HedgeStreet. 

E:XCHAN13E 

July2, 2008 

Via E-Mail: seeretarv@d'tc:.gov 

Mr. David Stawick 

Secretary of the Commission 

Office of the Secretariat 

~-

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21 51 Street, N.W. 

Washington D.C. 20581 

Aecelvecl CFTC 

Records Section 7/J/oi 

COMMENT 

RE~ Response to Request for Public: Comment: 

Concept Release on the Appropriate Regulatory Treatment of Event Contracts 

Dear Mr. Stawick: 

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HedgeStreet, Inc. (''HedgeStreet'') welcomes the opporttmity to comment in response to the "Concept 

Release on the Appropriate Regulatory- Treatment of Event Contracts" ("Release") published by the Commodity 

Futures Trading Conunission (the "CFTC" or the "Commission''). 73 FR 25669 (May 7, 2008). HedgeStreet 

applauds the Commission in continual1y taking strides to update and enhance, as necessary, the current regulatory 

system in order to keep pace with the ever changing marketplace while ensuring market integrity and public trust in 

the United States' futures and options markets. 

Introduction 

HedgeStreet is a for-profit corporation organized under the laws of the state of Delaware. HedgeStreet is a 

fully electronic designated contract market ("DCM'') and is registered as a derivatives clearing organization 

("DCO") with the Commission. The exchange CWTently lists daily and weekly Binary Options on various currency 

pairs, Crude Oil, Gold and Silver. In addition to these current offerings, HedgeStreet previous1y has listed Binary 

Options on events such as corporate mergers, hwricanes, corporate earnings-per-share annoWlcements and 

economic numbers such as Non-Farm Payrolls and Core CPJ. The majority of the contracts that HedgeStreet offers 

or has offered fall within the class of contracts described in the release as ''unambiguously subject to CFTC 

regulation." (Release at 25669 fn. 2) Certain of HedgeStreet's offerings or potential offerings, however, could fall 

within the category of "event contracts" as described in the release. Accordingly, HedgeStreet has significant 

interest in.the appropriate regulatory treatment of event contracts. 

311 S. Wider Drive 

$ultii287S 

Chlalgo, IL eoeoe 

tfll: 312.884.0100 
HedgeStreet. EXCHANI!E 

HedgeStreet's members primarily are retail traders who- because HedgeStreet is a non-intermediated 

exchange~ open accounts directly with HedgeStreet, not with separate clearing members. Moreover, HedgeStreet's 

contracts are "fully collateralized", so that the exchange and its members do not take on any signific< credit risk 

with respect to the contracts that are traded. 1 HedgeStreet's structure, together with its product offering. provides it 

with a unique perspective with respect to the issues raised in the Release. 

HedgeStreet would like to expand its offering of unique financial instruments to include additional event 

contracts, such as contracts that have an underlying value based on certain political events, including Election 

Contracts. Congress made plain in its amendments to the Act in 2000 that it found the national public interest to be 

served by the regulated futures and option markets is to provide a means for ''managing and assuming price risks, 

discovering prices, or disseminating pricing information through trading in liquid, fair and financially secure trading 

facilities". (CEA §3(a), 7 U.S.C. §S(a)). That same section of the Act provides that the Act's purpose is to provide 

a system of effective self-regulation of trading facilities, clearing systems, market 

participants and market professional under the oversight of the Commission . • . [and] to 

deter and prevent price manipulation or any other disruptions to market integrity; to ensure 

the financial integrity of all transactiQDS subject to this Act and the avoidance of systemic 

risk; to protect all market participants from fraudulent or other abusive sales practices and 

misuses of customer assets; and to promote responsible innovation and fair competition 

among boards of trade, other markets and market participants. 

(CEA §3(b), 7 U.S.C. §S(b)). The Election Contracts that HedgeStreet wishes to offer would be consistent with 

Congress' finding and in furtherance of the Aces public policy pUIJlOses, especially the "promot[ion ofj responsible 

innovation and fair competition among ... markets". Id. More specifically~ the offer of Election Contracts can be 

designed to provide risk management value to the public as well as to pennit price discovery and dissemination. 

Furthermore, if traded on a DCM, the Election Contracts can satisfy the Act's applicable Core Principles. 

Election Events are "Excluded Commodities" Subject to CFTC Jurisdiction 

The Election Contracts that HedgeStreet contemplates offering would be binary options on a commodity. 

The underlying commodities would be expressed as the occurrence of an event. The event, for example, could be 

defined as whether the Republican party will win the majority of the United States House of Representatives, 

Democratic party will win the majority of the United States Senate, or whether a specified candidate or party will 

win the United States Presidency. 

The underlying events for such Election Contracts are commodities for purposes of the Commodity 

Exchange Act. Indeed, they are well described by the Act's definition of an "excluded commodity", which, as the 

Commission is well aware, is not itself excluded from the Act's coverage. Instead, such commodity is "excluded" 

only in the sense that it is eligible to be the l.Ulderlying commodity for off-exchange contracts between certain 

1 For example, if Member A buys a $100 contract opposite Member B at a price of $60; then Member A 

pays $60 to the Exchange and Member B pays $40 to the Exchange. If the contract finishes in the money, 

the contract pays $100 to Member A (his original $60 plus $40 in profit) and Member B loses her $40. 

(Both members also pay exchange fees to HedgeStreet in connection with this activity.) Our current 

contract size is limited to $100, but we anticipate listing larger contracts in the near future. 

-2- 311 S. Wackllr DIMt 

Swt..2075 

ChiCG(A IL 80101 

Ml: 31~8fM.0100 
.. 

HedgeStreet. EXCHANI!l! 

sophisticated parties that are excluded from the Act. 2 Indeed, exchange-traded futures and options contracts are 

permitted to be and presently are listed on excluded commodities, such as interest rates, currencies and security 

indexes. 

Section 1 a(l3) of the Act describes an "excluded commodity", in relevant part, as follows: 

"an occurrence, extent of an occurrence. or contingency ... that is (l) beyond the control 

of the parties to the relevant contract ... ; and {ll) associated with a financial, commercial, 

or economic consequence.'' 

(CEA § la(l3), 7 U.S.C. § la(13)). Election Contracts meet the requirements of this definition. With respect to the 

first part of the definition of"excluded commodity", the underlying events for Election Contracts are "occurrences." 

The strike conditions or payout criteria for the binary options are the occWTences of the election results for the 

United States House of Representatives, the United States Senate elections, and the United States Presidency, all of 

which will take place on a specific date. 

The nature of the Wldetlying occurrence would be ''beyond the control of the parties to the relevant 

contract" to affect the outcome of the occurrence in each case, in accordance with the second requirement of 

Section 1 a( 13) identified above. For example, elections that will determine the President of the United States, as 

well as control of the House of Representatives and the Senate, are scheduled for November 4, 2008. The 

Presidential Election involves the registered voters in each state, who vote for a block of electors who, in tum, are 

pledged to vote for a particular Presidential ticket. These electors actually vote for the presidential candidate. Each 

state is apportioned a number of electors equal to the total number of their Congressional delegation. Given the 

number of registered voters in the United States (over 142 millio~) and the role of the Electoral College in the 

Presidential election process, it would be impossible for any one person to control the outcome of the Presidential 

elections. Similarly, given the large number of citizens eligible to vote in the Congressional elections, it would be 

impossible for any one person to control the outcome of any Congressional elections, let alone the detennination of 

which party would control the House of Representatives or the Senate. 

With respect to the final requirements of the definition of "excluded commodity" set forth above, it is self• 

evident that federal elections have both macroeconomic and microeconomic impacts. Elected officials set fiscal 

policy and influence monetary policy, thereby affecting US Treasury issuance volumes, US interest rates and the 

value of the US dollar in the currency markets. The President nominates and the Senate confinns the leadership 

ranks of the Federal Reserve Board of Governors, tbe Council of Economic Advisors, all the Departments of the 

Cabinet and a range of agencies and bureaus collectively overseeing the nation's commercial and economic 

pursuits. The federal budget on which these elected officials eventually agree allocates vast sums among industries 

and individuals. Commercial winners and losers are directly created by the decisions of elected officials on the 

allocation of federal resources among health services, national defense, transportation and agriculture - sectors on 

which Presidential candidates and political parties routinely stake out competing positions. For example, a shift in 

national health care policy might be expected to sharply affect the profitability of health insurers, HMO's and 

pharmaceutical companies which collectively account for a substantial portion of the United States' GOP. 

2See, e.g., CEA § 2(d) and (g). 7 U.S.C. § 2(d) and (g). 

3 Voting and Registration in the Election of November 2004, Kelly Holder, United States Census Bureau, 

Issued March 2006. 

- 3- 311 S. WIIICker Drive 

Sullt2875 

cnJcaoo, IL 80808 

Nl: 312.884.0100 
'• 

HedgeStreet. EXCHANIIE 

Election Contracts, which are in the nature of binary options, would be within the Commission's 

jurisdiction even if the related event was not a "conunodity" for purposes of the Act. Indeed, Congress bas given 

the Commission plenary jurisdiction over exchange traded options, except for options on securities. Section 

2(a){l )(A) of the Act provides the Commission juriSdiction over options on a DCM without regard for whether the 

underlying is a commodity. That section provides, in pertinent part, as follows: 

The Commission shall have exclusive jurisdiction, except as provided in subparagraphs (C) 

and {0) of this paragraph and subsections (c) through (i) ofth1s subsection, with respect to 

... any transaction which is of the character of ... an "option" ... traded or executed on a 

contract market designated [pursuant to the Act] ...• 

(CEA § 2{a){l)(A), 7 U.S.C. § 2(aXl)(A)) . 

.Eiedlon Contracts and the Potential for Hedalnx and Risk Management 

Since the economic consequences of elections can be so substantial, individuals and businesses have a 

strong interest in properly anticipating election-day results and, where possible, hedging against adverse outcomes. 

For example, if a government contractor who participates in government procurement programs can reliably predict 

the victory of a candidate or a party opposed to those programs. it may use that information to defer or revise its 

business expansion plans. With the opportunity to evaluate market-based predictions, the contractor may decide to 

avoid expenditures for business opportunities that will not materialize or shift into other product lines more likely to 

be valued by the incoming administration. In any case, the accurate election forecast helps the manager to allocate 

resources and anticipate hiring needs; the information also helps workers in that business make plans for their 

personal expenditures. Similarly, Election Contracts could give the business and the individual employees a 

vehicle to hedge the event-specific risks that they face. Critically, the offer of such contracts by a DCM can serve 

the public policy purposes set forth by the Act while complying with the Act's Core Principles applicable to a 

DCM. 

Election Contracts and the Potential for Manipulation 

Core Principle 3 in Section S(d) of the Act stipulates that a board of trade shall list on the contract market 

only contracts that are not readily susceptible to manipulation. {CEA § 5(d)(3), 7 U.S.C. § 7(d)(3)). Election 

Contracts can be designed to meet this Core Principle. 

• First, there is no underlying cash market for these contracts. Thus, the Election Contracts will not 

rely upon any cash price series or cash market trading activity to determine whether a Contract is to 

be exercised or the amount of the fixed cash settlement payment. That is, there is no underlying 

cash market to be manipulated. 

• Second, as explained above, the outcome of the underlying event - whether Republicans or 

Democrats win the House, Senate and Presidency on November 4, 2008, - would not be within the 

control of any person, except perhaps the candidates themselves. Nonetheless, as an added 

precaution, in addition to the candidates themselves, any individual who may have control or 

influence over the timing or outcome of the event underlying in any Election Contract could be 

precluded by exchange rule from trading that contract on the market. lhis restriction could apply, 

for example, to members of the Electoral College with respect to trading of Presidential Election 

Contracts. 

311 s. w .... Ollwl 

&IIIII 2CI75 

Chlcllgo, IL 60806 

tel: 312.8114.0100 
HedgeStreet. EXCHANI3E 

• Third, an independent federal agency, the Federal Election Commission for the Presidential, House 

and the Senate, wilt verify the results of the elections. The results will be published on the official 

outcome of the vote on its website. 

DCMs and the CFTC are very familiar with the issue of potential price manipulation and steps to protect against 

manipulation. The potential for price manipulation is no reason to preclude the offering of Election Contracts by a 

DCM; to the contnuy, that potential argues in favor of requiring these types of contracts to trade in the regulated 

markets with appropriate controls and oversight. 

The Commission Should Regulate Elec;tion and Other Event Contracts 

The Act clearly provides that event markets are subject to CFTC regulatory jurisdiction As discussed 

above, in view of the Aces public policy purposes and the manifest commercial and financial interest in electoral 

outcomes, it is appropriate that the CFTC exercise that jurisdiction with respect to Election Contracts and other 

political event markets. These markets already exist, but in imperfect forms. Currently, these markets exist in at 

least three forms: 

• First, the CFTC has, through exemptive authority, granted relief to the Iowa Electronic Markets 

("IEM") to operate an election market. As noted in the Release and a number of academic studies 

(Release at 25670 & :fh 6), the IEM has demonstrated the superior predictive power of a financial 

derivatives market in political contracts. The IEM, however, has strict limits on contract value 

($1.00), participation (a maximum of 2,000 traders) and position size (a maximum of $500 risk in 

any particular market). The IEM's limited pool of participation arguably limits the opportunity for 

information aggregation and, though still better than ordinary polls, the accuracy of its predictive 

power. In addition, the limitations on the size the contract value and amount of risk exposure a 

market participant can acquire essentially render moot any meaningful hedging value in this 

market. 

• Second, a host of .. free, prediction markets exist throughout the United States. (See, e.g., CNN 

Political Market, http://politicalmarket.cnn.com; and WSJ Political Market, 

http://predictions.wsi.com/#). These markets lack the price discovery incentives of a true fmancial 

market like a DCM or even the IEM, offer no hedging value and are not subject to regulatory 

oversight or other protections that would enhance the integrity of such markets. 

• Finally, one of the most popular Election Markets concerning the United States' political process is 

operated by a business incorporated in Ireland, Intrade, at http://www.intrade.com. Intrade's 

market is restricted with respect to participation by United States residents. Despite these 

limitations, trading information from these markets - and, in particular, lntrade's current 

Presidential Election contracts - is broadly disseminated to the United States voting public and 

other U.S.-based users. (See, ''About Intrade", http://www.intrade.coml (June S, 2008) ( .. we have 

supplied market data to CNBC, CNN, FOX, WSJ, FT, New York Times. 7 Federal Reserve 

Districts, over SO major universities and graduate schools in the US, the ECB, Cato, Bank of Japan. 

Bank of England, presidential candidates and major and boutique Wall Street ftrrns.,') Despite the 

broad dissemination of Intrade's market data to United States citizens and the obvious national 

interest in its election market data, this for-profit market is not subject to any regulation comparable 

to the regulatory regime for DCMs. According to lntrade 's website: 

3118.W.._.Drtw 

Sull8 2875 

Cl*llgo, IL. 80608 

let 312.884.0100 
HadgeStreet. I!:XCHANDE 

.. Intrade is not a recognised or designated investment exchange as defined by the Financial 

Services Act 1986 of tht:: UK, the Stock Exchange Act, 1995 of Ireland or the Central Bank 

Act, 1989 of Ireland nor an investment business ftrm as defined by the Investment 

lntennediaries Act, 1995 of Ireland. Trading contracts on-line on the Intrade exchange 

involves risk. ... 

Intrade is neither a bookmaker nor does it hold itself out to be a bookmaker under hish or 

UK law." 

"About Intrade", http://www.intrade.com/ (June 5, 2008). Accordingly, Intrade would assert that 

the Core Principles that protect the integrity of United States futures markets, including the 

principles prohibiting manipulation, do not apply to this market. 

Each of the existing market models falls short of potential benefits to the public of an Election Market operated as a 

OCM. 

DCMs Should Be Permitted to Om:rate Election Markets 

The CFTC's recognition of the ability ofDCMs such as HedgeStreet to offer Election Markets would fulfill 

Congress' mandate ''to promote responsible innovation and fair competition among boards of trade( and] other 

markets." (CEA §3(b), 7 U.S.C. §S(b)). DCMs are well-suited to operate effective, efficient Election Markets. As 

described above, DCMs by definition have the capacity and experience to self-regulate their markets with CFTC 

oversight. This regulatory regime mandates, among other things, that DCMs protect against manipulation of their 

markets (Core Principle 3), have the capacity and structure to ensure the financial integrity of their contracts (Core 

Principle 11) and protect market participants from abusive practices by their agents (Core Principle 12). 

Compliance with these and the other Core Principles that govern DCMs will, in the context of Election Contracts, 

provide a market for the public that is both widely available and reliable. 

Moreover, in order for these markets to operate efficiently and serve the public interest, they should be 

available to all suitable investors. Alternative markets, such as an Exempt Board of Trade ("EBOT") or a 

Derivatives Transaction Execution Facility ("OTEF') are not open to all market participants and are subject to 

lesser (or, in the ease of EBOTs, virtually no) regulatory oversight. To be most beneficial, Election Markets should 

not be limited to a small class of high-net-worth investors such as Eligible Commercial Participants or be required 

to transact business through, and pay requisite brokerage fees to, large futures commission merchants. Any such 

mandated barriers to entry into the market would significantly limit the ability of the market to aggregate all 

relevant infonnation. The HedgeStreet model provides the protections of a DCM structure and without the same 

burdensome expenses of the traditional intermediated DCM market. Accordingly, the CFrC should not limit- and 

should, in fact, recognize- the ability ofDCMs such as Hed.geStreet to offer Election Markets. 

~onclusion 

The public interest in Conunission regulated Election Markets is manifest. The CFI'C has been authorized 

under the Act to regulate such an event market. The market structures currently in place in the United States do not 

sufficiently meet the need for or interest in Election Markets. Therefore, the CFTC should act to permit Designated 

Contract Markets in the United States to offer Election Contracts to the public. In order for these markets to operate 

efficiently) they should be available to all suitable investors among the general public, not just to a select few high-

-6- 311 S. Wecker DIM 

Sll*2075 

Chlcllgo, IL 60808 

181: 312.884.0100 
.. ~ ' ' 

Hedsestreet. , EXCHANIIE 

net-worth investors. Finally, these markets should operate in conformity with the Core Principles applicable to all 

Designated Contract Markets and must be able to demonstrate tbis ability to the satisfaction of the Commission. 

Should you have any questions regarding the above, please do not hesitate to contact me by telephone at 

(312) 884-0171 or by email at tmcdermott@hedgestreet.com. 

CC: Ed Dasso- NFA 

Yossi Beinart- HedgeStreet, Inc. 

-7- 311$. WadrerDrlw 

Sult.2875 

Ollaqci,IL eoeoe 

tM: 312.1184.0100