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

The Commodity Futures Trading Commission (CFTC) 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 on whether sports-related event contracts are swaps, the CFTC took two coordinated actions: it adopted an interim final rule excluding certain "casino-style gambling products" from the CEA definition of "swap," while separately proposing that event contracts based on sports, politics, culture and weather fall within the definition of "swap." The interim final rule excludes a transaction from the swap definition when it satisfies two conditions: the Provider Test, requiring the product be offered by a person authorized under state or tribal law to offer gambling or gaming products or accept wagers acting within the scope of that authorization and regulated as gaming or gambling; and the Product Test, requiring that 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. The CFTC reasons that the distinction turns on market structure, since traditional wagers are generally bilateral transactions between the house and its customer with odds set by the house, while event contracts trade on registered exchanges at prices generated through competing bids and offers, with the exchange acting as a neutral venue, and are centrally cleared through CFTC-registered clearinghouses. 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, consistent with its longstanding treatment of event contracts as derivatives subject to its plenary jurisdiction. The Commission argues these instruments qualify as swaps because they are commonly known in 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, reading "potential" broadly to require only that an event be capable of producing such consequences. These actions respond to divergent appellate decisions, as the Third Circuit concluded the contracts at issue likely qualified as swaps while the Sixth and Ninth Circuits concluded those before them likely did not, with the terminology reflecting the preliminary-injunction posture of those cases rather than a final decision under the CEA. The interim final rule attempts to address the distinction by treating the venue, provider, method of price formation and regulatory structure as legally meaningful distinctions. On joint rulemaking, 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," and the interim final rule states that the SEC joins in adopting the exclusion and that the CFTC consulted with the Federal Reserve Board, with the companion proposal similarly acknowledging the joint-rulemaking requirement. Both actions have 30-day comment periods after publication in the Federal Register.

(Source：National Law Review)