Coalition for Political Forecasting response to CFTC’s request for public comments

What role does the requirement that the contracts trade in multiples of 5000 and/or the position limits applicable to the contracts play in the analysis of whether the contracts involve, relate to, or reference gaming as described in Commission regulation 40.11(a)(1) and section 5c(c)(5)C) of the Commodity Exchange Act? Are the position limits reasonably enforceable?

The minimum order sizes and position limits are likely to deter traders interested in gaming while drawing a relatively greater degree of liquidity from skilled traders with motives other than gaming, such as hedging.

Of the three categories of traders delineated in Kalshi’s proposal—individuals, entities, and eligible contract participants—individuals appear to us to be the most likely to enter the markets with gaming motives. 

Our expectation is that the more money individuals are required to wager on the outcome of congressional elections, the more likely they are to approach these markets either with a long-term edge and/or with an understanding of how to use these markets for hedging and price-basing.

Evidence for our thesis can be found in data from the 2020 U.S. elections on PredictIt and UK-based markets. Many of the most irrational, speculative, and gaming-oriented bets we observed were on PredictIt, where the average first-time deposit was $216. Due to the betting limits on PredictIt, the markets had limited ability to correct small-scale speculators who wagered on highly improbable outcomes, such as the possibility that Trump would remain president despite losing the election. As the markets reached new heights of irrationality, the gaming frenzy often grew. Traders who were placing these types of bets were often highly vocal on social media, where they broadcasted their wagers in the hopes of eliciting reactions from fellow MAGA enthusiasts. Once the markets were settled against them, however, they were relatively absent from political betting circles.

On Betfair Exchange, by contrast, which does not have position limits, the biggest winners were smart whales who took advantage of mispriced odds driven by gaming oriented retail traders. Although 46.6% of the money wagered in these markets was on Trump compared to 50.6% for Biden, the 10 largest bets placed on Betfair were for Biden. These include at least 7 bets on Biden of more than $400,000.

The main challenge we foresee regarding the enforceability of Kalshi’s position limits is the unlikely scenario that individual speculators will falsely claim to have a demonstrated established economic hedging need so that they can wager up to $250,000 rather than being limited to $125,000. 

It would be reasonable of the Commission to request from Kalshi greater clarity on the precise “means and methods” it intends to use to exercise sole discretion in determining whether a member has demonstrated a sufficient economic hedging need. The number of individuals who could be expected to wager more than $125,000 on Congressional control markets is relatively small, and only a small percentage of those would do so with a genuine hedging need. Especially as it works on building liquidity on its platform, Kalshi could be tempted to accept alleged hedgers with minimal scrutiny. More transparency on Kalshi’s standard would also set a precedent for future market participants.

Overall, however, we see minimal concerns regarding enforceability. The main reason is that Kalshi’s contracts create strong incentives for self-regulation. At least in terms of its political and election markets, Kalshi has one overwhelming comparative advantage vis-a-vis its competitors: the regulatory certainty it can provide traders by virtue of its status as a DCM and its strategy of hewing closely to CFTC regulations.

More so than the vast majority of other market operators in the political betting space, Kalshi, in our assessment, has a strong motive to take a highly conservative, risk-averse approach to regulation.

On the trader side, the small number of individuals seeking to wager more than $125,000 on Congressional control markets can easily place bets on other platforms with far less scrutiny of their motives. Political bettors are already trading political contracts on a growing number of offshore platforms, which are increasingly keen on expanding election lines. As VPNs and other technologies advance and the reality becomes clearer that the government has a minimal capacity and political will to pursue enforcement actions against small-scale retail traders, this activity will likely continue to grow.

Does the requirement that these contracts trade in multiples of 5000 and/or the position limits applicable to the contracts affect the analysis of the hedging utility of the contracts?

We believe that the proposed changes to the contract trading requirements bring them closer in line to practices in futures markets, which increase their likelihood of serving price-basing and hedging functions.

Although the vast majority of political event contracts are used for speculation, we have seen cases of retail traders using these markets for hedging. We are aware of young professionals, for example, who use Kalshi to hedge their student loans. Our concern is that the order size and position limits will deter young, early adopters of political prediction markets from exploring their hedging use case with small amounts of money.

If Kalshi is proposing the order size and position limits at the request of the Commission, we urge the CFTC to grant Kalshi more leeway.

What is the price forming information for these contracts while the contracts are trading? If the price forming information includes polling and other election prediction information, is that information regulated? How does the price forming information compare to informational sources (e.g. government issued crop forecasts, weather forecasts, federal government economic data, market derived supply and demand metrics for commodities, market-based interest rate curves, etc.) that are generally used for pricing commodity derivative products within the Commission’s jurisdiction?

The question of which party will control Congress is determined by so many factors that the price forming information is effectively the totality of the American and global political discourse.

The vast majority of price forming information in these markets cannot be regulated by the government. Polling illustrates why price forming information in election markets is nearly impossible to regulate. Polling is conducted by a wide array of sources with varying degrees of reliability and motivations. Even if the government were to find ways to regulate fraudulent polls, it would need to contend with the reality that it is often not polls themselves, but rather, the interpretation, analysis, and dissemination of polls that drive market prices. For example, predictive models that seek to turn polling data into quantified forecasts are the subject of trader debates due to the way they weight different pollsters.

Price forming information in election contracts tends to be based more on qualitative data points than the informational sources used for pricing commodity derivative products. Market odds of a party controlling the House and Senate are influenced not only by polls, election models, and other quantitative data, but also on news reports and political commentary related to national trends, individual races, and other potential signals. Opinions and analyses by a wide variety of experts, media personalities, and influencers on the rel-ative strengths of weaknesses of parties and candidates contribute to narratives that drive movements in the markets. This is why market prices frequently seem to be incongruous with polling and other data.

Price information in Congressional control markets is more difficult to regulate than the information used for pricing other commodity derivative products because it is more clearly protected by the First Amendment. Predictions broadcasted by politicians, pundits, and other political commentators inform prices in election contracts. Even when these predictions may be misleading in the sense that they are intended to shape narratives and push agendas, they typically cannot be regulated because they are constitutionally-protected speech.

Should, and if so how would, the registered entity listing the contracts take steps to address possible manipulative and/or false reporting activity involving the price-forming information for the contracts, while the contracts are trading?

Manipulative and/or false reporting activity is relatively unusual in markets on the control of Congress. It is more common in smaller scale, lower liquidity markets where there is less public, relevant information; more volatility; higher degrees of uncertainty; and short deadlines.

Insofar as these markets would be targeted for manipulation at all, we believe this would happen primarily through the dissemination of misleading news reports and polls. Given how quickly market participants themselves fact-check these sources, it would be difficult if not impossible for registered entities to address this type of manipulation more effectively than the markets.

The only scenario we can think of where manipulation would have a meaningful distorting impact on price forming information for the contracts would be on election day. In the event of a close election, when media reporting is unreliable and jittery traders are buying and selling in a state of panic, manipulators could cause major movements in the markets.

The easiest way a registered entity could address possible manipulation is by refusing to host discussion boards on their platforms. Comments sections have historically been among the most common vehicles for market manipulators to affect prices on PredictIt. The amount of activity in these comments sections makes it difficult for sites to police them.

Do Kalshi’s limitations on market participation affect the susceptibility of the contracts and/or markets for the contracts to manipulation? Do the limitations affect the extent to which these markets could be used to influence perception of a political party or candidate or otherwise be implicated in an attempted election manipulation? Are the limitations reasonably enforceable?

In rare cases, political insiders buy or sell positions in prediction markets to manipulate the price at which a contract is trading. In every instance we have seen this happening, this manipulation is motivated by a desire to generate optimism in the broader political conversation about an individual underdog candidate’s electoral prospects. Markets that are targeted for these efforts typically have limited liquidity, which makes market manipulation a cost-effective campaign and public relations strategy. We are highly skeptical that anyone would have sufficient motivation to spend the amount of money it would take to make it seem as if the Republicans or Democrats have a marginally higher chance of achieving overall control of the House or Senate.

The nine categories of individuals Kalshi would exclude are broad and diverse. The degree to which limitations on their participation can be enforced likely varies depending on their profile, employment, and compensation structure. The important point, from our perspective, is that Kalshi is endeavoring in the first place to limit market participation for the sake of advancing democratic norms. In the vast majority of other political betting platforms, market participants are restricted not out of concern for election integrity, but because they are winning accounts that generate more accurate odds at the expense of bookmaker profits.

Kalshi’s decision to exclude a broad array of market participants speaks to the company’s desire to work with regulators to assuage concerns about the threat election contracts might pose to democratic institutions. If the CFTC prevents Kalshi from offering these markets, the beneficiaries will be other platforms with fewer qualms about enabling election manipulation.

Should the Commission be responsible for surveilling, and enforcing against, possible manipulative and/ or false reporting activity involving the price forming information for these contracts, while the contracts are trading?

As with the registered entity, surveillance and enforcement of market manipulation by the CFTC would generally be an exercise in futility. These attempts would serve little purpose given how efficiently Kalshi’s highly liquid Congressional control markets would self-correct. 

There is only one type of surveillance or enforcement we believe the Commission should take responsibility for: trading in these markets by CFTC staff. A strict policy prohibiting CFTC staff from trading in these markets might help to bolster the agency’s credibility as a regulator. It would assuage doubts that Commission staff have a motive to engage in manipulation and/or false reporting activity in these contracts. 

Could trading in the markets for the contracts obligate the Commission to investigate or otherwise become involved in the electoral process or political fundraising? If so, is this an appropriate role for the Commission?

Ever since Chairman Behnam raised the possibility of the CFTC turning into an “election cop” in his interview on the Odd Lots podcast, we have interviewed numerous elections and compliance officials to explore this issue. 

We are not aware of anyone in Congress or the policymaking community who believes that the CFTC has authority to be an “election cop” in the electoral process or political fundraising. Indeed, this concern is so speculative that it provokes suspicion about whether it is merely a pretense for the CFTC to avoid decisions on political event contracts. 

It is important to consider that the CFTC has had oversight over several political prediction markets that offered contracts for the 2000, 2020, and 2022 U.S. elections. In each of these years, election disputes were litigated across state and federal electoral apparatuses and courts. Notwithstanding the deep, widespread, and, in some cases, violent public reactions that these disputes engendered, they did not require any meaningful CFTC intervention in betting markets. Nor did they even generate any significant legislative or public demand for CFTC involvement.The easiest way to prevent the Commission from becoming involved in the electoral process is to establish clear settlement rules for the contracts. We believe that Kalshi and other political betting operators need to prepare for the possibility that election disputes could leave unresolved the question of which party controls Congress well after election day. It would be reasonable for the Commission to encourage Kalshi to develop and publicize contingency plans for this scenario. Clarity among traders and the public on precisely when and under what circumstances the contracts will pay out would prevent the types of outcomes that could invite CFTC involvement.

The easiest way to prevent the Commission from becoming involved in the electoral process is to establish clear settlement rules for the contracts. We believe that Kalshi and other political betting operators need to prepare for the possibility that election disputes could leave unresolved the question of which party controls Congress well after election day. It would be reasonable for the Commission to encourage Kalshi to develop and publicize contingency plans for this scenario. Clarity among traders and the public on precisely when and under what circumstances the contracts will pay out would prevent the types of outcomes that could invite CFTC involvement.

What other factors should the Commission consider in determining whether these contracts are “contrary to the public interest?” 

Perhaps because political event contracts are so tightly regulated in the United States, debates on this issue are often defined by arguments that are theoretical and speculative in nature. 

The UK would be a useful case study to explore the public interest implications of these markets as it has had a liberal regulatory regime on political betting for more than 60 years.

We would encourage the Commission to seek feedback from British policymakers, academics, and industry leaders on three main questions:

• Have theoretical concerns about the risks betting markets can pose to election integrity materialized in practice in the UK?
• Has the absence of position limits and other regulations facilitated hedging and price basing in British political betting markets? 
• Have the purported benefits of political betting for the public interest been realized in the UK?
  

We would also recommend that the CFTC monitor deliberations in the UK related to the British government’s April 2023 white paper on the Gambling Act of 2005. Discussions regarding reforms on regulations and legislation governing the gambling sector may provide useful lessons for the American context.