Friday, November 03, 2023

KalshiEX challenges CFTC’s denial of event contract listing

By Suzanne Cosgrove

KalshiEX LLC, a regulated designated contract market that offers event contracts, sued the Commodity Futures Trading Commission in federal court Wednesday, challenging the Commission’s September 2023 order that prohibits Kalshi from listing its controversial Congressional Control Contracts (KalshiEX LLC v. CFTC, November 1, 2023).

The court should vacate the CFTC’s order, Kalshi contended in its suit, because it exceeds the regulator’s statutory authority under the Commodity Exchange Act and is “arbitrary and capricious.”

A CFTC spokesman said Thursday that the Commission had no comment on the Kalshi lawsuit, and none of the CFTC commissioners had posted individual comments on the complaint as of press time.

In the disputed order, the CFTC noted that under CEA section 5c(c)(5)(C)(i), the Commission may determine that contracts in certain excluded commodities, as defined in CEA section 1a(19), are contrary to the public interest if they involve activity that is unlawful under any federal or state law, terrorism, assassination, war, gaming, or other similar activity determined by the Commission, “by rule or regulation, to be contrary to the public interest.”

Risks and rewards. Event contracts are financial instruments that entitle a purchaser to payment based on the occurrence or non-occurrence of a real-world event. Ideally, they could be used to mitigate the risk of an event that could have a strong economic or market impact, for example, if the Federal Reserve unexpectedly raised its benchmark interest rates by a full percentage point.

In its filing, Kalshi states it creates opportunities for individuals and small businesses to hedge risk in ways previously available only to large corporations using tailored products designed by investment banks.

Noting that “election outcomes have vast consequences for businesses and individuals,” Kalshi self-certified Congressional Control Contracts on June 12, 2023, and the CFTC initiated a review of the contracts on June 22, 2023.

“Those contracts do not involve unlawful acts, terrorism, assassination, war, or gaming,” Kalshi stated in its lawsuit.

But it’s the word “gaming” that is central to the CFTC’s argument against the listing and trading of the Congressional Control Contracts, something that Kalshi acknowledged is a sticking point for the regulator in its court filing.

Is it “gaming”? Payouts in the case of Kalshi’s political events contracts are contingent on whether a particular party will control the House of Representatives or the Senate on a particular date. The contracts are cash-settled, binary (yes/no) contracts based on the question: “Will the (chamber of Commerce) be controlled by (party) for (term)?” An absolute amount is paid to the holder of one side of the trade at the contract’s settlement, with no payment made to the counterparty.

As reported previously by Securities Regulation Daily, the CFTC’s states Congressional Control Contracts involve “gaming” because taking a position in the contracts would be staking something of value upon the outcome of a contest of others.

Further, “if trading in the Congressional Control Contracts were to be permitted, the Commission, as regulator of the markets in those contracts, would be required to investigate suspected manipulation in those markets,” the CFTC said. “By extension, the Commission could find itself investigating election-related activities—potentially including the outcome of an election itself.” “The prospect of the Commission assuming the role of an ‘election cop’ raises very serious concerns about the misalignment of such a role with the CFTC’s historic mission and mandate as established by Congress,” the order concluded.

A political event contract similar to Kalshi’s offering was available for trading by New Zealand-based PredictIt, which operated under a no-action letter issued in 2014 by the CFTC’s Division of Market Oversight. The CFTC withdrew its no-action relief in March 2023, asserting that the trading platform’s operator, Victoria University, had not operated its market in compliance with the terms of the relief.

PredictIt appealed the CFTC’s no-action letter withdrawal and continues to operate pending the outcome of the appeal.

The case is No. 1:23-cv-03257-JMC.