US regulators prepare ruling on elections market bets


US regulators will decide this week whether investors can place market bets on elections, a move that critics warn would muddy the distinction between trading and gambling on American democracy.

The Commodity Futures Trading Commission, the main US derivatives regulator, is scheduled to decide by Friday if Kalshi, a retail-focused futures market, can offer contracts representing a bet on whether the Democrats or Republicans will prevail in the upcoming midterms.

Kalshi’s efforts to persuade authorities come as a new wave of companies target the army of everyday investors who provided a powerful but fleeting boom to markets by trading equities, options and crypto during the Covid lockdowns. It would also open the door to large institutions trading directly on the US election outcome for the first time.

But some campaigners have said the proposal crosses a line.

“You can create a financial product or a gambling situation out of most events in the world. The question is: is that necessarily a good idea? And do you worry about market integrity and market manipulation of the underlying thing?” said Tyler Gellasch, president of the Healthy Markets Association.

The US election system differs from many other democracies because of the volume of corporate cash that backs campaigns and influences elections. The CFTC is asking the market whether political action committees — large groups of political donors — should be allowed to trade election derivatives. “It’s a lot to ask the CFTC to weigh in on gambling on democracy,” Gellasch added.

Currently, if an investor has a view on the likely economic impact of a certain politician or party’s victory in an election, he or she can buy or sell the stocks, bonds or currencies likely to be affected. Banks can build bespoke derivatives speculating on politics, sometimes folding in several asset classes, but these contracts are traded bilaterally and are unregulated.

Kalshi wants to put this activity in a regulated market, starting with binary contracts that pay out if an investor guesses correctly which political party will be in control of each chamber of the US Congress.

A correct guess leads to a payout, while if a user guesses the wrong way they lose their initial outlay. If Kalshi is approved by the CFTC, it could open the door for other exchanges to quickly apply to offer elections contracts.

This would mark new territory for America’s vast exchange-traded derivatives markets, which allow users to predict price moves, generally as a way to hedge against or speculate on shifts in commodities, interest rates and stocks.

Tarek Mansour, a former quant trader and co-founder of Kalshi, said his proposal was an effort to offer retail investors the same sorts of tools regularly used by institutional investors to get hedged exposure to election outcomes.

“If a bank wants exposure to Brexit, someone will structure that for them,” he told the Financial Times. “Those products were not available to everyday Americans. But the risk from Brexit or climate change or an election is not just borne by big institutions, it is borne by everyone.”

Retail investors have rushed into more complicated investment instruments since the start of the pandemic, including options trading in individual stocks and leveraged exchange traded funds. This has coincided with the federal legalisation of sports betting in the US and the rise of betting apps in large markets such as New York.

This has fuelled a rush to exploit markets that offer bets on short-term upcoming events that have a binary, yes/no outcome.

Last month, CME Group began offering so-called event contracts to retail investors, so they can bet on the daily up or down price moves on the S&P 500 stock index, gold or crude oil. CME executives call it a “critical” new market for its growth strategy.

Wall Street has tried offering derivatives tied to known economic events before, with little long-term success. In 2002, Goldman Sachs offered options on the closely watched non-farm payrolls data. But those products were offered between professionals and traded off-exchange, which required minimal amounts of margin.

Critics of such products have said exchanges were touting high-risk gambling products, but wrapping them up as safe, regulated investment hedges.

“This proposed contract [by Kalshi] would contribute to the deeply troubling trend toward the ‘gamification’ and ‘retailisation’ of finance,” Dennis Kelleher, president of US consumer financial reform group Better Markets, wrote in a letter to the CFTC.

The US has long banned betting on the US election. The CFTC also rejected a 2012 proposal from Nadex, a small derivatives market, for “political event” futures, arguing it was against the public interest.

Binary options are controversial among other global regulators. They are banned in the UK, where the regulator called them “gambling products dressed up as financial instruments”.

Mansour said futures trading should not be equated with gambling. “In sports betting or roulette, that risk does not need to exist — it’s artificial risk that you’re creating,” he said. “But in the futures market, that risk exists. So you’re transferring the risk from those who can handle the risks to people who can take it. It’s more like insurance.”

Some market participants have supported Kalshi’s proposal. “Election risk is one of the largest risks our clients face, and they frequently engage us proactively on how to minimise it (hedge it, in other words),” wrote Angelo Lisboa, managing director of JPMorgan’s private wealth management division.

“Kalshi is not the first to wonder how impactful it would be to bring these capabilities to the rest of the population who does not have access to desks at large banks,” he added.

However, Gellasch said: “There’s a big difference between betting on the price of cotton in a few months and the fabric of society itself.”

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