Tag: Derivatives

When Does A Stock Picking Contest Turn Into a Derivative

Forcerank’s premise was simple: “fantasy sports for stocks”.

Forcerank runs mobile phone games where players predict the order in which stocks would perform relative to each other.  In its original form, if a player did well he or she won points and could some receive a cash prize. Forcerank kept 10 percent of the entry fees.

The gaming is a ruse to collect data. Forcerank iss looking to obtain data about market expectations that it hopes to sell to hedge funds and other investors.

forcerank

It seems clear to me that Forcerank was concerned about the gambling aspect of the app. There was a provision in the rules the stated the Forcerank contest was a “skill based” contest. If it were not skill-based (i.e luck) then it would be gambling. You pay an entry fee and if you win you get a prize. If winning is based on luck it’s gambling.

The Securities and Exchange Commission looked at the Forcerank contest in a different light.

Dodd-Frank gave the SEC new powers to regulate security-based swaps.

The Commodity Exchange Act defines the term “swap”:

“[T]he term ‘swap’ [includes] any agreement, contract, or transaction—… (ii) that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence[.]”

That’s a very broad definition. It was a definition that the SEC applied to the Forcerank contests.

[E]ach Forcerank entry was a swap because each participant paid to enter into an agreement with Forcerank LLC that provided for the payment of points and, in certain cases, cash. Those payments were dependent upon the occurrence, or the extent of the occurrence, of an event or contingency (i.e., the player’s predictions about the price performance of individual securities being compared to actual performance and the player’s aggregate points being compared to other players). Such event or contingency was “associated with a potential financial, economic or commercial consequence” because it was calculated by measuring the change in the market price of an individual security over a period of time and comparing that change to an identical metric based on the market price of other individual securities.

I find this an interesting roadblock to stock-picking contests.

I looked at the Forcerank website and downloaded the app. There is no longer an entry fee and there are no cash prizes. That removes it from the definition of “derivative”. It also removes the incentive to enter the contest and the revenue stream from Forcerank.

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The Slow Rulemaking on Swaps and Derivatives

One of the strange splits in US financial regulation is that many swap and derivatives are regulated by the Commodities Futures Trading Commission instead of the Securities and Exchange Commission. I think of the CFTC, I think of Trading Places and with the SEC I think of Wall Street.

The Commodity Futures Trading Commission has delayed its rollout of regulations under the Dodd-Frank Wall Street Reform and Protection Act has been pushed back until at least early 2012. This delay is the second time the CFTC has put the brakes on its new rules that will govern the over-the-counter derivatives market. In my view, taking longer to get the rules right is better than pushing through bad rules just to meet some arbitrary deadline. The question will be whether the CFTC will succeed in creating rules that will make the derivatives market one that is more transparent and easier to oversee for lines of trouble.

As for trouble, take a look at Greek bonds as an example. The Credit Default Swaps cost a record $5.8 million upfront and $100,000 annually to insure $10 million of Greece’s debt for five years using credit-default swaps. That means the market is saying it’s about a 58% chance that Greece will default in the next five years. But how extensive is that exposure in the US? How many people are on the hook for payouts if Greece defaults?

If your firm uses derivatives or swaps for dealing with debt risks or foreign exchange risks, you should pay attention to the CFTC rulemaking. They are likely to change the process and the cost of dealing with these risks.

Gary Gensler, Chairman of the CFTC, says that “until the CFTC completes its rule-writing process and implements and enforces these new rules, the public remains unprotected. That’s why the CFTC is working so hard to ensure that swaps-market reforms promote more open and transparent markets, lower costs for companies and their customers, and protect taxpayers.”

Europe’s Approach to Derivatives Regulation

With this summer’s passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, it’s Europe’s turn to address financial regulation. This morning, the European Commission released its Proposal for Regulation on OTC Derivatives, central counterparties and trade repositories.

The proposal seems to look a lot like the Dodd-Frank’s approach by creating a central trade repository, required margins, and required collateral. The proposal follows the commitment from the G-20 that

“All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.”

The proposal excludes non-financial firms who use derivatives to mitigate risk in their core business from the central clearing requirements.

More analysis to come.

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I’m reading through the proposal and the supporting documents.