CFTC: Sports Contracts ‘Based On Actions Of Single Individual’ May Be Manipulation Risk

The Commodity Futures Trading Commission (CFTC) is warning prediction markets that some event contracts, such as sports contracts “based on the actions of a single individual or small group,” may be susceptible to manipulation.

The CFTC’s Division of Market Oversight (DMO) put out an “advisory” on prediction markets Thursday, which it said existed to remind exchanges “of their regulatory obligations pursuant to the Commodity Exchange Act and Commission regulations.”

Alongside the advisory, the CFTC published an “Advanced Notice of Proposed Rulemaking” for prediction markets, including more than 150 questions about different rules that prediction markets face.

DMO warns on manipulation risks

In the advisory, the DMO noted that exchanges have to abide by 23 core principles, including one that says they may list “only contracts that are not readily susceptible to manipulation.”

It noted that there might be “certain categories of event contracts” that “create a heightened potential for manipulation or price distortion.”

“For example, in the context of sports-related event contracts, such contracts could involve those that resolve or settle based on injuries to individual sports participants, unsportsmanlike conduct, or physical altercations between sports participants, as well as contracts that resolve or settle based on the action of a single individual or a small group of individuals, such as officiating actions occurring during a sporting event,” it said.

CFTC-registered prediction markets do not currently offer trades on the actions listed. The examples given did not specifically mention player props on traditional statistics like points or yardage, though these would also seem to be heavily based on the actions of one individual.

It went on to say that sports contracts related to the performances of multiple players over a longer period of play are less likely to be manipulated.

“Sports-related event contracts and event contracts more generally have often been shown to be consistent with DCM Core Principle 3 where the settlement outcome depends on the aggregate performance of multiple participants over an extended period of play,” it said. “The breadth of the outcome, in the typical case, reduces the ability of any single actor to manipulate the settlement value without material cost or substantial risk of detection.”

The DMO’s advisory added that exchanges should consider “the nature and sources” of data that is used to resolve contracts in order to ensure that it is reliable and can’t be manipulated.

CFTC actively working with leagues

The DMO added that exchanges should work more with leagues, and said that the CFTC “is actively discussing issues of settlement integrity with some relevant sports leagues and their governing bodies and foresees that appropriate information sharing by these entities with the CFTC may lead to enhanced CFTC oversight capabilities.”

It recommended that exchanges communicate with leagues before self-certifying contracts, in order to improve market oversight, establish information sharing with leagues, and rely on official data.

“DCMs are also encouraged to look to, among other items, any league integrity standards or guidance around markets, contracts, and restricted or insider participants lists, in order to protect against manipulation and insider trading, and to protect the integrity of the relevant league or governing body, as applicable, and the sporting events which it administers,” the advisory said. “DMO staff also recommends that DCMs cooperate with any league-run investigations into potential manipulation or insider trading investigations.”

The advisory also warned against “overly broad” self-certifications. 

Though there are other methods of listing contracts, in practice, all prediction market contracts are self-certified, meaning that an exchange tells the CFTC that it plans to list a new type of contract, and provides certain details such as the applicable rules. If the CFTC does not object before the listing date specified, the contract may be listed, though it is not technically considered “approved.”

Exchanges typically provide a template contract name in a self-certification, such as “Will <team> win <football game>?” 

The DMO noted that if a self-certification encompasses too many different types of event, the exchange should account for that in its filing by explaining what data it will use and how it will abide by CFTC core principles for each type of contract that could be offered under the same filing.

“DMO staff would expect a product submission to include, among other things, a description of the settlement methodology that accounts for differing potential permutations of the contract, including identification of the specific data source(s) on which settlement will be based, and an assessment of the reliability, objectivity, and manipulation resistance of such sources,” it said. “DMO staff recommends proactive engagement with DMO staff when designing contracts with multiple possible permutations.”

CFTC asks questions in proposed rule advisory

The CFTC also issued an advisory as it prepares to issue new rules that will govern prediction markets.

Interested parties will have 45 days to respond to the notice. 

The notice includes fairly open-ended questions about virtually every rule that affects prediction markets, making it hard to discern exactly what the new rules might look like.

It included several questions about contracts involving gaming, war, terrorism, or assassination, and might have suggested a willingness to allow certain contracts on the latter three of those topics.

CFTC rules reference a “prohibition” on these categories, but in practice the regulator has treated the topic more like a “two-part test,” where it can allow these contracts if it believes they are within the public interest.

The notice suggested the commission’s stance is that it has the ability to ban contracts on those topics for being against the public interest, but is not required to do so, as it referenced the idea of the regulator making “public interest determinations” on contracts. 

The advisory asked questions such as “What public interest factors should the Commission consider for event contracts involving terrorism or assassination?” and asked a similar question for war, suggesting that there was room for a contract to involve terrorism, assassination, or war but still be within the public interest. 

It also asked about the exact definitions of these terms, noting that there could be debate on the lines between civil unrest and war, or cyberattacks and terrorism.

With regard to gaming, it asked, “What factors should the Commission consider in determining the scope and public interest implications of this activity?”

Other questions in the advisory included whether trading on margin should be allowed, and if so what kind of market participants should be allowed to trade on margin and what rules should govern the practice.

It also asked more questions about what it should mean for a contract to not be readily susceptible to manipulation, and what exchanges can do to prevent manipulation.