The SEC may get involved as prediction market bring new contracts

The Commodity Futures Trading Commission has been the lead regulator of event contract exchanges for more than 30 years, after issuing a 1992 decision on the Iowa Electronic Markets, widely considered the first prediction market.

Now, as prediction markets boom, legal experts increasingly speculate that the U.S. Securities and Exchange Commission, the CFTC’s sister agency, will soon have a role to play in this new asset class.

“The CFTC has stated that they have jurisdiction over event contracts, but some of them also appear to be more within the purview of the SEC,” said Joe Zales, a partner at King and Spalding.

This question is not just a hypothetical: it is a question that two agencies are currently working on.

Last month, the SEC and CFTC filed a joint request. public comment It is about updating, clarifying and harmonizing certain definitions and issues. Topics they examine include definitions of swaps (the derivative into which event contracts are classified) and the issue of “new or emerging products.”

A spokesperson for prediction market platform Polymarket confirmed to CNBC: The company has contacted both the CFTC and the SEC regarding definitional frameworks for prediction market products. Rival platform Kalshi declined to comment on whether it had engaged with agencies on this matter.

Some companies already use the SEC as a starting point for event contracts. CBOE in an application Seeking to operate within the SEC’s regulatory orbit to create binary options contracts on key performance indicators for a number of large companies.

The jurisdictional issues that exist between the SEC and CFTC are not new, especially when it comes to emerging asset classes. However, although the two institutions have been in a similar position before, this does not provide much direction in this regard.

“This is truly a jump shot,” said Jeff Le Riche, Husch is a partner at Blackwell and former lead trial attorney for the CFTC. “No one knows how it will turn out.”

SEC’s potential

It is thanks to the 2010 Dodd-Frank law that the SEC may have a role in regulating prediction markets, although it does not currently have one. The law says that while the CFTC generally regulates swaps, the SEC has jurisdiction over security-based swaps.

Security-based swaps are financial contracts linked to a single security. If an event contract asks about a publicly traded company, it may look more like a security-based swap rather than a traditional swap.

An easy example, according to legal experts, is a contract that asks merchants: “ Nvidia Has the stock increased by more than 5% at the end of the month?” This has a direct connection to a publicly traded stock, and the prediction market’s solution depends on the performance of the shares.

But where things get even more complicated is that security-based swaps are also defined as financial contracts that directly affect a company’s financial statements or conditions.

“The problem is, what ‘direct influence’ means is really an open question,” said Sarah Razaq Sallis, a partner at Husch Blackwell. he said. “This uncertainty is exactly what is being tested in real time right now.”

Take, for example, a contract about when to do it. Apple will launch the new iPhone model. This isn’t directly tied to the company’s share price, but the launch of a highly anticipated product could impact Apple’s shares.

Whether this contract will be a security-based exchange will determine how big a role the SEC will potentially play.

The SEC declined CNBC’s request for comment, while the CFTC did not respond.

A complicated history

The SEC and CFTC’s separation of studies on prediction markets is certainly unprecedented.

In the options market, the CFTC regulates options based on futures contracts, while the SEC regulates those based on securities.

But despite instances of the two working together, the sister agencies have had a decades-long rivalry over who is in charge of what.

“These agencies are at each other’s throats in jurisdiction,” said Jerome Tomas, a partner at Baker McKenzie and a former SEC employee. Recently, the SEC and CFTC – before this year’s harmonization efforts – clashed The person who has jurisdiction over cryptocurrencies.

This is not to mention that the two agencies operate differently. The SEC is much larger and has a longer history, while the CFTC is smaller and younger.

“Although the two institutions are structurally similar, they have very different approaches to regulation,” Le Riche said. “The way the rules are written at the CFTC and the way the rules are written at the SEC are fundamentally different approaches.”

In March, the two agencies announced they had reached an agreement. memorandum of understanding Establishing clear regulatory definitions and limits of authority, as well as ensuring coordination on inspection and increasing data sharing. Experts are now monitoring whether the two agencies can work together smoothly despite past regulatory battles.

“I think they’re trying to make sure they’re not stepping on each other’s toes or trying to copy the business,” said Yelena Kotlarsky, a partner at King and Spalding.

Aaron Klein of the think tank Brookings Institution said this is an opportune time for the two Republican-dominated institutions to collaborate. Both institutions require a five-person board of commissioners but currently have vacancies.

Only three of the five commissioners at the SEC currently sit, and all of them are Republicans. Meanwhile, CFTC Chairman Michael Selig, also a Republican, is the only member who typically sits on the five-member board. Selig previously served as general counsel to the SEC’s Crypto Task Force and was a senior advisor to SEC Chairman Paul Atkins.

“I think this is the easiest time for these two agencies to get on the same page,” Klein said.

More clarity, tighter protocols

Legal experts generally say the SEC will likely take a more supportive role in regulating prediction markets, while the CFTC will retain its primary role. This could be welcome news for platforms that previously had to interact with a single federal agency.

Baker McKenzie partner and former SEC employee Peter Chan said harmonization would be a benefit for prediction markets if the two agencies can avoid a repeat of past regulatory disputes and provide clear definitions.

Kalshi is the largest regulated prediction market in the US; Polymarket, on the other hand, derives most of its volume from the international stock market. Polymarket’s US platform became available to domestic traders in May.

The Polymarket spokesperson added that the company is concerned about possible duplicate or conflicting compliance requirements, which could harm innovation. Therefore, the willingness of institutions to work together to create efficient and harmonious structures is encouraged.

Troy Dixon, co-head of global markets Tradeweb Markets A market infrastructure company that has a partnership with Kalshi said getting clarification from the two institutions is critical for institutions looking to trade in prediction markets. Driving Wall Street adoption has been a key priority for prediction market platforms lately.

“As long as the SEC actually comes on board and there is some sort of broad collaborative effort between the two agencies…that would accelerate this quite significantly,” Dixon said of corporate adoption.

Zales thinks the SEC’s involvement could mean tighter protections for investors, including a more cumbersome account opening process on prediction market platforms.

Chan believes that although the legal picture is murky, institutions should not move too quickly to adapt. Instead, he said, agents should take the necessary time to understand the markets and products offered on event contract exchanges.

“I think it’s not necessarily real-time rule making that’s required, but I think it does require real-time learning,” Chan said.

Disclosure: CNBC and Kalshi have a business relationship that includes customer acquisition and minority investment.