The CFTC safe-harbor option for event markets

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The recommendation for safe-harbor of a group of influential economists to the CFTC aims squarely at the 4(c)3(K)* clause of the Commodity Exchange Act. The CFTC may approve a public interest exemption under 4(c) provided that the affected contracts are traded only between &#8220-appropriate persons&#8221-. 4(c)3(k) is the only qualification that would accommodate &#8220-retail&#8221- trading in the style of IEM, allowing, &#8220-Such other persons that the Commission determines to be appropriate in light of their financial or other qualifications, or the applicability of appropriate regulatory protections.&#8221- Regarding &#8220-other qualifications&#8221-, the economists recommend:

&#8220-that three types of entities be eligible for safe harbor treatment. The first would be not-for-profit research institutions, including universities, colleges, and think tanks wishing to operate exchanges similar to the Iowa Electronic Markets. The second would be government agencies seeking to do research similar to that of nongovernmental research institutions. The third group would consist of private businesses and not-for-profits that are not primarily engaged in research, which would only be allowed to operate internal prediction markets with their employees or contractors.

Regarding the applicability of regulatory protections, the economists recommend that such markets should be limited to small-stakes, low-fee contracts. This limitation addresses consumer protection because the CFTC is typically much less interested in non-levered transactions, and there is little chance of being able to manipulate a market with a small-stakes account. Possibly, consumer protection measures could completely satisfy 4(c)3(K).

The safe-harbor proposal looks like an expedient option that would avoid the problems of treating event markets as excluded commodities (or exempt commodities), which were touched on last time. One problem the CFTC faces is selecting a principle that would include only markets that pass an economic purpose test within their jurisdiction, and the safe-harbor proposal avoids this problem. Although there doesn&#8217-t seem to be anything in the CEA to indicate that an exempted market could possibly lie outside the agency&#8217-s jurisdiction, Congress has determined – significantly – that, &#8220-Rather than making a finding as to whether a product is or is not a futures contract, the Commission in appropriate cases may proceed directly to issuing an exemption.&#8221-

Arguably, if someone were to set-up non-profit small-stakes exchanges similar to the ones the economists describe, they would not need CFTC safe-harbor anyway – especially if they restrict trading to States where the predominant factor test applies. Safe-harbor would, however, allow for exchange profits.

I believe that a combined approach would work best. Treating event markets as excluded commodities would not contradict granting some exchanges public interest safe-harbors, which would especially be appropriate if they wanted to host markets like research science claims, where a trader might be in control of the outcome. Exchanges seeking to host larger stake markets useful for hedging could do so with a trading prohibition for people who might be in control of the outcome. From the CFTC&#8217-s perspective, the safe-harbor would be a less complicated option with regard to their jurisdictional scope. Ultimately, statutory clarification is needed.

* This section is listed as USC Title 7, Chapter 1 6(c) here.

Cross-Posted from RM&amp-P


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Freakonomics, the famous blog on economics, is powered by WordPress, which is known [*] to have grave security vulnerabilities. Yesterday, a dangerous hacker managed to get access to their blogging software, and published an opinion on the regulation of prediction markets, which represents the total opposite of what Steve Levitt believes in. No doubt the hacker (who signed as &#8220-The Australopithecus&#8220-) will get caught by the Police. No doubt Steve Levitt will get out of his torpor soon and re-establish the truth. We will then give airtime to Steve Levitt&#8217-s arguments, on Midas Oracle. We&#8217-re with you, doctor Levitt.

[*] I know that for a fact. Midas Oracle was hijacked yesterday by a dangerous hacker who signed as &#8220-The Barbecue&#8221-. I&#8217-m not responsible for what he said.

Robin Hanson wants to rule the world -just as CEOs and heads of states do for a living.

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Our Master Of All Universes moans that the Free World&#8217-s private and public decision makers rarely or never ask him for advice &#8212-even though he sits on many &#8220-Boards Of Advisors&#8221- (like NewsFutures&#8216- one), which are, by definition, set up to provide advice &#8212-or so he thought, at inception. How come CEOs and heads of states are not imploring him for advice to help them run the word, he asks. He blogs that advisers are probably paid primarily for the prestige value that they lend to the company.

Which leads me to realize that I pay zero French franc for having economist Michael Giberson on our Scientific Advisory Board, which is quite about what his prestige is worth in the field of prediction markets, as of today. :-D That might change in the future, though &#8212-especially if I continue to flatter him publicly in posts like this present one. He might suffer from ego inflation and charge me for using his so-called &#8220-prestige value&#8221-. All economists, be damned. They are as greedy as the people they study.