CFTC Draws the Line Between Event Contracts and “Casino-Style Gambling Products”

The Commodity Futures Trading Commission (CFTC or the Commission) has moved to clarify and codify the distinction under the Commodity Exchange Act (CEA) between federally regulated event contracts and gambling products traditionally overseen by state and tribal authorities. Following conflicting federal appellate decisions concerning whether sports-related event contracts are swaps, the CFTC has taken two coordinated actions. It has adopted an interim final rule excluding certain “casino-style gambling products” from the CEA’s definition of “swap,” while separately proposing that event contracts based on sports, politics, culture and weather are within the definition of “swap.”¹

The paired actions could strengthen the CFTC’s position that event contracts traded on registered derivatives exchanges differ from sportsbook wagers and casino games, even when the products refer to similar underlying events. They also explain how the Commission has coordinated with the Securities and Exchange Commission (SEC) and the Board of Governors of the Federal Reserve System in exercising its authority to further define “swap.”

What Qualifies as a “Casino-Style Gambling Product”?

The interim final rule excludes a transaction from the swap definition when it satisfies two conditions.

First, under the Provider Test, the product must be offered by a person authorized under state or tribal law to offer gambling or gaming products or accept wagers. The provider must act within the scope of that authorization, and the transaction must be regulated as gaming or gambling under the applicable law.²

Second, under the Product Test, the transaction cannot be traded on a board of trade, organized exchange, swap execution facility or another market where trades are executed multilaterally or individually negotiated. A sportsbook wager offered by the house on standardized terms would generally satisfy the test. A competitively priced contract traded among multiple buyers and sellers on a designated contract market would not.³

The CFTC reasons that the distinction between these products turns on their market structure.  Traditional wagers are generally bilateral transactions between the house and its customer, with odds established by the house. Event contracts are traded on registered exchanges at prices generated through competing bids and offers, with the exchange acting as a neutral venue. Further, event contracts traded on designated contract markets are centrally cleared through CFTC-registered clearinghouses.⁴

The interim rule states that such products require a separate facts-and-circumstances analysis.⁵

The Other Side of the Line: Event Contracts as Swaps

In its companion proposal, the CFTC would amend its regulations to expressly identify event contracts as swaps, including contracts based on sports, political, cultural and weather-related events.⁶ This is consistent with the CFTC’s longstanding treatment of event contracts as derivatives subject to its plenary jurisdiction.⁷ The Commission argues that these instruments qualify as swaps because they are commonly known to the derivatives trade as swaps, often structured as binary options and provide for payment based on an event associated with a potential financial, economic or commercial consequence.⁸ The Commission reads “potential” broadly, requiring only that an event be capable of producing financial, economic or commercial consequences. Weather can affect agriculture and energy use, for example, while sports outcomes can affect ticket sales, broadcasting, sponsorships and local businesses.⁹

These actions respond to divergent appellate decisions concerning whether sports-related event contracts qualify as swaps. The Third Circuit concluded that the contracts at issue likely qualified as swaps, while the Sixth and Ninth Circuits concluded that the contracts before them likely did not.¹⁰ The terminology “likely” or “likely did not” reflects the preliminary-injunction posture of those cases: the courts considered whether the prediction markets had demonstrated a likelihood of success on the merits, rather than finally deciding whether the contracts qualify as swaps under the CEA. The CFTC’s interim final rule attempts to address the distinction between event contracts and “casino style gambling products” by treating the venue, provider, method of price formation and regulatory structure as legally meaningful distinctions.

Joint Rulemaking and Agency Coordination

Section 712(d)(1) of the Dodd-Frank Act directs the CFTC and SEC, in consultation with the Federal Reserve Board, to jointly further define “swap.” Section 712(d)(2)(A) similarly authorizes the two commissions to jointly adopt other rules concerning that definition.¹¹

The interim final rule expressly addresses these requirements by stating that the SEC joins in adopting the exclusion and that the CFTC consulted with the Federal Reserve Board.¹² The companion proposal similarly acknowledges the joint-rulemaking requirement and notes the CFTC consulted with the Federal Reserve Board.¹³

Both actions have 30-day comment periods after publication in the Federal Register.¹⁴