However, three of the five commissioners put on record their misgivings about movie futures, and emphasised that just because they had permitted the exchange’s establishment, that did not mean they would grant the separate approvals needed for its contracts.

In addition, Cantor Fitzgerald, the New York-based brokerage, who first proposed the idea of a movie futures exchange in 2008, has won CFTC approval to establish a designated contract futures market, but not approval for the trading of motion picture box office receipts.

The idea of box office futures is that market participants can bet on the quantity of revenues a certain film will make in a given period after its release. This instrument would allow film makers and distributors to hedge the commercial risk of a film.

The concept draws on the experience of “opinion markets” in which people wager on the outcome of an event such as an election. Such markets have sometimes proved good predictors – perhaps because they synthesise the knowledge of many people.

Trend Exchange is owned by Movie Derivatives, a company wholly owned by Veriana Networks of Scottsdale, Arizona.0

Film body opposed

In recent weeks the Motion Picture Association of America has urged the CFTC to block the exchanges. It argued movie futures would be unacceptably risky and could lead to “rampant speculation and financial irresponsibility”.

The Futures Industry Association backed the idea, telling the CFTC: “No one can argue that the movie-making business is without risk or that there is no need for effective risk management tools. The potential introduction of innovative instruments for managing that risk should be applauded rather than criticised.”

On April 16, the CFTC approved the application, begun on September 25, to register Trend Exchange as a designated contract market. It also approved the exchange’s rules.

The Minneapolis Grain Exchange will clear the exchange’s contracts, which will be based on revenue data collected by Rentrak Corp. The National Futures Association will provide trade practice and market surveillance and other compliance services.

The CFTC reminded Media Derivatives of its obligation to set position limits and position accountability levels.

Contracts not allowed yet

But the CFTC has not yet signed off any contracts for the exchanges, and trading cannot begin until it has. Opening Weekend Box Office Revenue binary options and collared futures have been submitted by TrendEx for its approval.

And alongside its order granting the Trend Exchange DCM status, the CFTC also published two statements, one from commissioners Scott O’Malia and Jill Sommers, and one from commissioner Bart Chilton.

The statements concurred with the decision granting DCM status, but expressed the commissioners’ doubts that movie derivatives would be beneficial.

O’Malia and Sommers said: “We have serious concerns regarding the trading of media contracts and we support a very thorough review of all of these first-of-a-kind products to ensure they will provide a useful commercial hedging tool and are free from fraud and manipulation.”

They emphasised that while the Commodity Exchange Act allows DCMs to self-certify contracts, in this particular case, a condition has been imposed on Media Derivatives, that the CFTC must approve each contract it introduces.

Sommers and O’Malia’s statement concluded by saying that they expected CFTC staff soon to review the proposed contracts and inform the Commission whether they satisfy the rules.

Manipulation fears

“Specifically,” they wrote, “we expect that Commission staff will review and have a thorough understanding of: (1) whether the contract provides a useful hedging tool for a variety of industry participants and investors with commercial exposure on both the long and short side of the contract; (2) whether the contract is susceptible to manipulation or distortion; (3) whether the cash settlement of the contract is at a price reflecting the underlying cash market; and, (4) whether the price is based upon a cash price series that is reliable, acceptable, publicly available, and timely.”

The commissioners said these conditions were relevant to the approval of both a traditional cash-settled futures contract and a novel one such as the box office receipts contract.

“If MDEX’s contracts fall short of these conditions,” they warned, “then it is our opinion that approval is not permitted under the Act.”

The comments hint at several weaknesses the commissioners perceive with movie futures. While it is easy to see that producers and distributors might want to hedge downside risk, what market participants have “commercial exposure” that would be harmed if a film performed well?

Such contracts are controversial because futures and options are traditionally used to hedge risks that are beyond the control of any one market participant, and where a movement of the underlying in one direction benefits some players and harms others. Commercial risks such as the success or failure of a film might be judged too susceptible of influence by insiders to constitute a fair proposition for third parties.

It is not clear whether the commissioners’ points 3 and 4 are a torpedo that could sink movie derivatives or a more modest expression of concern.

If the commissioners mean they will only permit box office futures if there is a transparent underlying cash market in forecasts of movie revenues, then that is a bar the new exchanges cannot leap – there is no such market.

If, on the other hand, they merely mean that the “price series” could be the data gathered on movie revenues after the fact, then these conditions could presumably be fulfilled fairly easily.

Chilton looks for 'legitimacy'

Characteristically, commissioner Bart Chilton expressed his view with more vehemence and colour.

“I reluctantly concur in the Commission’s action,” he began, before explaining that the CFTC was only approving the application because it had no choice – it was obliged to rule within a specified time and could only turn down an application if the would-be exchange did not satisfy the designation criteria.

The agency has until June 7 to approve or disapprove the contracts submitted on March 9. Chilton said: “While I certainly promote innovation in futures markets, I remain adamant that I will not cast a vote to approve a contract that I believe serves no legitimate risk management purpose, that cannot be used to effectively price a commodity, or that is inherently susceptible to manipulation.”

He emphasised that even though the Commodity Futures Modernization Act of 2000 had removed the test that contracts must serve an economic purpose, the CFTC’s mandate was still “to oversee markets that provide a means for ‘managing and assuming price risks’ and ‘discovering prices’”, as well as protecting consumers from price manipulation.

Chilton has “significant concerns” about box office futures in each of these areas, he said, before concluding “I have not heard any arguments to persuade me that ‘movie futures’ generally can overcome some fundamental design flaws”.

Jon Hay +44 207 779 8372 jhay@fow.com