Will SCOTUS take up prediction markets case after CFTC issues proposed rules on swaps?

With divergent opinions on the jurisdiction for sports event contracts, a battle for the future of the burgeoning industry may eventually head to the US Supreme Court.

As industry stakeholders await the court’s move, several circuit decisions have further contextualised the legal interpretation of a swap, which has received polarised judicial analysis. Before the nation’s highest court decides whether to take up the case, a federal regulator on derivatives released new proposed rules broadening their definition of swaps. The proposal, released last Friday, provides the latest twist in the intense battle on the future of the multibillion-dollar industry.

Amid contentious debate on whether event contracts qualify as sports wagers, the US Commodity Futures Trading Commission released a notice of proposed rulemaking on 9 October, hours before the start of a busy football weekend. Although the CFTC has historically recognised that most event contracts are covered within the Commodity Exchange Act, the agency seeks to expand the definition of swaps even further. Under the new definition proposed last week, the Commission expressly defines swaps to include event contracts based on sports, politics, cultural and weather-related events.

“Americans use event contracts to hedge risks, speculate, and provide the public with information about the outcome of future events,” said CFTC Chairman Michael Selig, in a statement. “These products are commodity derivatives squarely within the CFTC’s regulatory remit under the Commodity Exchange Act and are within the agency’s exclusive jurisdiction.”

A circuit split

Traditionally, a swap is viewed as a transaction that’s dependent on an event occurrence with “financial, economic or commercial” consequences. Under the Dodd-Frank Act, Congress defined a set of “core prongs” for swaps covered under the CEA. The so-called “non-securities swaps” exclude securities-based swaps that are governed by the SEC.

The CFTC received a favourable decision from the US Court of Appeals for the Third Circuit in April. In that decision, the Third Circuit ruled that sports event contracts could be classified as swaps through the CEA. The majority in KalshiEX LLC v. Flaherty held that their outcomes are tied to possible commercial or economic consequences.

The CFTC cited the ruling numerous times in the proposed rules. There, the commission wrote that the Third Circuit expressly endorsed the district court’s identification of the broad range of economic stakeholders, including sponsors, advertisers, television networks, franchises and communities whose financial interests are directly affected by sporting event outcomes.

In one example, Madison Square Garden Sports’ valuation nearly doubled amid the New York Knicks’ NBA championship run. In addition, the playoff frenzy generated about $380 million for the Big Apple economy, according to the commission.

To date, it doesn’t appear that a municipality has hedged the cost of a championship parade with an event contract.

The Third Circuit ruling contrasts with an August decision from the Ninth Circuit. In that decision, the appellate court found that Kalshi’s sports event contracts do not qualify as swaps. In ruling for the majority, US Ninth Circuit Judge Ryan Nelson indicated that courts should view event contracts as sports wagers, not risk-transfer financial instruments.

Casino games exempt from proposed rules

Separately, the Sixth Circuit ruled that even if event contracts qualified as swaps, the derivatives don’t preempt sports gambling laws. Historically, a circuit split on the appellate level increases the likelihood that the Supreme Court will take up a case.

One section that bears watching centres on a provision that excludes casino-style games from the definition of a swap. The designation should appease pro-casino advocates who expressed concern that the proliferation of event contracts could create a slippery slope. Earlier this year, stakeholders appeared incensed that traditional games such as blackjack could morph into event contracts.

In an 11 October note, Citizens wrote that it is unlikely Kalshi and Polymarket will begin offering casino-style games. As a result, those games will not be a “base-case concern” for investors, analyst Jordan Bender added.

The contentious battle on the jurisdiction of the derivatives may represent the sports betting industry’s most bitter dispute since PASPA. The contracts are responsible for more than $1 billion in lost state tax revenue, according to the American Gaming Association.

At the AGA’s Global Gaming Expo, Nevada Gaming Control Board Chairman Mike Dreitzer questioned the legality of the contracts. At the same time, Dreitzer accused prediction markets of engaging in deceptive conduct.

“All we as regulators ask for is a level playing field,” he said.

The CFTC will publish the proposed rulemaking in the Federal Register. Upon publication, the public should submit all comments within a period of 30 days, according to the CFTC.