The major question here is what degree of trading restrictions the CFTC considers appropriate in order to fulfill the CEA’s “beyond the control” criterion of excluded commodities. There is little doubt that low position limits alongside candidate death contingencies and prohibitions on trading by candidates, their staffs, members of the electoral college, and their proxies would not satisfy the CEA in this respect. The challenge lies in enforcing such trading prohibitions. I hope that Hedgestreet is in the process of developing a framework to do so. The CFTC could also issue an interpretive letter on this specific point, without addressing the more general, challenging issues related to their jurisdiction over event markets.

If Hedgestreet’s trading restrictions are conservative and rigorous, it is improbable that such a self-certification would put Hedgestreet in bad graces with the CFTC. Alternatively, Hedgestreet could submit the futures (or options) for approval under CFTC regulation 40.3. If they do so, the CFTC has 45 days to review the products, at which point they could render a decision or extend the review process. In the meantime, however, Hedgestreet could be in communication with the CFTC and NFA concerning the development of trading restrictions, which again should be the main point of contention here, as there is no doubt that such event markets are associated with an “economic consequence”. Note that CME does not even believe that trading prohibitions are necessary, citing the role of the Fed in determining interest rates and the lack of problems there with respect to manipulation. I tend to believe that the Fed and interest rates is a special case, not to mention that it is treated differently in the CEA, and that it is prudent to impose special trading restrictions on political event contracts. Those restrictions, however, can remain flexible and be loosened over time, especially the position limits, as the market grows.

Given the current political climate in which the CFTC operates, the Commission may welcome such an active stance from Hedgestreet and other DCMs on this issue, as it will allow them to take a more passive role in the process. In the case of vote-share, electoral college and tax futures with appropriate trading restrictions, the Commission would simply be complying with the CEA by allowing such contracts. Allowing winner-take-all options would be incrementally more sensitive for the CFTC given their additional discretion in such cases. In any case, I think we have passed beyond the point where there is any material doubt that such markets are bona fide excluded commodities.

[Previously, my response to the CFTC, where I take a broader view with respect to jurisdiction and issues like gaming law preemption. Cross-posted from Risk Markets and Politics]

Coming soon after speculators were blamed for rising commodity prices, I fear this is bad news for hopes for legal prediction markets anytime soon.

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The CFTC decisions are politically sensible in 4 areas:

1. The CFTC will never allow real-money prediction markets on sports. That’s too close to gambling, for some critics. (Some ventures have approached the CFTC with the idea for new financial instruments with sport hedging capability. We will see what the CFTC makes of that in the near future.)
2. The CFTC will never allow real-money prediction markets on politics that will allow economic agents to hedge against the future economic consequences of the election of one particular presidential candidate. Hedging on “Obama as 2009 US president” is too sensitive. I expect the CFTC to send HedgeStreet and the CME Group packing. The CFTC won’t classify political elections as “excluded commodities”, as those DCMs asked. (But it could be that the CFTC will find another way to allow DCMs to offer prediction markets on political elections. That could be.)
3. The CFTC will never allow real-money prediction markets on terrorism. The CFTC will tell Tom W. Bell to get lost in his Orange county.
   
4. The CFTC will never allow insider trading on public, real-money prediction markets. Robin Hanson has long argued that insider trading enhances the accuracy of the marked-based predictions. The CFTC will never rule in such a way. Plus, insider trading is a very touchy issue for the event derivative traders, who hate to get skimmed by people in the know. Rightfully, BetFair make their possible to enforce fair trading on their prediction markets.

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[...] I was heartened to read John Delaney’s (InTrade CEO) contribution [...]. I would certainly have endorsed this contribution – well crafted, robust, articulate and (imo) stating the blindingly obvious [...].

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Yes, his input was great, but, alas, it won’t win in the end.

The CFTC will probably rule out the “excluded commodities” way (against the will of HedgeStreet and the CME Group) in favor of the “exempt commodities” route (for a reason of convenience). In parallel (and maybe as a consequence of), the CFTC will probably direct those “event markets” to lightly-regulated, US-based, small prediction exchanges —with plenty of restrictions upon them. Those restrictions are what is still up in the air, in my assessment.

So, the picture does not look like the CFTC ruling will please InTrade CEO John Delaney —but if I’m wrong in the end, of course, I’ll be happy.

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As for me, I’m intrigued by the contribution from “Crystal World Markets” – (PDF file). I will blog about it, at a later time, this Summer 2008.

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Honesty and fairness, when writing in a prestigious publication, would dictate that you mention your opponents’ opinions.

Academia = Ivory Tower.

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Will the Wall Street Journal give the same airtime to HedgeStreet and the CME Group?

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CME Group – (PDF file)

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CME’s comment is not far away from HedgeStreet’s take, which I told you I like. – (PDF file)

I suppose our good friend Jason Ruspini somewhat shares HedgeStreet and the CME’s views. Here’s his comment to the CFTC. – (PDF file)

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I like InTrade CEO John Delaney’s take, but, of course, on a different level. I mean, I like his industry analysis, but he didn’t elaborate in the legal way that was expected by the CFTC. That’s not a slam, just an observation. – (PDF file) — (original PDF file)

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I’ll analyze all this tomorrow. I was off this afternoon.

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InTrade – (PDF file)

Robin Hanson – (PDF file)

Tom W. Bell et al. – (PDF file)

Tom W. Bell – (PDF file)

Chris F. Masse – (PDF file) —

Robin Hanson – (PDF file)

Iowa Electronic Markets – (PDF file)

Phil Goetz – (PDF file)

Chris F. Masse – (PDF file) —

Crystal World Markets – (PDF file)

EurAsia Group – (PDF file)

Mark L. Bender – (PDF file)

CME Group – (PDF file)

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HedgeStreet are saying that:

1. The political elections qualify as “excluded commodities” (as opposed to “exempted commodities”). The reason for that is that electing a Republican president can have some economic consequences for some industries (e.g., the oil industry, the health services industry, etc.), while electing a Democratic president can have opposite economic consequences, or economic consequences for other industries. Hence, the risk, and thus, the need for hedging those risks. And, so, the role of the CFTC is to guard against manipulations, etc.
2. If the political elections qualify as “excluded commodities”, then, logically, the prediction markets on political elections should be offered by Designated Contact Makers (DCMs), like HedgeStreet —and not by ECMs or by event derivative exchanges crowned with a “no-action” letter by the CFTC.

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Besides the point #2 made by Vernon Smith in his comment back in May 2008, that is the strongest point made to the CFTC —as of today, Sunday, July 6th, 2008. (Jason Ruspini bought it, too.) I can’t imagine that the CFTC will ignore this point.

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However, HedgeStreet are not saying that:

1. The topics other than political elections are “excluded commodities”, too.
2. They are “exempt commodities”.
3. They should be offered by DCMs.
4. They should be offered by ECMs or by event derivative exchanges crowned with a “no-action” letter by the CFTC.

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They just say nothing.

See, HedgeStreet make a point that the CFTC should allow them to offer prediction markets on political elections to retail traders, but do not discuss the status of all the other prediction markets —and you’ve have seen that, in their concept release, the CFTC have mentioned many examples other than political elections.

What I’m trying to do this Sunday is to analyze their silence. Would that mean that HedgeStreet wouldn’t mind a dual decision by the CFTC —as long the first part of this dual decision consists in granting (maybe, non exclusively) to the DCMs the right to offer prediction markets on political elections?

In other words, if the CFTC makes HedgeStreet happy, can they, also, satisfy (even partially) the other people? (Some people are petitioning for the right to offer all kinds of prediction markets, but they would like to do that thru a ECM or a “no-action” letter.)

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UPDATE: See also the CME Group’s comment to the CFTC. – (PDF file)

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As you all know:

• The SEC regulates the securities markets (which support capital formation).
• The CFTC regulates the futures markets (which exist to discover prices).
• The SEC is rules based, meaning it sets regulations that institutions must follow, while the CFTC is principles based, in that it sets broad parameters under which the regulated entities try to operate.

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US Treasury’s Blueprint for a Modernized Financial Regulatory Structure (PDF file).

The United States has the strongest and most liquid capital markets in the world. This strength is due in no small part to the U.S. financial services industry regulatory structure, which promotes consumer protection and market stability. However, recent market developments have pressured this regulatory structure, revealing regulatory gaps and redundancies. These regulatory inefficiencies may serve to detract from U.S. capital markets competitiveness.

In order to ensure the United States maintains its preeminence in the global capital markets, the Department of the Treasury (“Treasury”) sets forth the aforementioned recommendations to improve the regulatory structure governing financial institutions. Treasury has designed a path to move from the current functional regulatory approach to an objectives-based regulatory regime through a series of specific recommendations. The short-term recommendations focus on immediate reforms responding to the current events in the mortgage and credit markets. The intermediate recommendations focus on modernizing the current regulatory structure within the current functional system.

The short-term and intermediate recommendations will drive the evolution of the U.S. regulatory structure towards the optimal regulatory framework, an objectives-based regime directly linking the regulatory objectives of market stability regulation, prudential financial regulation, and business conduct regulation to the regulatory structure. Such a framework best promotes consumer protection and stable and innovative markets.

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The CFTC is not that seduced by the idea (PDF file):

Statement of CFTC Acting Chairman Walt Lukken Regarding Department of Treasury’s Blueprint for Modernizing the Financial Regulatory Structure March 31, 2008 Washington, DC

Today, the U.S. Department of Treasury released a regulatory blueprint that includes recommendations to improve the U.S. financial regulatory structure with the goal of enhancing U.S. competitiveness in the global marketplace. Some of the proposals include recommendations related to combining the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). CFTC Acting Chairman Walt Lukken made the following statement in response to the blueprint:

It is essential to examine ways to enhance the competitiveness of U.S. financial markets and seek improvements to the regulatory structure. Policymakers all strive for good government solutions that protect the public, reduce duplication and enhance competition and innovation. While I am still studying the Blueprint’s many recommendations, I applaud Secretary Paulson and the Treasury Department for their work on this critical undertaking and for recognizing the CFTC model of regulation as an advantageous one.

The CFTC utilizes a flexible and risk-tailored approach to regulation aimed at ensuring consumer protection and market stability while encouraging innovation and competition. [*] Congress gave the CFTC these powers with the passage of the Commodity Futures Modernization Act (CFMA) in 2000, which shifted the CFTC’s oversight from a rules-based approach to one founded on principles. This prudential style is complemented by strong enforcement against market abuse and manipulation as evidenced by the $1 billion worth of penalties assessed by the CFTC since the CFMA. [**] The regulatory balance fostered by the CFMA has enabled the futures industry to thrive and gain market share on its global competitors with volumes on the U.S. futures exchanges increasing over 500 percent since 2000. During recent economic stress, these risk-management markets have performed well in discovering prices and providing necessary liquidity.

Although the creation of a new unified regulator for securities and futures could bring efficiencies, the tradeoffs of such a significant undertaking should be weighed carefully given these turbulent economic times and the competitive global advantage currently enjoyed by the U.S. futures industry. The CFTC is a world-class regulator because of its focused mission, market expertise, manageable size, problem solving culture and global outlook—all of which may be jeopardized with the creation of a larger regulatory bureaucracy. Any regulatory reform effort must preserve the benefits of the CFTC’s principles-based model and recognize the distinct functions of the futures markets and mission of the CFTC.

Many of the benefits of a unified regulator can be immediately gained through enhanced coordination and information sharing between agencies. In fact, the CFTC and SEC recently signed a cooperation agreement aimed at addressing cross-agency issues, including the approval of hybrid products that may have otherwise fallen between our jurisdictional divide. These sorts of agreements should be given time to bear fruit. As Treasury recognizes in its Blueprint, the laws that govern the securities markets should be modernized similar to the futures laws before unification is contemplated to improve its chances of success. Unless the securities laws are first rationalized with those governing the futures markets, a merger may ironically make the U.S. futures industry less competitive globally and run counter to the explicit goal of this important endeavor. I look forward to working with policymakers to ensure that these issues are properly debated and addressed.

[*] Quite true.

[**] Which includes the fining of InTrade.

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CME Group

Chicago Tribune

The Wall Street Journal

Via mister Jason Ruspini

–> On Thursday, they sent out an e-mail to everybody saying that the two legacy websites will be closed just after the launch of the new website —that is, this Saturday, January 19, 2008.

–> Then, on Friday, they back-pedaled. The two legacy websites will remain on the Web for two short weeks. They call it a “grace period”.

–> Definitions of “grace” on the Web:

- (Christian theology) a state of sanctification by God; the state of one who under such divine influence; “the conception of grace developed …
- elegance and beauty of movement or expression
- seemliness: a sense of propriety and consideration for others
- a disposition to kindness and compassion; “the victor’s grace in treating the vanquished”
- (Greek mythology) one of three sisters who were the givers of beauty and charm; a favorite subject for sculptors
- a short prayer of thanks before a meal
- decorate: make more attractive by adding ornament, colour, etc.; “Decorate the room for the party”; “beautify yourself for the special day”
- (Christian theology) the free and unmerited favor or beneficence of God; “God’s grace is manifested in the salvation of sinners”; “there but for the grace of God go I”
- deck: be beautiful to look at; “Flowers adorned the tables everywhere”
–> wordnet.princeton.edu/perl/webwn