The following letter was sent to the Secretary of the Commission of the U.S. Commodity Futures Trading Commission on July 24, 2023 regarding the KalshiEX LLC - Commission Regulation 40.2(a) Notification Regarding the Initial Listing of the “Will <chamber of Congress> be controlled by <party> for <term>?” Contract [“Control Contract”]. To read the full letter, download the PDF.
The Institute for Agriculture and Trade Policy (“IATP”)1 appreciates the opportunity to comment on the Kalshi proposal of June 122 and to respond to a few of the Commission’s questions about it.3 First, we give an overview of why the Commission should not approve the Control Contract, a contract that would allow betting on which major party controls the majority of seats in one or both chambers of the U.S. Congress following each federal election. Then we respond to a few of the Commission’s questions.
IATP commented on Kalshi’s 2022 proposal for a similar Control Contract.4 The publicly available documentation for evaluating the proposal’s consistency with the Commodity Exchange Act and the CFTC’s Core Principles was scant. The lack of publicly available documentation for this Control Contract is not a small matter for a proposal that must show that trading the contract is not “contrary to the public interest.” (17 CFR, Sec. 40.11). The regulation on “Listing products for trade by certification” (17 CFR, Sec. 40.2)5 requires the designated contract market to include in its submission to the Commission:
“A concise explanation and analysis of the product and its compliance with applicable provisions of the Act, including core principles, and the Commission's regulations thereunder. This explanation and analysis shall either be accompanied by the documentation relied upon to establish the basis for compliance with applicable law, or incorporate information contained in such documentation, with appropriate citations to data sources;” [para 3. subpara v]
Kalshi’s explanation and analysis, at two pages, is indeed concise. However, “Further information about the Contract, including an analysis of its risk mitigation and price basing utility, as well as additional considerations related to the Contract, is included in Confidential Appendices.”6 The public, lacking access to the Confidential Appendices, is constrained to analyze the “General Terms and Conditions” of the proposal, in addition to responding to the Commission’s questions.
The “General Terms and Conditions” do not inspire confidence that the Control Contract is consistent with the CEA, the Core Principles and Commission regulations. Kalshi claims disingenuously that “The Contract operates similar to other event contracts that the Exchange lists for trading.”7 However, the Control Contract is only superficially “similar” to other Kalshi event contracts. For example, the contract certified by Kalshi on July 18, 2023, “Will the SAG strike end by <date>?”, allows market participants, with no minimum order requirement, to take positions up to $25,000, betting on when the Screen Actors Guild strike will end against the owners of streaming services, cable networks and television production companies.8 The SAG event contract, like Kalshi’s other event contracts, are mostly directed towards retail investors. For example, Kalshi’s website instructs how you can receive $25 for referring a friend to its platform who trades a certain amount in an event contract within a certain time frame.9
However, Kalshi’s understanding of the function of the Control Contract’s order size and the position limit is clearly not oriented to retail investors.
“Contracts must be purchased in multiples of 5,000 contracts per order. This order size is an appropriate amount for large institutions to mitigate risk and is consistent with other futures and derivatives products. The Exchange has further imposed position limits (defined as maximum loss exposure) as described in Appendix A.”10
Position limits for “excluded commodities,” such as event contracts, have only the function to limit the losses of a market participant according to Kalshi’s Rulebook, likewise confidential in this application. Kalshi position limits do not have the normative purposes of speculative positions limits for physically backed derivatives contracts.11 However, the value of the position may be far larger than positions taken in physically backed derivatives contracts.
The position limit for the Control Contract for “Entities shall be $5,000,000 per [Kalshi Exchange] Member; and $10,000,000 for those with demonstrated established economic hedging need. The Position Limit for Eligible Contract Participants (“ECP”) shall be $50,000,000 per Member; and $100,000,000 for those with demonstrated established economic hedging need.”12 Kalshi determines what is an “sufficiently established economic hedging need” “solely at Kalshi’s discretion.” In other words, Kalshi defined “Entities” and “Eligible Contract Participants” can bet on the party control of Congress, with Kalshi’s confidential methodology to determine a market participant’s “sufficiently established economic hedging need” that bears only superficial similarity to Kalshi’s retail-oriented event contracts.
According to the CFTC “Glossary,” a hedger is “A market participant who enters into positions in a futures or other derivatives market opposite to positions held in the cash market to minimize the risk of financial loss from an adverse price change; or who purchases or sells futures as a temporary substitute for a cash transaction that will occur later.”13 The Control Contract allows market participants to take long and short positions on the outcome of the party control of the U.S. Senate and House of Representatives and thus superficially resembles hedging.
However, the economic consequences of the results of a party’s control of a chamber of Congress during a specific session of Congress are impossible to predict, so there is not a cash market price to hedge. A Kalshi defined Entity or ECP may also be a political donor who spends $5,000,000 and more to ensure that the donor’s party of choice wins an election in anticipation that the party’s control of the House and/or the Senate will benefit the donor’s economic interests. But those anticipated economic benefits do not constitute a cash market price that can be hedged by betting on the Control Contract. The public has no access to the confidential documents of Kalshi’s methodology for demonstrating if a market participant has a “sufficiently established economic hedging need” to take a position of up to $100 million in the Control Contract. If the Commission were to approve the Control Contract, it would allow Kalshi to determine the economic hedging need of investors seeking to bet on the election cycle future of a major institution of U.S. democracy.
IATP urges the Commission to disapprove the Control Contract. The Commission is not required by law or regulation to approve the Control Contract. At least $8.9 billion was spent to influence the 2022 congressional election outcome.14 Bets to predict future congressional election outcomes will partly be informed by how and when such money is spent. Leave betting on electoral horse races to bookies. The CFTC must not give its imprimatur to that betting by approving the Control Contract, notwithstanding its superficial resemblance to bona fide hedging.
IATP responds here to a few of the Commission’s many thoughtful questions about the Control Contract and its relation to the Commodity Exchange Act, Core Principles and CFTC regulations.