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April 23, 2012

Betting against Obama? The WTO may have something to say about that.

Ben Protess wrote in the NYT a few weeks ago about a new effort following from the Dodd-Frank financial overhaul legislation:

The Commodity Futures Trading Commission is poised this week to reject plans for so-called political event contracts, a lucrative derivative deal that would allow firms to wager on Congressional races as well as the presidential battle, the people briefed on the matter said...

[the The North American Derivatives Exchange,] which currently is a marketplace for derivative contracts tied to commodities and stock market indexes, wanted to offer five basic contracts. One contract allows traders to wager that President Obama will win another four years in the White House. Other contracts say that either Democrats or Republicans will control the Senate or House...

Some states explicitly outlaw gambling on elections. Even in Las Vegas, the epicenter of gambling, betting on elections is off limits, regulators say.

Intrade is the most prominent player in the world of trading political event contracts, but it is based in Ireland. It is unclear whether American law applies to Intrade.

Only academics have escaped the strict rule. For two decades, United States regulators have allowed business students at the University of Iowa to operate an electronic exchange for trading political contracts.

The basis for the CFTC decision can be found in this CFTC order, which details the statutes and regulations that lead it to rule that NADEX is against the public interest. it's also worth pointing out that Nadex - despite the homegrown sounding name - is a subsidiary of a European financial services group.

The question we like to ask often at EOT is how might the under-studied, underappreciated rules of the World Trade Organization (WTO) and other trade rules relate to this legitimate political event regulation?

The first part to answering the question would be, does the U.S. have relevant commitments? Derivatives trading and gambling are categorized separately under the WTO's General Agreement on Trade in Services, and it seems like political event trading might be deemed either.

Say political event trading were considered a form of derivatives trading. The U.S. has full commitments in derivatives trading, with the sole exception of a ban on onion futures contracts, which political event trading clearly is not.

Alternatively, political event trading could be classified as a form of gambling. The WTO determined in the U.S.-Gambling case that the U.S. had deep commitments in this area. In "other recreational services," the U.S. has full cross-border commitments in both Modes 1 and 2. (These modes refer, respectively to U.S. consumers accessing UK financial services remotely, or U.S. consumers traveling to the UK to consume the service. In the era of the Internet, however, the distinction between the two has gotten blurry, since all transactions can be consummated in the clouds.) 

The U.S. has a partial gambling commitment in Mode 3, which refers to the services being supplied and established within the U.S. to consumers here (The limitation on market access reads "The number of concessions available for commercial operations in federal, state and local facilities is limited.")

The second part of answering the question would be, does the CFTC ban break any specific GATS rules? The U.S.-Gambling case noted above ruled that a ban (implemented in a straightforward fashion or thorugh the cumulative effect of different policies, statutes, regulations, practices, etc.) constitutes a GATS Article XVI-prohibited quota of zero. The U.S. could ban onion futures, but few other services of relevance to this discussion. 

Moreover, the U.S. (like most OECD countries) adopted the Understanding on Commitments in Financial Services, which has a provision that reads: "A Member shall permit financial service suppliers of any other Member established in its territory to offer in its territory any new financial service." (Since WTO panels like China-Publications have interpreted the GATS as comprehensive and including new financial services, it is unclear to me that this language is additive to what's already in the GATS. But that's a topic for another post.)

In sum, if the CFTC takes the smart policy move and bans political event trading (i.e. institutes a maximum quantitative cap of zero), it is likely to run afoul of its WTO rules on market access or new financial services.

If it allows the Iowa based academic group to continue providing the service, it might face market access claims (on the basis of this being a cap of one) or national treatment claims under Article XVII.

The only chance for getting off the hook would be for a WTO panel to view this as falling within the Mode 3 market access limitation in gambling services, but that refers to a number of concessions being limited, not a total cap on the service provision per se.

Will the UK or Ireland push for a WTO case on the matter? Or would a Caribbean offshore services center do the same? We'll have to wait and see, but this short analysis suggests that a case is certainly possible.

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