A Brief Explanation of Event Contracts

Syed Rahman considers the nature of event contracts and the authorities’ approach to them so far.

Event contracts are starting to become the topic of commentary. This follows the US Commodity Futures Trading Commission’s (CFTC’s) order disapproving the listing and trading of congressional control event contracts by KalshiEX LLC.

Event contracts allow an individual to trade based on their view of the outcome of an event. To put it in its simplest terms, they allow someone to effectively bet on the likelihood of something happening. This can range from the price movement of an equity index right through to the outcome of elections. If the outcome you predict will occur does indeed occur then you will return a profit. It is, in reality, a pretty simple concept, with one’s liability being limited to the amount of the trade itself.

Event contracts are similar to betting but they are actually trades based on one’s own views. Moreover, they (currently) primarily allow trades on views relating to regulated markets. There is, therefore, more security behind these trades than the hit or miss betting approach that some may employ in gambling.

KalshiEX is a regulated exchange that allows individuals or entities to trade such event contracts. Whilst event contracts primarily deal with financial markets and indexes, Kalishi recently sought approval from the CFTC to trade event contracts in relation to elections that would determine control of Congress in the US.

The CFTC ruling against this was based on a variety of factors. One of these was that the contracts related to the outcome of a contest of others - the election itself. Broadly speaking, the CFTC took the view that this was in effect a form of gambling. The CFTC held that such contracts do not hold any public interest elements to them. The CFTC was also concerned that if such contracts were permitted there was the risk that they could threaten electoral integrity and even promote manipulation and fraud.

The CFTC’s views on such contracts clearly have a political element. But more general concerns do exist about such contracts and, while the CFTC has permitted certain types of event contracts, these are seemingly very limited in nature. Given the nature of such contracts, an argument could be made in favour of them being treated as their own asset class. Such an argument could be viewed alongside the UK Treasury Committee’s call earlier this year for consumer trading in unbacked crypto to be regulated as gambling. While distinctions can be drawn between event contracts and gambling in general, the question remains as to whether these contracts should be dealt with as a separate commodity, in a similar manner to cryptocurrencies.

It is perhaps regrettable that the Commission has chosen to adopt its view regarding KalshiEX. It is worth pointing out that comparisons can be made between ‘shorting’ a stock and predicting a negative outcome in event contracts. The two practices can in no way be described as identical – as there are distinct differences – but there are similarities. So CFTC’s approach to KalshiEX could be seen as yet another example of governmental agencies adopting one rule for traditional finance and another - more restrictive one - for innovative financial products and services.

This approach has been seen more overtly in the crypto markets. Whilst the technologies behind these markets are immensely useful and have the potential to have a hugely positive effect, the stigma associated with such markets has caused regulators to be hesitant in promoting and regulating this space. Whilst the Financial Conduct Authority is yet to take a substantive view on event contracts in the UK, it is hoped it will take a more expansive outlook than that so far adopted by the CFTC.