTC regulation 40.11, released in July 2011 as part of Dodd-Frank:

“(a) Prohibition. A registered entity shall not list for trading or accept for clearing on or through the registered entity any of the following:

(1) An agreement, contract, transaction, or swap based upon an excluded commodity, as defined in Section 1a(19)(iv) of the Act, that involves, relates to, or references terrorism, assassination, war, gaming, or an activity that is unlawful under any State or Federal law”

“… involves, relates to … an activity that is unlawful under any State or Federal law” is very broad. Not only does it include election outcomes, which several States have explicit laws against, but Massachusetts, Mississippi, Nebraska, North Dakota and South Carolina have laws against bets on “events”.

This is not the only reading of 40.11 and is certainly not the one Nadex holds. In the short term, it seems that any argument for this sort of contract has to address the broad interpretation above all.

We are academic researchers who study prediction markets. We are writing in favor of allowing NADEX, or a similar entity, to offer a broad range of political and policy event futures, including the three they are currently proposing.

There are four broad reasons for our support:

1. Existing political event futures have proven useful. Political event futures have been offered in small quantities by the onshore Iowa Electronic Markets (IEM), and by offshore exchanges such as Intrade. Prices from these markets have made possible a broad range of academic research.

2. Political event futures facilitate price discovery in other asset markets. One of the findings of this research is that firms and industries are exposed to political and policy risk. Political event futures provide investors with a market-based assessment of outcome probabilities, which reduces investors’ uncertainty when trading other assets. In addition, if allowed to operate onshore, political event futures markets might eventually grow to the point where they might provide useful hedging opportunities for firms. The currently proposed position limits are likely sufficient for most individuals to hedge their personal exposure to election outcomes.

3. The full potential of political event futures cannot be realized in academic-scale markets or offshore. Despite the utility of the IEM and Intrade, both markets are hampered by the current regulatory environment. An onshore exchange that allowed positions of the size NADEX is suggesting could ultimately reach a scale where it could attract liquidity to contracts that currently do not succeed on Intrade. There are many exciting potential applications of such markets, in research and policy making. Offering contracts on questions of great popular interest (such as Presidential elections) is crucial to attracting investors to an exchange. Once there, they face lower costs of participating in other markets, such as those currently offered by NADEX.

4. Concerns about gambling and manipulation are misplaced. Trading securities whose payoffs depend on political outcomes is no more “gaming” than trading securities whose payoffs depend on commodity or equity prices. Clearly, one can trade any security out of gambling motives, so the key question is whether the subject of these contracts is a “game,” or an economically important event. It is hard to argue that elections are not economically important events.

One might be concerned with two forms of manipulation: outcome and price manipulation. Many individuals have already large stakes in election outcomes; for example, a top executive in a public company will have will have a significant exposure via their equity holdings, as well as through any impact of the election on policies such as tax rates. Many individuals also have substantial exposure to election outcomes via their careers. Given the position limits proposed by NADEX, the market is likely to make at most a small contribution towards the number of individuals with meaningful stakes in election outcomes. One might be concerned with trading by those involved in supervising elections, and it might be reasonable for policy to prohibit trading by those individuals.

Turning to price manipulation, there have been a couple episodes that appeared to be attempt by traders to influence perceptions of an election by manipulating prediction market prices. The evidence suggests that effects on prices are relative short-lived, and effects on perceptions are often counter-productive for the manipulator (e.g., through media stories mentioning the manipulation). Onshore election markets will likely be significantly more liquid, making price manipulation even less attractive. A further protection comes from the fact that the outcomes of interest (election winners) will be linked to prediction market prices only through perceptions. Concern about price manipulation might be better devoted to cash-settled futures, where contracts settle based on other financial market prices.

To summarize, we view markets in securities contingent on economically-relevant events as an innovation that generate positive externalities (by aggregating information) as well as benefits to participants. Innovations with positive externalities should be encouraged by policy makers, not limited. If the Commission has questions about any of the statements made or research mentioned in this letter, it should feel free to contact any of the undersigned.

- Election gag.

More.

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“A financial adviser or stock broker should be licensed to provide any consultation on investment in securities.”

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InTrade wasn’t authorized to trade yearly contracts. Do you, guys, have an explanation on why InTrade does it anyway?

Release: 5124-05
For Release: October 4, 2005

U.S. COMMODITY FUTURES TRADING COMMISSION ASSESSES PENALTIES AGAINST IRISH COMPANY TRADE EXCHANGE NETWORK LIMITED FOR OFFERING ILLEGAL COMMODITY OPTION CONTRACTS

Trade Exchange Network Cooperates with Federal Investigation and Agrees to Pay Civil Penalty of $150,000

WASHINGTON, D.C. – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing and simultaneous settlement of charges under the Commodity Exchange Act (CEA) that Trade Exchange Network Limited (TEN), a limited liability company based in Dublin, Ireland, solicited and accepted orders from U.S. residents for commodity option contracts that were not excepted or exempted from the Commission’s ban on options. TEN owns and operates an Internet-based trading platform that facilitates trading through its websites www.Tradesports.com, www.Intrade.com, and www.TradebetX.com.

The CFTC consent order finds that between January 2003 and May 2005, TEN, through its websites, offered the following commodity option contracts, among others, to U.S. residents: Gold Futures Year End; Daily Crude Oil; Light Sweet Crude Oil Futures Year End; Intraday Euro versus U.S. Dollar Rate; and U.S. Dollar versus Yen Cash Rate.

According to the findings in the order, TEN actively solicited U.S. residents to trade such contracts by retaining an individual in the U.S. to market TEN’s products throughout the country, and TEN ultimately developed a U.S. customer base that was roughly 33 to 40% of its total customer base. The order further finds that the commodity option contracts offered on TEN’s websites were not excepted or exempted from the Commission’s regulation banning options trading, and therefore violated the CEA.

TEN’s high level of cooperation during the underlying investigation resulted in a reduction of the civil monetary penalty to $150,000, which TEN agreed to pay. The order also calls for TEN to cease and desist from further violations of the CEA and comply with specific undertakings. In consenting to the entry of the CFTC’s order, TEN neither admitted nor denied the findings made in the order.

The following Division of Enforcement staff members were responsible for this case: Anne M. Termine, William Hoar, Kathleen Banar, Richard Glaser, and Richard Wagner.

- BetFair moves to Gibraltar.

- CEO’s health.