Securities Regulation Daily Game not over? CFTC’s Berkovitz indicates concerns with proposed NFL futures contracts are narrow, not absolute
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Wednesday, April 7, 2021

Game not over? CFTC’s Berkovitz indicates concerns with proposed NFL futures contracts are narrow, not absolute

By Lene Powell, J.D.

As legal sports betting spreads rapidly, an exchange moved to list futures contracts based on NFL games. But according to Commissioner Berkovitz, while not inherently off limits, the contracts had fatal flaws as proposed.

It might one day be possible to trade futures contracts based on aspects of NFL games. But according to CFTC Commissioner Dan Berkovitz, to satisfy the CFTC that such contracts would be appropriate, an exchange would have to show that the contracts had a legitimate economic purpose, and would have to make the contracts available to the public, not limit them to institutional users. If an exchange made these changes, such contracts would not be against the public interest, said the commissioner.

The commissioner released a statement explaining his position as part of a volley with fellow Commissioner Brian Quintenz over a proposed order that never became final, after the exchange involved withdrew its proposed contracts. But the issue could resurface if exchanges move to list similar contracts in the future.

Self-certification of NFL contracts. In December 2020,Eris Exchange, LLC (ErisX) self-certified three RSBIX NFL futures contracts for listing on the exchange, based on moneyline, point spread, and total points for individual NFL games. The CFTC announced that it was initiating a review of the contracts. The CFTC opened the matter for public comment and asked questions for consideration.

In March 2021, Commissioner Brian Quintenz issued a statement announcing that ErisX had withdrawn its self-certification before the CFTC issued a final order, apparently upon learning that the CFTC intended to prohibit the contracts. Quintenz said he would have dissented from the order. In his view, the contracts had a legitimate economic purpose, and the CFTC’s proposed order was arbitrary and capricious. More broadly, he believes that the Commodity Exchange Act provision and CFTC regulation providing for CFTC prohibition of certain contracts are unconstitutional delegation of legislative powers to the CFTC.

Berkovitz’s concerns. Although the order was never finalized because ErisX withdrew its self-certification, Berkovitz said it might be helpful to provide his views because ErisX has publicly indicated they might re-file another certification and the proposal received public comment.

Berkovitz emphasized that his concerns with the contracts are not because they involve gaming. In his view, contracts involving gaming should be permitted to be traded on a designated contract market (DCM) if they have an economic purpose, which may include hedging by sports bookmakers. Rather, he believes the self-certification was faulty because ErisX did not provide sufficient evidence of hedging utility, and because the proposed exclusion of the general public from trading the contracts would violate core principles involving impartial access and antitrust considerations.

Gaming is OK, but do the contracts have an economic purpose? According to Berkovitz, sports betting has expanded rapidly since 2018, when the Supreme Court decision in Murphy v. NCAA struck down the federal law that severely limited legal sports betting. Since 2018, half of the states and the District of Columbia have legalized sports betting, and more are considering doing so. Morningstar projects that in 2024, the aggregate amount of legal sports betting in the U.S. will reach $81 billion.

As a result, it would not be contrary to the public interest for the Commission to allow the listing of sports event contracts, as long as an exchange can demonstrate that the contracts will be used to hedge commercial risks arising from lawful commercial activity related to sports betting, said Berkovitz. However, Eris did not demonstrate this, in Berkovitz’s view.

ErisX said the contracts would allow licensed sportsbooks to manage commercial risk by hedging their exposure to imbalances in their books, and were tailored to address the "unique risks" of licensed sportsbooks. ErisX also suggested that vendors and stadium owners could use the contracts to hedge commercial risks that depend on attendance at football games.

But the American Gaming Association (AGA), which represents licensed sportsbooks, cast doubt upon the utility of the contracts, said Berkovitz. The association said the proposed contracts "pose complex legal and policy questions," and some AGA members believe the proposed contracts will have limited utility for their individual operations. Moreover, ErisX did not show evidence that the contracts could be used to hedge the non-gaming economic consequences arising from the outcomes of NFL games, such as changes in revenue for in-stadium and other vendors, said Berkovitz. As a result, he did not think that ErisX had made its case.

Impartial access and antitrust. In addition to the economic purpose issue, Berkovitz had serious concerns about another aspect of the proposed contracts. ErisX proposed to limit trading in the contracts to commercial market participants seeking to hedge their cash market exposure and designated market makers. As a result, retail traders would not be able to trade the contracts.

Lack of retail access was a problem for two reasons, said Berkovitz. First, it violated Core Principle 2 for DCMs, relating to impartial access. Berkovitz noted that the exclusion of retail traders was unprecedented. As to the best of his knowledge, no DCM has ever prevented retail customers from trading a contract competitively on a DCM. Exclusion of individuals who are not eligible contract participants (ECPs) is the very kind of discrimination based on net worth that the Commission has prohibited, said Berkovitz. He added that if ErisX applied its access criteria in a truly non-discriminatory manner, all other persons "seeking to profit based on the outcome of sporting events" also would not be able to trade the contracts, and there would be nobody left to trade.

Second, the limitation violated Core Principle 19, relating to antitrust considerations. In Berkovitz’s view, the sports betting market as envisioned by ErisX would be anticompetitive, because it would protect the bookmakers from competition by members of the public and non-market making ECPs. Sports bookmakers could trade amongst themselves to swap their risks and together balance their books, while preserving their exclusive ability to provide sports event contracts to the public. This would prevent retail participants from benefitting from exchange-based prices that would more accurately reflect the market’s assessment of the probability of an event, rather than the odds dictated to the customer by a bookmaker. Moreover, the price discovery process on the exchange would be transparent, and the bid/ask spread on the exchange would likely would be smaller than the commission or "vig" charged by the bookmakers. Thus, the proposed restrictions were anticompetitive and harmful to retail market participants.

"The contracts proposed by ErisX would be a no-lose situation for the bookmakers, and a no-win situation for the public," said Berkovitz.

Conclusion. Berkovitz summed up by reiterating that gaming contracts with no economic purpose should not be permitted on a DCM. If gaming contracts with an economic purpose are listed on a DCM, then the public must have access. If not—no dice.

MainStory: TopStory CommodityFutures Derivatives ExchangesMarketRegulation Swaps

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