Question of the Day - 30 April 2021

Before we get into the nitty-gritty of this concept, we should note right off the bat that ErisX withdrew its proposal only days before the U.S. Commodity Futures Trading Commission (CFTC) was set to approve or deny the controversial plan. Thus, as of now, this whole issue is moot. But it's an interesting story that will reappear in one form or another down the road. We probably won't do it justice, given the technical nature of the beast, but we'll take a stab at it.

Eris Exchange LLC (ErisX) is a regulated futures exchange, also known as a DCO or derivatives clearing organization. We'll let Investopedia explain it.

"A clearing house acts as a third party to a trade. From the buyer, the clearing house receives cash and from the seller, it receives securities or futures contracts. It then manages the exchange, making it possible for traders and investors to negate the worry that the party on the other side of their trade will somehow act in bad faith."

Of course, the clearing house takes a fee for the service. It seems to us not unlike the role a title company plays in a real estate transaction, where the buyer's funds are held in an escrow account till the transaction closes and they're distributed to the seller, while the buyer receives the property and the deed. 

Anyway, ErisX was first licensed by the CFTC to clear futures on cryptocurrencies only. But last November, the company's license was expanded to clear all futures and swaps. Little more than a month later in the run-up to the National Football League playoffs, ErisX submitted a proposal to the CFTC to make a futures market for the playoffs "as a mechanism to assist legal sports books in dealing with imbalances in sports betting volumes."

ErisX proposed three types of futures contracts for NFL games: money line, pointspread, and over/under. Since major sports books are prohibited by the Wire Act from laying off bets across state lines, ErisX appeared to be offering them risk-hedging opportunities through the futures market by balancing their action.

For example, a sports book with an enormous amount of action on one side or the other of a game could hedge its risk by selling or buying a contract on the exchange.

According to SportsHandle.com, another element of the proposal was a hedge for stadium operators. By purchasing a money-line contract on the outcome of a playoff game, "the stadium operator could mitigate the risk of losing millions in revenue from ticket sales and food-and-beverage sales" if its team lost the game, precluding the stadium from hosting upcoming post-season games.

SportsHandle reported that the NFL "didn't vehemently oppose the idea during the CFTC comment period." But the league did "urge the CFTC to postpone its decision pending a more comprehensive study" of the contracts themselves to ensure that they "represented a legitimate effort to hedge commercial risk" -- and weren't just another form of outright gambling.

As the deadline for the CFTC's decision loomed in late March, the Commission apparently threw off enough signals about its intention to reject the proposal that ErisX withdrew it from consideration. For example, The Wall Street Journal ran a story just before the deadline, citing the CFTC's belief that an NFL futures market was "contrary to the public interest," in that it "could promote gambling and that ErisX hadn’t proven its ability to help firms hedge commercial risks." That led to ErisX withdrawing its plan from consideration.

ErisX claims that it has plans to consult further with "other sports-related businesses that may benefit from the listings," then resubmit a modified proposal, but as yet hasn't announced any timeline for that. 

All in all, ErisX's proposal is an intriguing effort to link up the growing sports betting market with the financial futures market.

Where it gets tricky, at least in terms of how we see it, is in the interface between gambling products and financial instruments, which is sure to get blurrier and blurrier as time goes on. This could cause a rift in regulation, whereby gaming regulators are hesitant to address issues that are in the realm of financial markets and financial regulators don't want to come anywhere near sports betting issues. At some point, it seems inevitable that they'll have to get together and decide where the boundaries might or should be.