As prediction markets boom, questions arise over who will be the watchdog
As new contract types are introduced, prediction markets may have to work under two regulatory bodies.
As new contract types are introduced, prediction markets may have to work under two regulatory bodies.
The Commodity Futures Trading Commission has been the lead regulator on event contract exchanges for over 30 years after it issued a 1992 ruling on the Iowa Electronic Markets, widely recognized as the first prediction market .
Now, as prediction markets are booming , legal experts increasingly speculate the CFTC's sibling agency — the U.S. Securities and Exchange Commission — will have a role to play soon in this novel asset class.
"The CFTC has come out saying that they have jurisdiction over the event contracts, but there's also some that seem like they're more in the SEC's realm," said Joe Zales, a partner at King and Spalding.
This question isn't just a hypothetical: it's one that the two agencies are currently sifting through.
Last month, the SEC and CFTC issued a joint request for public comment regarding updating, clarifying and harmonizing certain definitions and issues. Included in the topics they're reviewing are definitions related to swaps — the derivative that event contracts are classified as — along with the treatment of "novel or emerging products."
A spokesperson for prediction market platform Polymarket confirmed to CNBC that the company has engaged with both the CFTC and SEC regarding definitional frameworks for prediction market products. Rival platform Kalshi declined to comment if it has interacted with the agencies or not on this matter.
Some companies are already using the SEC as the launching pad for their event contracts. CBOE in a filing is seeking to operate in the SEC's regulatory orbit for creating binary options contracts on key performance indicators for a slew of major companies.
Jurisdictional questions existing between the SEC and CFTC aren't new, especially when it's about emerging asset classes. But while the two agencies have been in a similar position before, that doesn't provide much direction on this issue.
"This is really a jump ball," said Jeff Le Riche , a partner at Husch Blackwell and a former chief trial attorney at the CFTC. "Nobody knows how it's going to turn out."
Why the SEC may have a role in regulating prediction markets — despite not having one at the moment — is thanks to the 2010 Dodd-Frank law. The law says that while the CFTC typically regulates swaps, the SEC has jurisdiction over securities-based swaps.
Securities-based swaps are financial contracts that have ties to a singular security. If an event contract asks questions about a publicly traded company, that may look more like a securities-based swap rather than a traditional one.
An easy example of this, according to legal experts, is a contract that asks traders, "Will Nvidia stock end the month up more than 5%?" That has a direct link to a publicly traded stock and the resolution of the prediction market depends on the shares' performance.
But where it gets more complicated is that securities-based swaps also are defined as financial contracts that directly affect a company's financial statements or conditions.
"The problem is that what 'directly affects' means has really been an open question," said Sarah Razaq Sallis, also a partner at Husch Blackwell. "That ambiguity is exactly what's being tested now in real time."
Take, for example, a contract on when Apple will release its new iPhone model. That isn't directly tied to the company's share price, but when it may launch a highly anticipated product could impact Apple's stock.
Whether that contract would be a securities-based swap or not will decide how large of a role the SEC potentially will play.
The SEC declined a request to comment from CNBC, while the CFTC didn't respond to one.
