The collared futures contract and binary option contract that
have been approved are based on the opening weekend revenue for
the forthcoming film Takers, due to be released on 20
The creation of film futures exchanges has been highly
controversial, with strong opposition from the Motion Picture
Association of America and equally vehement support from the
two companies that have set up exchanges: Media Derivatives
(MDEX) and Cantor Exchange.
While the exchanges claim the instruments would be a useful
hedging product for participants in the multi-billion dollar US
movie industry, opponents believe they are an unprecedented
kind of instrument that is open to manipulation.
The CFTC explained in its statement that the Commodity Exchange
Act requires the Commission to "approve any such new contract
or instrument... unless... [it] would violate the Act". On the
advice of its staff, three of the commissioners believed the
Media Derivatives products did not violate the Act or the
CFTC’s regulations. However, the CFTC did require
certain modifications "to guard against manipulation or any
other abusive conduct in the trading of any contract by
knowledgeable and informed sources within the studio or
The CFTC decided that the contracts were based on commodities,
were not readily susceptible to manipulation and served an
economic hedging purpose – though the last of these
three is not legally required for approval.
A new kind of commodity
Both Chilton and Sommers expressed scepticism that film box
office revenues could really be characterised as
The CFTC’s majority view was that Section 1a(4) of
the Commodity Exchange Act (CEA) provides that "all services,
rights, and interests in which contracts for future delivery
are presently or in the future dealt in" are statutory
The Commission believes that Congress intends it to regulate
futures and options on "all commodities, goods, articles,
services, rights, and interests which are or may be the subject
of futures contracts".
It pointed to more than 500 existing contracts at US exchanges
that are based on intangible rights or interests, or on
non-price-based measures of economic, commercial or
environmental activity. In many cases there is no cash market
underlying these derivatives.
In an appendix, the CFTC listed 14 pages of such existing
contracts, ranging from options on the earnings per share of
specific companies to futures and options on economic
indicators like inflation and employment numbers, to specific
merger and acquisition scenarios and weather
The CFTC concluded that movie revenues were "little different"
from these other events.
The second major issue considered by the CFTC, which it said
was "of paramount concern", was the contracts’
potential susceptibility to manipulation "either (1) through
trading behavior or (2) by using or manipulating privileged or
insider information by certain studio or distribution company
Manipulation fears dismissed
US exchanges are obliged under Core Principle 3 of the CEA to
list "only contracts that are not readily susceptible to
The CFTC staff insisted on specific modifications to the
original contract proposal to "ensure that knowledgeable
parties cannot intentionally release or misreport data that
would have an impact on the trading or settlement of this
In its statement, the CFTC paid particular attention to
Rentrak, the company that collects the data on box office
revenues that will be used as the underlying indicator for the
The regulator said it was "satisfied that the revenue numbers
used by these contracts to determine settlement should minimize
the potential for manipulation".
In particular, it said Rentrak was a third party data
aggregator with no direct monetary interest in any film, and a
strong incentive to produce accurate figures. Its collection of
data is mainly automated but also involves emails and faxes
– the CFTC said this was analogous to the processes
used to compile pricing data for agricultural and commodity
"Fair and equitable"
Another point addressed by the CFTC was that
MDEX’s rules "properly address fair and equitable
trading and false reporting concerns".
The CFTC has insisted that MDEX adopt a rule that requires
entities and individuals who control a film’s
marketing budget, release date or opening screen number to
provide the exchange with information regarding such decisions
whenever that entity or individual holds a position of 1,000 or
"The Commission has responded," it said, "to the concerns that
have been raised by various individuals and parties that a
distributor could influence, to some degree, the level of box
office revenues for a film by changing a movie’s
marketing budget, release date or number of screens on which it
opens. Concerns were raised whether parties could
'intentionally or accidentally’ misreport data
relevant to the revenue contracts or change the number of
theaters that would show the film during the opening weekend.
This rule change will permit those entities to utilize this
hedge instrument, if they desire, but provide essential
transparency to the exchange, the National Futures Association
and the Commission, which all have oversight responsibilities
ensuring fair and equitable trading."
The Commission went on to say that while it did not believe the
revenue numbers were readily susceptible to manipulation,
"'false rumors’ or misreporting of data may exist
in the motion picture industry, just as it does with many other
Although such false reporting might be a violation, the CFTC
argued, the possibility of that happening did not mean the
contracts violated the CEA.
One of MDEX’s rules will require studios or film
distributors that trade contracts on films they have released
to adopt firewall procedures to separate employees.
Another MDEX rule forbids any employee of a distributor who is
responsible for compiling film revenue numbers to trade any
contracts on films released by that distributor; nor may any
Rentrak employee use them, or disclose information about the
The Commission said it "believes these additional protections
agreed to by MDEX satisfy the requirement to ensure that
trading in this contract is fair and equitable".
A way to manage risk
Finally, the CFTC addressed the question of whether the
contracts would "provide reasonable means for managing
The agency explained that since the Commodity Futures
Modernization Act of 2000, it has no longer been required to
apply an economic purpose test to evaluate whether proposed new
contracts fulfilled a useful hedging purpose.
Nevertheless, "in light of the comments raised by the studios"
which attacked the futures, the Commission did evaluate the
contracts’ utility as a hedging tool.
"The Commission found that the contracts can perform hedging
and price discovery purposes," it said. "Industry profit and
losses have a clear and direct relationship to box office
revenues. A contract based on those revenues could be used to
hedge related risks."
Its analysis found that "there are significant risks faced by
many firms in the movie industry", including "third party"
financing, estimated to amount to $14bn since 2004.
"Studios have increasingly relied on third party financial
arrangements through Special Purpose Vehicles and/or
securitization to reduce their own commercial exposure," it
found. "The Commission understands from numerous written
comments... that these third party investors may utilize
futures contracts to mitigate their commercial exposure, even
if the studios do not."
Second, the CFTC found that "box office revenue numbers are
viewed by the industry as meaningful indicators of the success
of a particular film", and that these numbers are used in
contracts such as for TV licence fees and payments to
Third, the CFTC relied on nine comment letters or statements at
its public hearing, which either said the contracts would
provide a risk management tool or expressed interest in using
them for hedging.
"Those commenters stated that direct participants in the motion
picture industry, such as studios and producers, may benefit
from having motion picture revenue futures contracts," it said.
"They also stated that parties not directly involved in the
motion picture business, such as third party financiers,
licensers and merchandisers, might hedge risks associated with
"A line that should not be crossed"
Sommers and Chilton both disagreed with the CFTC’s
analysis on fundamental points. Sommers concluded her
statement: "There are a number of questions which I believe
have never been answered and although staff has recommended
approval of these particular [contracts], it is unclear to me
how they fit into our current regulatory structure."
In particular, Sommers said the first step in analysing any
contract submitted for approval was to determine whether the
contract actually was a sale of a commodity, as defined by the
"While the definition of 'commodity’ is rather
broad, it is not without limits," Sommers contended. "The
Statement of the Commission does not appear to recognize a
limit to that definition."
She explained that the Commission had analysed whether box
office revenues were a "right or interest" and therefore a
commodity. The analysis found that they were not rights and
"did not fit within the common definition of an interest" but
that it was nevertheless "not problematic" to consider them an
interest because the CFTC had previously approved other futures
that did not fit within the definition.
But Sommers argued: "In applying the Act and Regulations, where
that which underlies a contract does not neatly or cleanly fit
within the definition of a 'commodity’, the
Commission should carefully exercise its judgment in
determining whether or not the underlying is, in fact, a
commodity. Carefully exercising that judgment involves drawing
lines. Invariably, when drawing lines some things will end up
on one side of the line, and some will end up on the other. I
believe that including motion picture box office revenues as
'rights or interests’ that fall within the
definition of 'commodity’ contained in Section
1a(4) of the Act crosses a line that should not be
Sommers regretted the fact that the CFTC had not completed a
process, begun in 2008, of devising a policy on how to regulate
event contracts, and said she would prefer that the Commission
solve the broad policy issues first.
Not commodities for Chilton
Chilton’s dissent was longer, more detailed and
more trenchant. He said he believed that the proposed contracts
violated the CEA.
His analysis came in two sections. The first examined the
question of whether movie box office revenues were a commodity.
In Chilton’s view, the CFTC’s ruling
on this point was "fundamentally flawed". Although Congress
meant to define "commodity" broadly, he said, "There is a limit
to the elasticity of the definition."
Chilton argued: "In interpreting the CEA, we are to exercise
some modicum of common sense in determining whether or not
there is a public interest in deeming some 'thing’
a commodity... Otherwise, the statute is meaningless; unless
some sensible judgment is exercised, we could approve terrorism
contracts, or contracts on whether a certain movie star will
die or become disabled, or contracts on the likelihood of UFOs
hitting the White House... To say that, simply because one can
develop a futures contract, the underlying is a
'commodity’ is circular reasoning, at best. Using
this analysis, anything under the sun could be a commodity if
you could, at some time in the future, have a futures contract
on it. We know that is not how Congress intended for us to
interpret the Act."
Chilton said the CFTC’s reasoning that movie
futures were like other contracts it had previously approved
was not supported by sufficient legal analysis, "particularly
when we have so much evidence that movie box office revenues
are not 'what we’ve seen
He also attacked the idea that movie futures could qualify as
"excluded commodities" under section 1a(13) of the Commodity
Futures Modernization Act. Chilton argued that these contracts
were not "occurrences" as contemplated in part (iv) of that
section, because the transactions are not "beyond the control
of the parties to the relevant contract".
Chilton said it was mystifying why the Commission had focused
on the question of whether there was a requirement for a
futures market to be based on a cash market, as that was not
the point at issue. Rather, it was the lack of clear policy on
event contracts that mattered. Instead of having "more fully
developed these legal issues" the Commission had "simply made
the virtually unadorned assertion that 'these are
Chilton concluded that "if there is no clear applicable
definition of 'commodity’ into which we can fit
movie box office returns, there is a fundamental jurisdictional
obstacle to approving the requested contracts".
The second part of Chilton’s statement analysed
whether the contracts involved managing and assuming price
He criticised the CFTC’s focus on whether the
contracts will be "susceptible to manipulation" and on the
Rentrak numbers. He said the key point, "whether there is
evidence that the contract can actually be used to manage those
risks" had "regrettably been avoided".
Chilton argued: "Given the conflicting information received on
this point, and the inherent conflicts that a single
producer/single 'commodity’ contract presents, the
Commission has not provided sufficient basis to approve this
contract as a viable hedging tool."
He went on: "This is an action of first impression at the
Commission – the first time that it has approved a
contract where there is a single producer, a single entity
controlling the entirety of the 'market’. The fact
that conflict of interest rules were necessary points out the
fundamental flaw in [the] reasoning of the approval: if it is
necessary to 'wall off’ the primary (or at least,
one of the primary) users of the contract, how can it be deemed
a viable transaction used to 'manage’
He said the testimony that movie investors "may" be able to use
such contracts was rebutted by other testimony "that the
contract design was fundamentally flawed, both in timing and in
Concluding that MDEX had not fulfilled its obligation to show
that the transactions did not violate the requirements of the
CEA, Chilton said "Moving forward on such slim evidence is not,
in my opinion, either warranted or wise. It is my hope and
expectation," he ended, "that, in the future, the Commission
will perform a more fulsome and careful review of such
The CFTC must now decide by June 28 whether to approve the
application of the Cantor Futures Exchange to offer contracts
linked to the soon-to-be launched film
However, while Media Derivatives seems to have won the battle
to list film futures, it may yet lose the war. The Motion
Picture Association has lobbied the Senate to include a section
in its financial market reform bill which would ban movie
derivatives, though this still needs to be approved by
Jon Hay +44 207 779 8372 email@example.com
Colin Packham, Sydney firstname.lastname@example.org