May 19, 2010
The purpose of this hearing is to provide the Commission with additional information related to pending contract approval requests submitted by two separate exchanges -- Media Derivatives Inc., which I’ll refer to as MDEX, and Cantor Futures Exchange. The settlement prices of the contracts submitted for approval are based on the level of box office receipts from theaters for particular movies (the contracts are often referred to as “movie futures” or “box office receipt futures”).
The Commission recently approved the contract market designation applications for these two exchanges. Staff found that the applicants met the CEA requirements applicable to operating as a designated contract market, and recommended to the Commission that the applicants’ request be approved. The Commission approved the designation of MDEX on April 16, 2010. Cantor was designated on April 20, 2010.
The Designation Orders for both MDEX and Cantor require them to submit to the Commission for prior approval any new class or category of media-related products before listing them for trading. In conditioning these designations, the Commission recognized that media contracts may require special review to ensure, among other things, that they are consistent with the Act and the Commission’s regulations, considering the unique nature of these contracts.
MDEX and Cantor Requests for Contract Approval
On March 9th, MDEX requested approval of its collared futures and binary option contracts based on the Opening Weekend Motion Picture Revenues for the film Takers. A collared futures contract is a contract that caps each trader’s possible gains while limiting potential losses. The caps and floors will establish trading ranges of $100 million, with each $1 million of revenue equal to $50. For example, MDEX can list a contract for Takers that has a floor of $200 million and a cap of $300 million. If a buyer and seller enter into the contract at an initial revenue level of $250 million, then the seller would collect $2,500 from the buyer. This figure is arrived at by subtracting the floor, $200 million, from the initial contract value, $250 million, resulting in a revenue level of $50 million. Since each million dollars of revenue is valued at $50, the initial contract value in this example would be $50 multiplied by 50, which is $2,500.
If the actual gross box office revenues for the film are below $200 million, then the buyer would lose $2,500 and no more than $2,500. The purpose of the cap and floor contract is to ensure that maximum gains and losses are known so that the contracts can be fully collateralized. With respect to position limits, MDEX’s has proposed a position limit of 25,000 contracts, net long or short, for its Takers collared futures contracts.
MDEX also intends to list binary call options with strike-price increments of $20 million. A binary call option contract is an option in which the purchaser either receives nothing or receives a fixed amount if the box office receipts are at or above a certain strike price. An option is in-the-money if the opening weekend motion picture revenues are greater than the strike price; the value of an in-the-money option is $5,000. MDEX has proposed a position limit level of 25,000 contracts, net long or short, for all strike prices listed.
Both MDEX contracts are settled based on the reported opening weekend motion picture revenues. The opening weekend is defined as the time that the motion picture is released through the following Sunday. The contracts are settled on the following Thursday.
The MDEX contracts’ 45-day fast track review period would have ended on April 23rd, but staff extended its review to the full 90-day statutory review period. The statutory review period ends June 7, 2010.
On March 30th, Cantor requested approval of its Domestic Box Office Receipts futures contract based on the film The Expendables. Cantor intends to list futures on domestic box office receipts covering revenues for the first four weeks that a motion picture has been released. The four-week period is defined as the time that the motion picture is released through the fourth weekend following release. The contract size is determined by dividing the box office receipts number by $1 million. Therefore, total box office receipts of $100 million would translate into a contract size of $100. Cantor has proposed a position limit of 10,000 contracts. As with MDEX contracts, staff extended the review period for the Cantor contract to the statutory deadline, which is June 28, 2010.
The box office receipt numbers used for cash settlement are calculated by the distributor of the motion picture. Staff understands that the vast majority of motion picture revenues are reported from the theaters to distributors through Rentrak Corporation. Rentrak is a media measurement and research company which, among other things, provides audience measurement services to the entertainment industry. Rentrak can be described as a third-party data aggregator; it has no direct interest in any motion picture. The company is headquartered in Portland, Oregon with offices in New York, Los Angeles and Ft. Lauderdale, Florida.
A small amount of box office receipts are not reported through Rentrak; they are reported directly from those theaters to the distributor. This data is referred to as call-around data. Once the distributor sums the Rentrak and call-around receipt data, that number is reported back to Rentrak which in turn distributes it to Variety Magazine, BoxOfficeMojo.com, and other news organizations and interested parties.
The exchanges have created processes to validate the gross box office revenue data disseminated by the studios that will be used to calculate the final settlement value. The objective is to ensure that the Rentrak raw data comprises a very high percentage of the gross box office revenues that are reported publicly by the distributing studios. If publicly reported data varies from the raw data in a manner that is statistically significant, the exchanges will initiate additional procedures to validate the Rentrak raw and call-around data.
Both contracts have been posted on the Commission’s website for public comment. The comment period for the MDEX contracts ended on May 14, 2010. The comment period for Cantor’s contract will end on May 21, 2010. As of yesterday, five comment letters relevant to both contracts were submitted to the Commission. Two comment letters were from Congress, one dated April 22, 2010 from a group of Senators, and a second dated April 28, 2010 from a group of Congressman. Both letters expressed concern about the CFTC’s possible approval of movie box office revenue contracts, citing pending financial legislative efforts that may prohibit such contracts, the opposition of a segment of the movie industry to the listing of these contracts, possible trading restrictions on studios, whether such contracts serve a hedging function, and the possible diversion of limited CFTC resources that could be put to more productive use. The other three comment letters were written in support of the movie contracts. One comment letter stated that the success of the Domestic Box Office Receipts contract was critical to fostering growth in the U.S. film industry and in creating efficiency and transparency in the finance phases of the filmed products, while a second comment letter stated support for regulated and transparent box-office futures exchanges.
With respect to our review, the CEA specifies that the Commission must take action on a proposed contract within 90 days of a request for its approval. The relevant provision particularly provides that, “The Commission shall approve any such new contract or instrument . . . unless the Commission finds that the new contract or instrument . . . would violate the Act.” If no action is taken at the end of the 90 days, under Commission regulations, the contract is deemed approved.
Under the CEA, the primary focus of the staff’s review of contract filings is to ensure that the contract is not readily susceptible to manipulation (Core Principle 3) and that the contract has speculative position limits or position accountability rules that minimize the susceptibility to manipulation (Core Principle 5). In addition, staff considers any comments received related to the approval request.
Under Core Principle 3, for cash settled contracts such as these, staff carefully evaluates the cash price series that will be used for settlement. In particular, we will consider the manner in which the Rentrak number is generated, the data collection methodology and data release procedures, the mechanisms and procedures in place by Rentrak and the distributors to ensure its reliability and that it is not readily susceptible to distortion or manipulation, and the specific rules and procedures adopted by the exchanges to mitigate against manipulation and inappropriate premature access to the numbers. Also, as a part of its Core Principle 3 review, and pursuant to the safe harbor conditions of Guideline 1, staff will consider whether the box office revenues are reliable, verifiable, publicly disclosed and available on a timely basis. Finally, staff will consider any contract design specifications, trading restrictions, and other protections that should be used to minimize the potential for price distortions and manipulation.
Under Core Principle 5, all exchanges are required to reduce the potential threat of market manipulation or congestion, particularly during spot months, by adopting position limits or position accountability rules. Staff will review each exchange’s position limit and accountability rules to ensure that the speculative limits are appropriate to reduce the incentive for a trader to attempt to distort the cash settlement price to profit on a large futures position. Staff will review the exchanges’ procedures for granting exemptions from the speculative position limits.
I would like to note that the Core Principle requirements for DCM contracts were added to the CEA in 2000 by the Commodity Futures Modernization Act. At that time, the CFMA repealed that section of the Act which embodied a public interest requirement that in turn included an economic purpose test. Under the economic purpose test, exchanges could only list for trading contracts that could be used on more than an occasional basis for hedging or price-basing purposes. As a result of the changes of the CFMA, staff does not routinely consider the economic purpose served by proposed contracts in its reviews. However, in view of the comments expressed by interested parties and several commissioners related to the potential hedging uses of the contracts, staff will consider the potential hedging utility of the proposed contracts. The comments of the panelists here today would be of much interest to staff in our analysis.
In conclusion, with respect to the contracts submitted for approval, staff review is ongoing. Our review will fully consider the relevant statutory and regulatory requirements as well as the comments submitted. In particular, we look forward to the views provided at this Hearing which should help inform staff about this issue so that the ultimate decision is based on a full consideration of all applicable statutory criteria and other relevant considerations. Thank you.
Last Updated: January 19, 2011