CFTC advisory warns against broad self-certification of event contracts

The Commodity Futures Trading Commission has warned prediction market operators, or designated contract markets (DCMs), that the self-certification of event contracts is becoming too broad, with licencees sometimes combining “potential contract variations into a single certification”.

In a staff advisory dated 24 July, the CFTC said that these “broad template certifications” can hamper the commission’s “ability to determine whether a DCM has supplied all information, explanation, and analysis required” under current regulations.

These broad swaths also call into question whether DCMs have “adequately evaluated the settlement methodology, data sources, and core-principles compliance of all permutations of the contract the DCM intends to list” of the contracts they seek to list.

The advisory was issued by the CFTC’s Division of Market Oversight, led by acting director Duncan Hennes. It is not considered binding and the notice says it reflects the views solely of the DMO and not the commission overall.

Self-certification is a staple of CFTC-regulated exchanges, and that has become perhaps their most controversial aspect when compared to state-regulated sportsbooks. Under state sports betting protocols, books must get prior approval for any new wagers or wager types, whereas CFTC-licensed prediction markets are considered self-regulatory bodies and can certify their own contracts so long as they satisfy CFTC requirements.

However, one section of the Commodity Exchange Act requires DCMs to adhere to a set of 23 distinct core principles. For instance, DCM Core Principle 3 stipulates that exchanges can only list contracts that are not readily susceptible to manipulation, an area that has garnered widespread media attention in recent months. CFTC-registered exchanges must follow the principles to maintain their registration.

Requirements for bulk self-certification

The notice issued last week hits on two points that have been central to prediction market controversies — rapid expansion and vague contract terms. In the last 18 months, the explosion of new contract types and scandals related to contract resolutions — such as the ouster of Venezuelan President Nicolas Maduro and the death of Iranian leader Ayatollah Ali Khamenei– have dominated headlines and lawsuits.

Hennes wrote to CFTC licencees that the current language allowing for bulk self-certification was implemented in 2011, at a time where interest rate swaps accounted for 77% of “the total outstanding notional value of over-the-counter swaps”. Certifying several contract types in one filing is easy with such markets because “they relied on identical pricing sources and methodologies”, he wrote. But today, new contract types related to elections, politics, sports and pop culture require more individualised submissions.

In order for a broad template self-certification to be considered valid, all of the individual contracts in the filing must satisfy the following:

• Each must centre around a valid commodity
• Each must centre around the same currency
• Each must feature an “identical pricing source, formula, procedure, and methodology for calculating reference prices and payment obligations;”
• Each must feature a “pricing source, formula, procedure, and methodology for calculating reference
  prices and payment obligations” identical to an existing, approved contract

Shifting goalposts and uncertain terms

One example that Hennes gave relates to soccer match contracts. When certifying a broad template for World Cup games, he wrote, DCMs could use one game as a representative for the entire tournament: “Will Mexico beat South Africa at the 2026 World Cup?”

But if a DCM wished to list contracts for the MLS Leagues Cup, it would have to use a different representative, as the MLS Cup features different rules and tournament layouts. The former contract for the World Cup offered a possibility for a draw, Hennes wrote, an option not available in the latter.

Issues regarding self-certification are the latest in a string of regulatory topics prediction markets are grappling with. In June, the CFTC released its first draft of a rulemaking proposal for prediction markets, which seeks to define key terms in the sector and clear up the various discrepancies regarding what types of contracts may be listed.

More robust guardrails?

The rulemaking proposal is broad in its treatment of sports-related contracts but aims to “establish a structured framework” for evaluating whether certain contracts involve an excluded activity and whether they are “contrary to public interest”.

The result of that rulemaking could, in turn, relate back to self-certification. For instance, Kalshi last December self-certified contracts on college athletes transferring to different schools using broad templates: “Will <player> enter/withdraw from the transfer portal in <time period>?” and another titled “Will <player> transfer to <team> in <time period>?”

Overall, last week’s advisory appears to be an effort by the commission to rein in some of the fast-paced growth that self-certification allows, which is somewhat contrary to the broad support the regulator has shown under the leadership of Chairman Michael Selig.

Under Selig, the CFTC has sued nine states to try and assert its regulatory jurisdiction over event contracts, as several states have tried to ban sports contracts or pass state-level prediction market legislation. Selig has asserted several times that sports events constitute legitimate economic hedging opportunities that prediction markets can facilitate.