Crystal World Holdings/Crystal World Markets (“CWM”) has been in development of two contracts, one a binary contract on future sports-related events and the other a futures contracts which would track the value of sports franchises. Neither contract includes as a variable specific win/loss outcomes of specific sports events.
CWM has consulted with CFTC staff throughout the period that the concepts and contracts have been in development.
1. CWM briefed staff of the CFTC Division of Market Oversight (“DMO”), the Division that reviews new contract and market applications for the Commission, on the concept of the contracts prior to development. CWM used a formal PowerPoint which was provided to staff under a Petition of Confidentiality. DMO staff indicated at that time that “sports were like any other industry and that they would review a contract submission involving the sports industry as they would a contract involving any other industry.”
Specifically, CWM met with staff of DMO on September, 26, 2007. CWM noted during the meeting that it had requested the meeting to learn what the staff was thinking with respect to binary markets and to let the staff know about two contracts under development.
CWM indicated that it welcomed staff’s preliminary feedback on the concepts being developed.
Staff indicated that they would be probably publishing a concept release and asking for comment from the public on it, instead of publishing proposed rules as some had previously thought. The concept release in broad outline would provide that contracts with obvious commercial use would be able to be approved. Contracts that provide information that others might find useful, such as political races, would fall into a gray area, and that gambling and entertainment contracts would be prohibited.
CWM stressed that the two contracts under development would have met the old “economic purpose test” that was removed from the law in 2000. It noted that that is the most stringent test that could be developed and that although CWM contracts touch on the sporting industry, they would pass this rigorous test.
CWM outlined that it anticipated that it would license its contracts to a designated contract market and would be seeking approval for them at a later time as agent for the DCM.
CWM outlined the uses and high level terms of the first contract, a binary, and event contract. CWM discussed with staff who would qualify as hedgers and make use of the contract. This included a discussion of the size of a contract and its utility for hedging. In this regard, however, there was also a discussion that these contracts would provide price discovery and that decisions on the allocation of business risk could be signaled through the prices of the contracts.
Staff indicated that they have been approving binary contracts on events that were related to specific events with business-related risks.
CWM then outlined the sports business risk index contract, the “SRI Index.” The discussion focused on the potential hedgers and how they could use the contract. There was also a lengthy discussion on the correlation between the value of ancillary business and the value of the sports franchises; that is, that the business risks of potential hedgers is correlated to the changes in the value of the franchises.
DMO staff suggested that the valuation we were proposing was more a measure of the financial value of the intangible of fan loyalty or interest. That member of the staff characterized the index as a “fan sentiment” index. We further noted that this type of value was not directly correlated with wins and losses in particular games and that the outcomes of individual games would therefore not be a component of the index. Staff indicated that once trading, the relative changes in the index level would provide the opportunity for real price discovery regardless of the individual components selected to comprise the index.
DMO staff indicated that they viewed sports as any other industry and that the association of these contracts with sports should not disqualify them from consideration for approval.
DMO staff opined that to the extent that the index correlates with the value of a franchise as a market price for a franchise, we would have a “good shot” of showing that it met the price discovery part of the test. Staff said that they would want to consider the contract size and whether that size would be useful for hedgers. CWM told the staff that it was constructing the contracts to meet the needs of potential hedgers.
The staff agreed that they would accept a draft copy of the contracts when CWM is ready regardless of whether a final license agreement with a DCM was in place.
Following the meeting in September 2007, and based on the positive feedback of DMO staff, CWM accelerated development of the contracts on which it had briefed DMO staff.
2. In July 2008, CWM entered into an agreement under which CWM licensed to United States Futures Exchange (“USFE “) the right to list for trading the SRI Index on various products. The license provided that CWM would act as agent of USFE in preparing documents for approval or certification of the contract and that USFE as the designated contract market would submit the moving papers for self-certification or approval of the contract by the CFTC. CWM informed USFE that the first such contract would be the SRI on Major League Baseball.
3. On October 27, 2008, CWM and USFE met with staff of DMO to review and discuss the SRI Index contract. CWM had previously submitted to DMO a draft filing that could be used by USFE either to self-certify the proposed contract or to request approval by the CFTC. The meeting was attended by the Division Director, the Chief Counsel and the Branch Chief for review of financial contracts.
USFE and CWM briefed DMO staff on the Index composition, the terms of the futures contracts and how the contract would meet the requirements of Guideline no. 1 (the former standard for contract approvals). CWM provided examples of how the contract could be used for hedging and for providing pricing information. These included media companies, concessionaires, businesses located near a stadium, advertisers within a stadium and merchandisers, such as clothing manufacturers.
CWM mentioned with respect to index calculation, that CWM was contemplating recalculation as often as data was available, at least weekly.
DMO staff did raise the issue of whether the index, through attendance and ratings indirectly responds to team performance. CWM explained that it was not a one-for-one direct relationship because attendance and ratings may not be directly tied to performance. CWM also noted that to the extent there was such a relationship at all, the 12 month rolling average of attendance figures would dampen and attenuate any such relationship. The staff appeared to accept this line of reasoning.
DMO staff also asked about the effect of post season activities on index behavior. CWM discussed why any such effect would be dampened. Staff asked further analysis of this issue and CWM subsequent to the meeting provided a supplementary analysis.
DMO staff wanted to consider the written draft further, but at the meeting expressed that they were comfortable with certification of the contract by USFE. The staff was also comfortable with approving the contract and did not express a preference between self-certification by USFE versus approval.
4. Upon further review of the draft application/certification, DMO staff requested supplementation with respect to one additional point. During this period, DMO staff relayed to counsel, by telephone that the staff was finished with their review and was comfortable with either self-certification or submission for approval. The staff had not at that point briefed the Commissioners but staff stated that its recommendation to the Commission would be that the contract was legally acceptable and could be self-certified by the contract market.
5. USFE ceased operations at the end of 2008.
6. Staff of DMO in response to USFE ceasing operations noted that their rules did have a procedure for a contract designer/licensor to apply to the Commission for approval or to certify a contract, the rules only provided for a registered entity to do so.
7 Staff confirmed, however, that the staff had review the USFE draft documents and was “comfortable” with the contract. The only remaining step before a contract market could get the go ahead from staff to submit the contract by self-certification or request Commission approval was for the staff to brief the Commission and to make sure that the Commissioners do not have a contrary view. The staff would recommend to the Commissioners that the contract as proposed meets legal requirements to be traded on a designated contract market. Staff further confirmed that another contract market to which CWM licenses the SRI Index would not need to begin the process anew and could pick-up the process where it stood when USFE ceased operations.
8. To complete the process and be able to trade the SRI Index for the Major League Baseball contract, therefore, a new contract market to which CWM licenses the contract would be required:
i) to notify staff of DMO that it wishes to proceed;
ii) for DMO staff to brief the Commissioners and get the Commissioner’s agreement to permit DMO to proceed; and
iii) for the contract market to formally submit the draft application.
9. More generally, the staff from the initial meeting has indicated that if we could satisfy the general requirements for contract designation that they would treat sports as any other line of business. Accordingly, although we have not done developed contracts for other sports or leagues, it is reasonable to assume that as long as the particular contract meets the applicable requirements, a contract market would be able to move ahead with contracts using the same index concept but for different sports. Of course, it is possible that a particular sport might not have the correct characteristics on which to construct an index, but that will have to be determined as we go through the development process. To sum up, the concept appears to be acceptable to the staff and it is our understanding that the staff found the first contract developed using that contract was acceptable to the staff.
