ESMA Confirms: Many Forecast Markets Fall Under EU Regulation

The European Securities and Markets Authority (ESMA) has recently issued a clear warning regarding prediction markets. The authority states that many contracts within these markets likely fall under the existing restrictions on binary options. This means that companies cannot evade financial regulation by simply labeling their products as “event contracts”.

In a public statement, ESMA reminds companies that event contracts meeting the definition of financial instruments are not permitted for marketing, distribution, or sale to retail investors. These guidelines have been implemented in national legislation stemming from the restrictions on binary options established in 2018.

The assessment of a contract depends on its characteristics, not on the way it is presented. Therefore, it is likely that event contracts with binary outcomes and fixed payouts will be considered financial instruments, which places them under the relevant restrictions. Additionally, it should be noted that offering such contracts to professional or institutional clients also entails required approval under the European Markets in Financial Instruments Directive (MiFID II), regardless of whether private investors are excluded.

The ESMA warning introduces no new restrictions. The authority has issued this reiteration due to the increase in event contract offerings and the accelerated growth of prediction markets. It is relevant to note that restrictions on binary options have already been in force in most EU countries since 2018.

In the United States, a legal battle is unfolding regarding prediction markets, with regional gambling authorities pitted against the Commodity Futures Trading Commission (CFTC). The central question is whether event contracts should be treated as games of chance or as federally regulated derivatives.

In March, government agencies in eleven states had taken legal action against platforms such as Kalshi and Polymarket. Nevada was the first state to temporarily block Kalshi's operations, while Arizona filed criminal charges accusing the company of operating an illegal gambling business.

In April, the CFTC claimed “exclusive jurisdiction” over prediction markets, stating that it had been granted sole authority by Congress to regulate commodity derivatives markets, including event contracts. The CFTC has sued various states and filed lawsuits in support of platforms such as Kalshi.

The legal battle escalates further. On June 30, a judge in Massachusetts allowed state authorities to file an amended complaint against Kalshi in an ongoing lawsuit, arguing that the company's sporting event contracts constitute illegal gambling under state law.

These disputes have also led to calls for action from Congress. Last month, the Indian Gaming Association and the American Gaming Association, backed by tribal and union organizations, urged lawmakers to amend the CLARITY Act to explicitly prohibit sports-related event contracts on prediction marketplaces. They argue that these exchange products fall outside the authority of the CFTC and should remain subject to state gambling laws.

Several legal experts believe that the growing conflict between federal and regional regulators over prediction markets may ultimately be decided by the U.S. Supreme Court.

Frequently Asked Questions

What are event contracts and how do they differ from binary options?
Event contracts are financial instruments that bet on the outcome of specific events (such as sports results) and can have binary outcomes. The main difference from binary options lies in the different legal and regulatory frameworks to which they are subject.

What are the implications of the ESMA legislation for investors?
Investors should be aware that event contracts, depending on their structure, may be considered financial instruments, which can affect their accessibility and the associated risks.

How can American institutions respond to the legal battle surrounding prediction markets?
U.S. institutions can proactively prepare for compliance challenges and potential new CFTC guidelines by reviewing their products and services, taking into account both federal and state laws.