Building Exits into CFTC Regulation

Much of my draft paper, Private Prediction Markets and the Law, focuses on nuts-and-bolts fixes for the legal uncertainty that currently afflicts private prediction markets under U.S. law. I’ll say more about those in later posts to Agoraphilia and Midas Oracle. The paper also dicusses a more theoretical and general issue, though: The benefits of designing regulatory schemes to include exit options.

The Commodity Futures Trading Commission recently issued a request for comments about whether and how it should regulate prediction markets. In earlier papers, I explained why the CFTC cannot rightly claim jurisdiction over many types of prediction markets. I recap that view in my most recent paper, but add some suggestions about how the CFTC might properly regulate some types of prediction markets. In brief, I suggest that the CFTC build exit options into any regulations it writes for prediction markets, allowing those who run such markets the same sort of freedom of choice that U.S. consumers already enjoy, thanks to internet access to overseas markets like Intrade, with regard to using prediction markets. Here’s an excerpt from the paper:

Those practical limits on the CFTC’s power should encourage it to write any new regulations so as to allow qualifying prediction markets to operate legally, and fairly freely, under U.S. law. . . . Ideally, the CFTC would offer prediction markets something like these three tiers, each divided from the next with clear boundaries.

• Designated Contract Markets. Regulations designed for designated contract markets, such as the HedgeStreet Exchange, would apply to retail prediction markets that offer trading in binary option contracts and significant hedging functions.

• Exempt Markets. Regulations for “exempt” markets, which impose only limited anti-fraud and manipulation rules, would apply to prediction markets that:
  • offer trading in binary option contracts;
  • thanks to market capitalization limits or other CFTC-defined safe harbor provisions do not primarily support significant hedging functions; and
  • offer retail trading on a for-profit basis.
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