[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
HEARING TO REVIEW PROPOSALS TO
ESTABLISH EXCHANGES TRADING ``MOVIE
FUTURES''
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
GENERAL FARM COMMODITIES
AND RISK MANAGEMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
__________
APRIL 22, 2010
__________
Serial No. 111-49
Printed for the use of the Committee on Agriculture
agriculture.house.gov
U.S. GOVERNMENT PRINTING OFFICE
56-431 PDF WASHINGTON : 2010
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COMMITTEE ON AGRICULTURE
COLLIN C. PETERSON, Minnesota, Chairman
TIM HOLDEN, Pennsylvania, FRANK D. LUCAS, Oklahoma, Ranking
Vice Chairman Minority Member
MIKE McINTYRE, North Carolina BOB GOODLATTE, Virginia
LEONARD L. BOSWELL, Iowa JERRY MORAN, Kansas
JOE BACA, California TIMOTHY V. JOHNSON, Illinois
DENNIS A. CARDOZA, California SAM GRAVES, Missouri
DAVID SCOTT, Georgia MIKE ROGERS, Alabama
JIM MARSHALL, Georgia STEVE KING, Iowa
STEPHANIE HERSETH SANDLIN, South RANDY NEUGEBAUER, Texas
Dakota K. MICHAEL CONAWAY, Texas
HENRY CUELLAR, Texas JEFF FORTENBERRY, Nebraska
JIM COSTA, California JEAN SCHMIDT, Ohio
BRAD ELLSWORTH, Indiana ADRIAN SMITH, Nebraska
TIMOTHY J. WALZ, Minnesota DAVID P. ROE, Tennessee
STEVE KAGEN, Wisconsin BLAINE LUETKEMEYER, Missouri
KURT SCHRADER, Oregon GLENN THOMPSON, Pennsylvania
DEBORAH L. HALVORSON, Illinois BILL CASSIDY, Louisiana
KATHLEEN A. DAHLKEMPER, CYNTHIA M. LUMMIS, Wyoming
Pennsylvania ------
BOBBY BRIGHT, Alabama
BETSY MARKEY, Colorado
FRANK KRATOVIL, Jr., Maryland
MARK H. SCHAUER, Michigan
LARRY KISSELL, North Carolina
JOHN A. BOCCIERI, Ohio
SCOTT MURPHY, New York
EARL POMEROY, North Dakota
TRAVIS W. CHILDERS, Mississippi
WALT MINNICK, Idaho
------
______
Professional Staff
Robert L. Larew, Chief of Staff
Andrew W. Baker, Chief Counsel
April Slayton, Communications Director
Nicole Scott, Minority Staff Director
______
Subcommittee on General Farm Commodities and Risk Management
LEONARD L. BOSWELL, Iowa, Chairman
JIM MARSHALL, Georgia JERRY MORAN, Kansas, Ranking
BRAD ELLSWORTH, Indiana Minority Member
TIMOTHY J. WALZ, Minnesota TIMOTHY V. JOHNSON, Illinois
KURT SCHRADER, Oregon SAM GRAVES, Missouri
STEPHANIE HERSETH SANDLIN, South STEVE KING, Iowa
Dakota K. MICHAEL CONAWAY, Texas
BETSY MARKEY, Colorado BLAINE LUETKEMEYER, Missouri
LARRY KISSELL, North Carolina ------
DEBORAH L. HALVORSON, Illinois
EARL POMEROY, North Dakota
TRAVIS W. CHILDERS, Mississippi
Aleta Botts, Subcommittee Staff Director
(ii)
C O N T E N T S
----------
Page
Boswell, Hon. Leonard L., a Representative in Congress from Iowa,
opening statement.............................................. 1
Prepared statement........................................... 2
Moran, Hon. Jerry, a Representative in Congress from Kansas,
opening statement.............................................. 2
Prepared statement........................................... 3
Peterson, Hon. Collin C., a Representative in Congress from
Minnesota, opening statement................................... 4
Prepared statement........................................... 4
Witnesses
Berkovitz, Dan M., General Counsel, Commodity Futures Trading
Commission, Washington, D.C.................................... 4
Prepared statement........................................... 6
Jaycobs, Richard, President, Cantor Futures Exchange, L.P., New
York, NY....................................................... 24
Prepared statement........................................... 26
Swagger, Robert S., Chairman and CEO, Media Derivatives, Inc.,
Scottsdale, AZ................................................. 31
Prepared statement........................................... 33
Pisano, A. Robert, President and interim CEO, Motion Picture
Association of America, Inc., Washington, D.C.................. 39
Prepared statement........................................... 40
Harbinson, Scott, International Representative, International
Alliance of Theatrical and Stage Employees, Ellicott City, MD;
on behalf of Directors Guild of America........................ 50
Prepared statement........................................... 52
Moore, Schuyler M., Adjunct Professor, UCLA School of Law;
Adjunct Professor, UCLA Anderson School of Management; Partner,
Stroock & Stroock & Lavan LLP, Los Angeles, CA................. 54
Prepared statement........................................... 56
Submitted Material
Chance, Ph.D., C.F.A., Don M.; on behalf of Cantor Fitzgerald,
submitted statement............................................ 75
Independent Film & Television Alliance, submitted statement...... 73
Plott, Charles R., Professor of Economics and The Edward S.
Harkness Professor of Economics and Political Science, Division
of the Humanities and Social Sciences, California Institute of
Technology, submitted letter................................... 88
Rutledge, M.B.A., Ann, Adjunct Associate Professor, Department of
Finance, Hong Kong University of Science and Technology,
submitted letter............................................... 91
Submitted questions.............................................. 92
HEARING TO REVIEW PROPOSALS TO
ESTABLISH EXCHANGES TRADING ``MOVIE
FUTURES''
----------
THURSDAY, APRIL 22, 2010
House of Representatives,
Subcommittee on General Farm Commodities and Risk
Management,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:30 a.m., in
Room 1300, Longworth House Office Building, Hon. Leonard L.
Boswell [Chairman of the Subcommittee] presiding.
Members present: Representatives Boswell, Marshall, Walz,
Schrader, Markey, Kissell, Pomeroy, Childers, Peterson (ex
officio), Moran, Luetkemeyer, and Goodlatte.
Staff present: Aleta Botts, Clark Ogilvie, Rebekah Solem,
John Konya, James Ryder, Debbie Smith, Kevin Kramp, Tamara
Hinton, and Sangina Wright.
OPENING STATEMENT OF HON. LEONARD L. BOSWELL, A REPRESENTATIVE
IN CONGRESS FROM IOWA
The Chairman. Our hearing will come to order. I would like
to thank everyone for joining us here today as we take a
thorough review of proposals to establish exchanges to trade
movie futures. I would like to give a special thanks to our
witnesses for testifying before the Committee and offering
their insight.
The hearing today explores a novel, new product being
considered for trading on a futures exchange regulated by the
Commodity Futures Trading Commission. This product is movie
futures or box office derivatives. When the Commodity Exchange
Act was first passed in the 1930s, it was very unlikely that
the Congress envisioned such a product would be regulated by
the Act. Even with subsequent amendments to the CEA, I doubt
those here today foresaw the development of this type of
exchange. Nevertheless, two applicants have developed proposals
to establish these box office exchanges and are seeking
approval of contracts that would be offered there.
I am pleased that both applicants are here today to discuss
the products in more detail and, hopefully, answer some of the
concerns that have been raised about the nature of the
marketing of these products. Mitigating financial risk is a
primary reason for futures exchanges; however, the natural
hedgers of the products have for the most part insisted they
will not be using the products to hedge their risk for various
reasons. We look forward to hearing from our witness today on
why this may or may not be the case.
The CFTC has approved the application to establish these
exchanges, but the contract applications are still pending.
This hearing is especially timely, given the current state of
financial regulatory affairs and the actions going on in the
Senate that we understand would establish in statute a
prohibition of such exchanges. I hope the witnesses will
provide this Committee with the context necessary to better
understand these exchanges and the issues presented by them so
that the Members here will be able to ascertain the correct
course of action, going forward, and for future consideration
of these applications by the CFTC and the law by the Congress.
Again, I would like to thank everyone for joining us today.
[The prepared statement of Mr. Boswell follows:]
Prepared Statement of Hon. Leonard L. Boswell, a Representative in
Congress from Iowa
I would like to thank everyone for joining me here today as we take
a thorough review of proposals to establish exchanges to trade ``movie
futures.'' I would like to give a special thanks to our witnesses for
testifying before the Committee and offering their insight.
The hearing today explores a novel new product being considered for
trading on a futures exchange regulated by the Commodity Futures
Trading Commission. This product is movie futures, or box office
derivatives. When the Commodity Exchange Act was first passed in the
1930s, it is very unlikely that the Congress envisioned such a product
would be regulated by the Act. Even in subsequent amendments to the
CEA, I doubt those of us here today foresaw the development of this
type of exchange.
Nevertheless, two applicants have developed proposals to establish
these box office exchanges and are seeking approval of contracts that
would be offered there. I am pleased that both applicants are here
today to discuss their products in more detail and hopefully answer
some of the concerns that have been raised about the nature of the
market for these products.
Mitigating financial risk is a primary reason for futures
exchanges. However, the natural hedgers of these products have, for the
most part, insisted that they will not be using the products to hedge
their risks for various reasons. I look forward to hearing from our
witnesses today on why this may, or may not, be the case.
The CFTC has approved the applications to establish these
exchanges, but the contract applications are still pending. This
hearing is especially timely given the current state of financial
regulatory affairs and the action taken in the Senate yesterday that we
understand would establish in statute a prohibition of such exchanges.
I hope the witnesses will provide this Committee with the context
necessary to better understand these exchanges and the issues presented
by them, so that the Members here will be able to ascertain the correct
course of action, going forward, and for future consideration of these
applications by the CFTC and of the law by the Congress.
Again I would like to thank everyone for joining me today, and at
this time I would like to turn it over to my good friend and colleague,
Jerry Moran from Kansas, for any opening remarks he would like to make.
The Chairman. And at this time I will turn it over to my
good friend and colleague, Jerry Moran of Kansas, for any
remarks he would like to make.
OPENING STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN
CONGRESS FROM KANSAS
Mr. Moran. Mr. Chairman, thank you. If somebody told me
several months ago or a month ago we would have the Motion
Picture Association of America and the Directors Guild in front
of the Agriculture Committee, I would have thought they were
kidding. But here we are, and we are here to review a proposal
to establish two box office future exchanges and the contracts
to be traded on those exchanges. In fact, the exchanges are no
longer proposals, because the CFTC has approved both the Cantor
Exchange and the Media Derivatives Exchange within the last
week.
It is my understanding that while the exchanges have been
approved, the actual contracts are still pending Commission
review and approval. Hopefully, Mr. Berkovitz will elaborate on
the process. Up until 2 weeks ago I had never heard, and I am
simply here to learn about a new exchange, the contracts those
exchanges plan to trade, and the benefits and challenges that
each may present.
The Commodity Exchange Act sets forth a set of standards an
exchange must meet before it is approved by the Commission. I
hope to learn how each exchange has met those standards and the
analysis used by the Commission in reaching its decision. For
instance, I hope the Commission and the witnesses explain the
economic relevance of these exchanges and the potential
contracts these exchanges will trade. I also want to know how
these exchanges will prevent potential fraud and manipulation
that might occur. In addition, there are some witnesses that
have concerns about the contracts, and I want to gain a greater
appreciation of those concerns.
I look forward to hearing the witnesses' testimony and hope
to learn much more about this new concept of box office futures
exchanges. Thank you, Mr. Chairman.
[The prepared statement of Mr. Moran follows:]
Prepared Statement of Hon. Jerry Moran, a Representative in Congress
from Kansas
Thank you Mr. Chairman. If someone would have told me a month ago
this Subcommittee would be holding a hearing where representatives of
the Motion Picture Association of America and the Directors Guild of
America were witnesses, I would have thought you were kidding. However,
here we are reviewing a proposal to establish two box office futures
exchanges and the contracts to be traded on those exchanges. In fact,
the exchanges are no longer proposals because the Commodity Futures
Trading Commission (CFTC) approved both the Cantor Exchange and the
Media Derivatives Exchange within the last week. It is my understanding
that while the exchanges were approved, the actual contracts are still
pending Commission review and approval. Hopefully, Mr. Berkovitz will
elaborate on that process.
Up until a few weeks ago, I had never heard of the concept of a box
office futures exchange. I am simply here to learn about a new
exchange, the contracts those exchanges plan to trade, and the benefits
and challenges each may present.
The Commodity Exchange Act sets forth a set of standards an
exchange must meet before it is approved by the Commission. I hope to
learn how each exchange has met those standards and the analysis used
by the Commission in reaching its decision. For instance, I hope the
Commission and the witnesses explain the economic relevance of these
exchanges and the potential contracts the exchanges will trade. I also
want to know how these exchanges will prevent potential fraud and
manipulation that might occur. In addition, there are some witnesses
that have concerns about these contracts and I want to gain a better
appreciation of those concerns.
I look forward to hearing from all the witnesses in today's hearing
and hope to learn more about this new concept of a box office futures
exchange.
The Chairman. Thank you, Mr. Moran. And I would like to
recognize the full Committee chair, Mr. Peterson, who has
joined us, for any remarks he might want to make at this time.
OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE
IN CONGRESS FROM MINNESOTA
Mr. Peterson. I want to thank the gentleman. I just want to
commend you and the Ranking Member for being on top of this
issue. It sounds like there are going to be votes, so I won't
take up any time and let you get on with the business. I look
forward to hearing what the witnesses have to say.
[The prepared statement of Mr. Peterson follows:]
Prepared Statement of Hon. Collin C. Peterson, a Representative in
Congress from Minnesota
Thank you, Chairman Boswell for holding this hearing today. While I
am interested to hear what the witnesses today have to say both for and
against this idea of establishing movie futures trading exchanges, I
have to say that I have some significant questions about this idea, and
I'm glad that we are having this hearing to learn more about the
details involved.
Futures markets were created to trade contracts to buy specific
quantities of a commodity or a financial instrument at a specific price
at a specific time in the future. At a fundamental level, this is a
risk management tool that offers benefits to both a buyer and seller of
a given product. Now we're in a situation where people want to sell
futures on movies the way they would sell a contract to purchase wheat.
I understand that markets evolve, but this seems to be a stretch.
The question is whether this is a stretch too far. Returns on a box
office are certainly different from bushels of wheat or barrels of oil.
The CFTC has approved the applications to establish these exchanges
based on their authorities in the Commodity Exchange Act. Given that it
is hard to imagine these products being contemplated in the writing of
that statute, I have to question what door to novel financial products
this current example opens and exposes in the law.
I am interested in hearing more about the CFTC's decision making
process and what they are considering as they make the determinations
on these markets and products. I want to hear from the applicants for
these futures contracts about what their rationale is for creating
these exchanges, and I want to hear from the groups opposing this about
why they are opposed to the idea and what they think will happen if
these markets are approved.
There are a lot of questions about this out there, and I hope that
we'll get some answers today. Thank you again, Chairman Boswell, and I
look forward to the testimony.
The Chairman. Thank you. And I want to state to the other
Members present, that their statements can be included in the
record to get us right on to the task before us. We would
recognize the first witness, and thank Mr. Berkovitz for being
here. So, Mr. Berkovitz, please begin.
STATEMENT OF DAN M. BERKOVITZ, GENERAL COUNSEL, COMMODITY
FUTURES TRADING COMMISSION,
WASHINGTON, D.C.
Mr. Berkovitz. Thank you, Mr. Chairman. Good morning,
Chairman Boswell, Ranking Member Moran, Chairman Peterson,
Members of the Subcommittee. Thank you for inviting the
Commodity Futures Trading Commission to testify at this hearing
on the possible trading of movie futures contracts. I would
like to request that the Commission's full written testimony be
included in the record.
The Commission's testimony addresses the standards and
procedures with which an exchange must comply to be approved as
a designated contract market, or DCM. This testimony will also
describe the process for the Commission's review of the box
office receipt futures contracts proposed to be listed for
trading by the two recently approved DCMs, Media Derivatives,
and Cantor Futures Exchange.
An applicant for a DCM license must demonstrate to the
Commission that it complies with the requirements of the
Commodity Exchange Act and the Commission's regulations.
Specifically, the applicant must make a showing that it
complies with the eight designation criteria and 18 core
principles in the CEA. The Act generally requires that the
Commission approve or deny a designation application within 180
days after it is filed. If the Commission denies the
application, it must specify the grounds for the denial.
With regard to the approval of a product to be traded on
the DCM, the CEA provides that a DCM may either self-certify
new futures and options contracts, or voluntarily request
approval of new products. To self-certify a new contract, the
exchange must provide to the Commission, at a minimum, the
rules that establish or relate to the contract's terms and
conditions, along with a statement certifying that the contract
complies with the Act and the Commission's regulations.
If an exchange requests Commission approval for a new
contract, the CEA requires the Commission to approve or
disapprove such product within 90 days. The CEA requires the
Commission to approve such contract unless the Commission finds
that the new contract would violate the CEA. It is the
Commission's practice that all new contract filings are posted
on the Commission's website, and public comment is requested.
The primary focus on the Commission's review is to ensure that
the contract is not readily susceptible to manipulation, and
that the contract has speculative position limits or position
accountability levels as appropriate.
The contract market designation process and the contract
approval process are separate and distinct. The two processes
involve different review procedures, time frames, and approval
standards. Contract market applicants have the option to submit
an application that does not include any proposed contract;
however, in conjunction with the review of a new DCM
application where the contract is not part of the application,
the Commission staff typically inquires about the type of
contract the applicant intends to offer for trading.
Information about potential products to be traded helps inform
the staff about the nature of surveillance and oversight
measures that the exchange should have in place to be
designated.
The Commission has recently approved contract market
designation for two applicants that contemplate listing box
office receipt contracts. The Commission designated Media
Derivatives, Inc. on April 16 of this year, and Cantor Futures
Exchange on April 20. Neither of these futures exchanges
submitted their proposed futures contracts as a part of that
DCM application. In both cases, the Commission carefully
considered the applicants' submitted materials, representations
made, and demonstrations related to the designation criteria
and core principles. The Commission determined that the Media
Derivatives and Cantor applications satisfied the requirements
of the CEA and CFTC regulations, including the designation
criteria and core principles. The order of designation for both
Media Derivatives and Cantor requires them to submit to the
Commission for review and approval any new class or category of
media-related products prior to listing them for trading. In
doing so, the Commission preserved its ability to affirmatively
review and approve these categories of futures contracts prior
to their listing by the DCM.
Media Derivatives' and Cantor's proposed contracts are
under active review. The Commission will carefully review these
proposed contracts according to the time frame and standards
under the CEA and the Commission's regulations. The focus of
these reviews will be to determine whether the contracts are
not readily susceptible to manipulation, whether there are
appropriate position limits or accountability levels, and the
integrity of the cash settlement process.
In summary, the Commission is committed to fulfilling its
statutory responsibilities to oversee the futures markets. It
has carefully reviewed the two recent DCM applications and
determined that they met the statutory standards.
With respect to the contracts submitted for approval, the
Commission, similarly, will conduct a thorough and careful
review, seek and consider public comments, and make a decision
based on whether the contracts under review meet the statutory
criteria.
Thank you for this opportunity to testify. I look forward
to any questions you may have.
[The prepared statement of Mr. Berkovitz follows:]
Prepared Statement of Dan M. Berkowitz, General Counsel, Commodity
Futures Trading Commission, Washington, D.C.
Chairman Boswell, Ranking Member Moran, and Members of the
Subcommittee, thank you for inviting the Commodity Futures Trading
Commission (``CFTC'' or ``Commission'') to testify at this hearing to
review proposals to establish exchanges trading ``movie futures.'' The
Commission appreciates this opportunity to present to the Subcommittee
information about the standards and procedures used by the Commission,
pursuant to the Commodity Exchange Act (``CEA''), to review
applications for new exchanges seeking to trade futures contracts.
This testimony will address the standards and procedures that
approved exchanges--called ``designated contract markets'' (``DCMs'')--
must follow in order to trade new futures contracts. In addition, this
testimony will describe the Commission's activities with respect to the
two applications recently approved for DCMs that intend to trade
futures contracts whose settlement prices are based on the level of box
office receipts from movie theaters (``movie futures'' or ``box office
receipt futures''), as well as the status of the Commission's reviews
of those proposed contracts.
The CFTC and its Mission
First, I would like to provide some background on the CFTC and its
mission. The CFTC was established in 1974 as an independent agency with
the mandate to regulate commodity futures and option markets in the
United States. The CFTC assures the economic utility of the futures
markets by encouraging their competitiveness and efficiency, protecting
market participants against fraud, manipulation, and abusive trading
practices, and ensuring the financial integrity of the clearing
process. Through effective oversight, the CFTC enables the futures
markets to serve the important economic function of providing a means
for price discovery and offsetting price risk.
The CFTC currently oversees 16 DCMs and one exempt commercial
market that lists a significant price discovery contract. The CFTC also
oversees 14 clearinghouses, which reduce systemic risks by providing a
guarantee of performance for all cleared trades. The CFTC oversees
66,187 registrants, which includes 51,921 salespersons, 1,277 commodity
pool operators, 2,568 commodity trading advisors, 7,114 floor brokers,
1,447 floor traders, 166 futures commission merchants, and 1,694
introducing brokers. In 2009, 2,051 contracts were listed for trading
on CFTC-regulated facilities, with a total trading volume of nearly 3
billion contracts.
There are several critical elements of the CFTC's oversight of
futures and option trading. These include, among other things, regular
surveillance of traders' positions and trading activity to detect and
deter manipulation, market congestion, and abusive and unfair trading
practices. Another fundamental component of market oversight involves
the evaluation of the futures exchanges' capabilities and operations to
ensure that they can fulfill the statutory requirements and their self-
regulatory obligations. Such reviews are conducted initially for
prospective DCM applicants and regularly thereafter through
comprehensive staff evaluations of the exchanges' operations (called
rule enforcement reviews).
Application Process for Contract Market Designation
An entity that seeks to establish an exchange for the trading of
commodity futures, options and futures options must apply to the
Commission to be designated as a contract market. In order to obtain
Commission designation, an exchange must demonstrate to the Commission
that it complies with the requirements of the CEA. Specifically, the
applicant must make a showing that it meets eight designation criteria
and complies with 18 core principles as specified in the CEA.
In general, to meet the requirements of the designation criteria
and the core principles, the exchange applicant must demonstrate, among
other things, that it has rules defining the manner in which it intends
to operate and that it has rules, systems and structures to ensure the
market and financial integrity of contracts to be traded on the
exchange. For example, the designation criteria require an exchange to
have systems in place to prevent market manipulation, to ensure fair
and equitable trading, and to arrange for the clearing of transactions
through a registered clearing organization. The core principles require
an exchange to provide a competitive, open, and efficient market, only
list for trading on the exchange contracts that are not readily
susceptible to manipulation, establish and enforce position limits or
accountability levels, and monitor trades for price distortion and
disruptions of delivery or cash settled process. The core principles
also address such issues as composition of boards, fitness standards
for directors and members of the disciplinary committee, conflicts of
interest in the decision-making process, and the emergency authority of
the exchange and its management.
The CEA requires that the Commission approve or deny a designation
application within 180 days of the filing of the application (Section
6(a) of the CEA, 7 U.S.C. 8(a)). If the Commission denies the
application, it must specify the grounds for the denial. Following a
refusal to designate an applicant as a contract market, the Commission
must provide the applicant with an opportunity for a hearing on the
record before the Commission (Section 6(a), 7 U.S.C. 8(a)). The
applicant thereafter has a right to appeal an adverse decision directly
to a Federal appeals court (5 U.S.C. 706(2)).
The statute also contains a provision for staying the running of
the 180 day time limit when an exchange is notified that the
application for contract market designation is materially incomplete,
and provides the Commission with at least sixty days for review once
the application has been resubmitted in completed form.
CFTC Review of DCM Applications
The review of new exchange applications is a key element of the
CFTC's oversight program. Such reviews are designed to ensure that the
applicant has the ability to comply with all statutory and regulatory
requirements. The review encompasses all aspects of the applicant's
proposed operations, and it is comprehensive in its scope.
Additionally, although not required by law, the CFTC's policy is to
post all pending applications on its website, so that interested
parties can comment on the merits of the filing.
The CFTC staff evaluates an applicant's ability to comply with the
designation criteria and the core principles by conducting a thorough
examination of the following elements of the proposed exchange:
the rule book to ensure that the exchange has rules that
promote transparent, fair and competitive markets, such as
rules describing operation of the market, providing trading
parameters and detailing the rights and obligations of
participants in the market;
clearing arrangements and settlement procedures;
surveillance systems, staffing and capabilities, including
the exchange's ability to obtain large trader and transaction
data to identify unusual price changes and concentrated
positions and to monitor position limit violations;
the adoption of trade execution systems and procedures to
ensure the integrity of trades, business continuity and data
retention and to allow the exchange to carry out trade practice
surveillance;
disciplinary procedures that address rule violations and
dispute resolution programs;
procedures for having an open, competitive and transparent
trading system to provide for the price discovery function of
the centralized marketplace and to make available information
to all traders on prices, volume and terms, through public
dissemination of price and trade activity information as well
contract terms;
procedures and rules to minimize conflicts of interest,
including composition requirements for the Board of Directors
and the establishment of a regulatory oversight committee;
procedures to take appropriate emergency action to protect
traders and the market in cases where intervention is required;
and
the exchange's rules, trading protocols or policies to
ensure that they do not result in any unreasonable restraints
of trade or any anti-competitive burden on trading in the
market.
Upon the conclusion of its review, the CFTC staff evaluates whether
the applicant meets the requirements of the CEA, and recommends to the
Commission whether to issue an order designating the exchange as a
contract market. If the Commission finds that the applicant meets the
requirements of the CEA and votes to designate, it issues an Order of
Designation which may impose certain conditions involving financial,
jurisdictional and regulatory compliance issues.
In conjunction with the review of a new DCM application, the CFTC
staff typically inquires about the types of contracts to be traded on
the exchange. Information about potential products to be traded helps
inform the staff about the nature of the surveillance and oversight
measures the exchange should have in place. The purpose of such
information is to address, in a generic way, the exchange's ability to
comply with designation criteria and core principles that address such
issues as contract manipulation, general availability of information
involving contract terms, mechanisms for executing trades, and
recording and storage of trade information.
Notwithstanding the fact that the Commission may generally be
cognizant during the course of the application review process of the
possible contracts that an applicant plans to offer, under the CEA and
the Commission's regulations, the contract market designation process
and the contract approval process are separate and distinct processes
subject to different review procedures, timeframes, and approval
standards.\1\ In contrast to the contract market approval process under
the CEA prior to the passage of the Commodity Futures Modernization Act
(``CFMA''), in which a prospective exchange had to include a contract
as part of its application package, since the passage of the CFMA
contract market applicants have the option to submit an application
that does not include any proposed product.\2\
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\1\ See section 5c of the Act, 7 U.S.C. 7a-2(c), section 6(a) of
the Act, 7 U.S.C. 8(a), regulation 38.3, 17 CFR 38.3, regulation
38.4, 17 CFR 38.4, and regulation 40.3, 17 CFR 40.3.
\2\ Because the CEA, as amended by the CFMA, no longer requires
that applicants include a proposed contract in their application to be
designated as a DCM, staff's review of the application is limited
regarding compliance with two contract-specific core principles;
specifically, Core Principles 3 (Contracts Not Readily Subject to
Manipulation) and 5 (Position Limits or Accountability). While the
other core principles require DCMs to have structures, rules and
procedures to address generic concerns, Core Principles 3 and 5 are
contract-specific. Staff is, therefore, limited in its ability to
assess compliance with those two core principles when a DCM application
does not include a contract. Instead, the analysis of a DCM's
compliance with Core Principles 3 and 5 is primarily carried out in the
context of the contract review process.
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Contract Certification and Approval
The CEA provides that a DCM may either self-certify new futures and
option contracts or voluntarily request approval of new products. To
self-certify a new contract, the exchange must provide to the
Commission, at a minimum, the rules that establish or relate to the
contract's terms and conditions, along with a statement certifying that
the contract complies with the Act and the Commission's regulations
thereunder. A self-certification filing must be received by the
Commission prior to the open of business on the business day prior to
the intended initial listing day. Commission staff conducts a due-
diligence review of the contract to verify the validity of the
exchange's self-certification and, when necessary, may request
amendments to the contract or additional information related to the
contract or the underlying cash market.
With respect to products submitted for approval, the CEA specifies
that the Commission must act to approve or disapprove within 90 days of
the request for approval (Section 5c(c)(2)(C) of the CEA, 7 U.S.C.
7a-2(c)(2)(C)). The Commission's regulations state that products
submitted for approval may be deemed approved 45 days after the filing
if the filing is complete and is not amended by the exchange, except
for amendments made at the request of the Commission (17 CFR
40.3(b)). The review period may be extended to 90 days if the product
raises novel or complex issues that require additional time for review
or is of major economic significance (17 CFR 40.3(c)). All new
contract filings are posted on the Commission's website, and the public
is welcome to comment on those filings. The CEA provides, ``The
Commission shall approve any such new contract or instrument . . .
unless the Commission finds that the new contract or instrument . . .
would violate the Act.'' (Section 5c(c)(3) of the CEA, 7 U.S.C. 7a-
2(c)(3)).
The primary focus of the Commission staff's review of a contract
approval request 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, as
appropriate (Core Principle 5). If an exchange seeks approval of a
contract, it must demonstrate that the terms and conditions as a whole
will result in a deliverable supply such that the contract will not be
conducive to price manipulation or distortion, in accordance with the
Commission's Guideline No. 1 (17 CFR Part 40, Appendix A (2009)). For
cash-settled contracts, such as the box office receipts contracts filed
for approval by MDEX and Cantor, Guideline No. 1 specifies that the
final cash settlement price must be not readily susceptible to
manipulation, must be reflective of the underlying market, and must be
reliable, acceptable for hedging, publicly available and timely.
MDEX and Cantor Applications for DCMs
The Commission has recently approved contract market designation
for two applicants that contemplate listing box office receipt
contracts. These exchanges are Media Derivatives Inc. and the Cantor
Futures Exchange.
Media Derivatives Inc. (``MDEX'') was formed in April 2007 to
operate as an electronic futures exchange to trade contracts based on
movie box office revenues and other unspecified entertainment industry
contracts. It is a Delaware corporation and wholly-owned subsidiary of
Veriana Networks, Inc., a privately-held media and technology company.
MDEX submitted its application for contract market designation on
September 25, 2009; the voluntary public comment period was open until
November 5, 2009. That application was preceded by numerous draft
materials submitted by MDEX to the Commission, as well as numerous
supplemental materials submitted after the formal filing date.
Some notable features of the MDEX application: MDEX has contracted
with the National Futures Association (``NFA'') to provide it with
regulatory services and has an agreement with the Minneapolis Grain
Exchange to provide clearing services. In addition to its reliance on
NFA, MDEX will conduct its own real-time surveillance and some general
market compliance. MDEX will be an intermediated market and will
utilize an electronic trading system with web-based access or direct
connections. MDEX initially intends to trade Opening Weekend Motion
Picture Revenue contracts in the form of binary options and collared
futures. That contract review process is separate from its DCM
application approval.
The Cantor Futures Exchange (``Cantor'') was created to operate a
non-intermediated electronic trading system to likewise trade, among
other things, futures contracts on movie box office receipts. Cantor
operates as a Delaware Limited Partnership and is a wholly-owned
subsidiary of Cantor Fitzgerald, L.P., a global financial service firm.
Cantor submitted its application to become a DCM on November 28, 2008;
the voluntary public comment period was open until January 28, 2009.
The NFA will provide regulatory services to Cantor, including
general market compliance and surveillance responsibilities. Like MDEX,
Cantor will be responsible for certain aspects of its market
surveillance and its market compliance. As proposed, clearing services
will be provided by the Cantor Clearinghouse, which is also a wholly-
owned subsidiary of Cantor Fitzgerald, L.P., and which submitted an
application to become registered as a derivatives clearing organization
contemporaneously with the Cantor DCM application. As a non-
intermediated exchange, Cantor has undertaken certain functions that
normally fall to intermediaries, such as filing certain reports with
the Commission and providing trade confirmations and account statements
to market participants.
As with the MDEX application, Commission staff was aware of
Cantor's intention to initially list box office receipt contracts.
Again, that contract review process is separate from its exchange
application approval.
Staff's review of both the MDEX and Cantor applications addressed
each of the regulatory requirements mentioned above.\3\ The CFTC staff
carefully considered the applicants' submitted materials,
representations made, and demonstrations related to the eight
designation criteria and 18 core principles, and in light of the
expected novel products that they intend to list, put special emphasis
on those designation criteria and core principles relating to the
prevention of market manipulation and fair and equitable trading.
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\3\ Except, as noted in note 2, supra, if the application does not
include a contract, the Commission is limited in its review of the
applicant's ability to comply with Core Principles 3 and 5 in the
absence of a contract.
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More specifically, staff considered whether MDEX and Cantor had the
ability generally to detect and prevent market manipulation and trade
practice violations, and also considered the extra steps MDEX and
Cantor would need to take if they offered futures contracts based on
box office revenue, such as the implementation of firewalls within a
movie studio. In this regard, staff considered the sources of data for
box office revenue figures, whether the information provided by these
sources is reliable and verifiable, what extra tools MDEX and Cantor
possess to track this information and analyze its reliability, and what
extra market surveillance resources each exchange would be able to use
to detect attempted manipulation or abusive trading practices.
Staff also considered the fact that NFA will be providing
regulatory services for both applicants. NFA currently provides
regulatory services to four other DCMs, and the Commission has
previously found that NFA maintains acceptable surveillance and
compliance practices in the context of other designated contract
markets to which it provides regulatory services.
Staff concluded that the MDEX application satisfied the
requirements of the designation criteria and core principles, and
recommended Commission approval of the exchange. The Commission
approved the designation of MDEX as a contract market on April 16,
2010.
Staff concluded that the Cantor application satisfied the
requirements of the designation criteria and core principles, and
recommended Commission approval of the exchange. Cantor was designated
as a contract market on April 20, 2010.
The Orders of Designation for both MDEX and Cantor require them to
submit to the Commission for review and approval any new class or
category of media-related products prior to listing them for trading.
MDEX and Cantor Requests for Contract Approval
MDEX's and Cantor's proposed contracts are under active
consideration for Commission approval as they were not part of the
Commission's designation of MDEX and Cantor as DCMs. In conditioning
these designations on the submission of the exchanges' initial
contracts and all other new classes of media-related contracts for
prior Commission approval, the Commission recognized that media
contracts may require special review of other issues to ensure, among
other things, that the contracts are consistent with the Act and the
Commission's regulations and that the exchanges have appropriate
surveillance and compliance measures in keeping with the unique nature
of these contracts.
On March 9, MDEX requested approval of its collared futures and
binary option contracts based on the Opening Weekend Motion Picture
Revenues for the film Takers. The 45 day fast track review period would
have ended on April 23, but the staff extended that review period by an
additional 45 days so that it now expires at the end of the statutory
review period (90 days after Commission receipt). That statutory review
period ends June 7, 2010. MDEX has indicated that it also intends to
list other media-related futures contracts.
On March 30, Cantor Exchange requested approval of its Domestic Box
Office Receipts futures contract based on the film The Expendables. The
Commission's 45 day review period for that contract ends May 14, but
the Commission may extend that review period to June 28, 2010. Cantor
has stated that it also intends to list other, non-media-related, more
traditional futures contracts.
The Commission will specifically evaluate whether the MDEX and
Cantor contracts are not readily susceptible to manipulation and
whether the cash settlement provisions of each contract meet the
Commission's Guideline No. 1 requirements, among other criteria. In
addition, the Commission will consider other issues that have been
raised as well as comments filed by interested parties related to those
contracts.
Conclusion
In summary, the Commission is committed to fulfilling its statutory
responsibilities to oversee the futures markets in a timely, efficient,
and thorough manner. The Commission has carefully reviewed the two
recent DCM applications and determined that they met the statutory
standards. With respect to the contracts submitted for approval, the
Commission similarly will conduct a thorough and careful review, seek
and consider public comments, and make a decision based on whether the
contracts under review meet the statutory criteria.
Thank you, and I look forward to answering any questions.
The Chairman. Thank you. Before we continue, I would like
to recognize Mr. Goodlatte from Virginia who has joined us. And
although he is not a Member of the Subcommittee, he is here
with us today, he is the former Chairman of the full Committee.
And I have consulted with the Ranking Member, and we are
pleased to welcome him to join us in questioning today.
Welcome.
Mr. Goodlatte. Thank you, Mr. Chairman. It is a pleasure to
be here. I look forward to hearing the testimony of the
witnesses regarding this very interesting subject.
The Chairman. Welcome.
The first question, I guess, would be: In reviewing the
applications, did the CFTC examine the question of whether
legitimate hedgers, both short and long, exist for these
products? And, if so, what did the CFTC discover?
Mr. Berkovitz. As I have described, Mr. Chairman, the
contract application and review process and the designation
process for the exchange are two distinct processes. In the
designation process for the exchange itself, in approving the
exchange, we reviewed whether it met the designation criteria
in the statute, including whether they have the trading
facility, how the trades are executed, the financial integrity
of the contracts, and the various systems in place to ensure
fair and equitable trading.
Regarding the contracts, the questions that you have raised
are more appropriately part of the contract approval process
which we are in right now. So those questions are some of the
questions that we are looking at in the contract approval
process.
The Chairman. I appreciate that. Another question: Would
you explain why the Commission approved the ability for people
with material inside information to participate in these
markets? All things being equal, would people with material
inside information be allowed to participate in an SEC-
regulated market?
Mr. Berkovitz. We have addressed that in a condition for
the application. As I mentioned in the oral testimony,
generally the exchange approval process and the contract
approval process are different. In these particular instances
we have looked at the request for approval of the exchange with
a view towards what contracts will be included in the exchange.
We have been in discussion with both applicants, so we have an
idea. We did, in fact, know their intentions to list these
movie futures contracts.
As part of that, to address the concern you have raised
about people with inside information, potentially about the
eventual box office numbers, trading in those futures
contracts, we have included in the contract approval process
the condition that these exchanges have what we call firewalls
between the people inside the studios who would have actual
knowledge of the box office receipts from the people in those
movie studios who might be trading for hedging purposes or
whatever purposes for the studio.
We have included firewall conditions as part of the
exchange approval process for both exchanges. Not only does it
prohibit them from--people with that inside information about
the actual box office receipts from trading, but it would
prevent them from communicating information to others in the
organization who might trade on that information. So those
conditions have been included as part of the approval process
for the exchange.
In addition, as part of the contract approval process, we
are looking at that question further in terms of whether the
contracts themselves are susceptible to manipulation. So the
question is, in view of these particular contracts now and
examining the concerns that have been raised by these
contracts, we are looking at that issue with respect to these
particular contracts: Are those firewalls sufficient? Have
other concerns been raised that need to be addressed as part of
the contract approval?
The Chairman. I will have further questions, but I will
recognize Mr. Moran at this time.
Mr. Moran. Thank you. Mr. Berkovitz, how does the CEA
define a commodity? And how does the box office futures
contract fit within that definition?
Mr. Berkovitz. The Commodity Exchange Act defines a
commodity very broadly. It is basically anything, a good, an
article, a service, or an interest in anything in which a
contract for future delivery is dealt in. So if something is
subject to a contract for future delivery, then under the
Commodity Exchange Act, it would be a commodity.
Mr. Moran. And the future delivery in this case is, what?
Mr. Berkovitz. The future delivery is the box office
receipt. It is a number that is related to the actual box
office receipts.
Mr. Moran. My questions may be more related to the actual
contracts. But what type of data do the exchanges use to settle
those contracts?
Mr. Berkovitz. According to the information that has been
supplied to us to date, and we are looking at this question in
great detail, but they basically--they are going to be relying
on the tally of box office receipts that are provided. There is
a service that provides from the movie theaters to the studios
what the actual box office receipt numbers are. That gets fed
to the studios, and the studios--I believe, and they will be
able to answer the questions--also collect some of this data
and the studios put the data together, and then there is the
final number from the receipts that they get plus their own
information.
Mr. Moran. When you say a final number, is that an actual
hard number, or is that an estimate?
Mr. Berkovitz. I believe there is an actual firm number.
Mr. Moran. Okay. How is the opening price of a contract
determined? And are there currently any other exchanges that
use that method?
Mr. Berkovitz. We can provide further information for the
record on this. But, generally, my understanding of it is that
it is similar to the process that other exchanges use for
determining what the opening price of a contract is, that
before the contract is actually open for trading, that there is
a type of bidding process that goes on that the exchanges use
to establish where the contractors should start to be traded.
But we can get you further information on exactly how that
would be determined and any similarities or differences.
Mr. Moran. Do you have an estimate of the time frame in
which the CFTC would make a decision in regard to the actual
contracts?
Mr. Berkovitz. There is a statutory deadline, I believe, it
is June 7 for one of the contracts and June 28 for the other
one.
Mr. Moran. Mr. Chairman, thank you. And I yield back.
The Chairman. Thank you. The chair now recognizes Mr.
Kissell from North Carolina.
Mr. Kissell. Thank you, Mr. Chairman.
Mr. Berkovitz, I am trying to get an understanding, as the
Ranking Member said, of knowledge of this subject matter, when
the Commission is looking at a new product coming on to a
market--and you mentioned about the factors that are considered
as to whether this is a legitimate product or not. How
judgmental does the Commission become in terms of one extreme,
just strictly, ``Okay, it meets the points, fine, let's do
it.'' And the other extreme, ``This just has no business being
there, this just is not something we should be doing.'' How
does that weigh in terms of, once again, is it just black and
white there, or judgmental it shouldn't be there?
Mr. Berkovitz. Generally, our first look at it would be, is
this something that is indeed a contract for future delivery?
That's our jurisdictional base. So we will say, is this a
contract for future delivery that is appropriate for further
review?
If it is indeed a contract for future delivery, then we
apply the standards set forth in the Act. Primarily, is it not
susceptible to manipulation? Are there appropriate position
limits? Is the settlement price of the contract appropriately
determined? Is there the process for determining that price, is
there integrity in that process?
Mr. Kissell. What considerations might be given to unique
circumstances that could affect a movie's popularity in terms
of the investments that were made versus the insurance that
might be used to offset unexpected things? What if we found out
3 days before the release that a star had been having illicit
affairs? Or the snows came deep in February and affected the
opening days; or there was some other crisis that kept people
at home? Are we opening ourselves up to issues there that are
beyond what we should normally expect? How does that play in?
Mr. Berkovitz. Well, our primary focus is on ensuring that
there was no manipulation of the price of that commodity that
is traded. So we would have our surveillance and the
exchanges--we require of the exchange to have surveillance,
too, to ensure that there is no artificial price created
through any intentional manipulation of the price. And we watch
the price move to ensure that indeed the price of these--or any
contracts that are traded on any exchanges, are determined
according to the laws of supply and demand, basically.
Mr. Kissell. Thank you, Mr. Berkovitz. Mr. Chairman, I am
looking forward to hearing more of the arguments from the
individuals. I yield back.
The Chairman. Thank you. Mr. Goodlatte.
Mr. Goodlatte. Thank you, Mr. Chairman.
Mr. Berkovitz, welcome. Can you think of any other
commodity that is traded on the major exchanges that is
anything like a motion picture?
Mr. Berkovitz. In a broad sense, the motion picture
contract, one could describe it as an event type contract that
is related to an economic event or an event. We have weather
derivatives, we have----
Mr. Goodlatte. But weather derivatives are beyond the
control of any individual. Are they not?
Mr. Berkovitz. Certainly.
Mr. Goodlatte. And the gentleman from North Carolina, he
raised several different types of events. Some of those events
were like a big snowstorm. That is beyond the control of
anybody who is trying to predict. And that certainly would not
be unlike buying corn futures, not knowing what the weather was
going to be like or things like that.
On the other hand, the motion picture itself, each one of
those that is produced is a very unique product, very much
unlike the next one. Whereas, one barrel of oil is not very
much different than the next one, one bushel of corn is not
very much different than the next one, one Euro dollar is not
very much different than the next one.
So it seems to me that in looking at the very broad
definition of commodities that the CFTC has, nonetheless in
looking at motion pictures you are going into an area that we
have never done before, in my opinion.
Can you give me anything that is like that, that is of such
subjective value as a motion picture that is offered on these
exchanges?
Mr. Berkovitz. I think the issue that you raised in terms
of control or ability to affect the price in terms of a weather
derivative, nobody can affect the temperature in Chicago or
Seattle. The question that has been raised about these
contracts: Can somebody affect the box office receipts? In that
sense, that distinction is indeed something we are looking at
and seeing whether----
Mr. Goodlatte. I have heard there is some discussion at the
CFTC about actually excluding people who are involved in the
making of a motion picture from being able to trade these
futures contracts. Is that correct?
Mr. Berkovitz. The conditions that were imposed upon the
exchanges themselves, the firewall that is between the people
that actually have knowledge about the actual box office
receipts, we are examining again whether those firewalls are
sufficient for these particular contracts, because these
concerns have been raised about who really has this type of
knowledge.
Mr. Goodlatte. But if you were to do that and to say that
all of the producers and directors, actors and the crews, and
the people involved in the promotion of the movie and so on
were not allowed to participate because they have a better idea
than the average public about whether this movie is going to be
an Avatar or whether it is going to be a bust. Correct? That
would be a concern. But aren't those the same people that you
ordinarily are wanting to have participating in commodity
trading? Because they are the ones who benefit from one of the
principle purposes of commodity trading, which is to take the
risk out of what you are investing in.
Like a farmer being able to buy or sell corn futures
because he wants to average out the future price, because
weather or other market conditions might affect his price. Or
somebody in manufacturing who is concerned about the price of
natural gas or oil that they use as a resource for their
business, they want to buy futures. Southwest Airlines very
notoriously, during the spike-up in prices, they had bought jet
fuel futures or oil futures or something that allowed them to
have a competitive advantage because they had built in a hedge
against the risk of higher prices at a time when prices did go
higher. But here, you are talking about eliminating from the
very marketplace the people who might most benefit from being
able to hedge, because they don't know for sure whether the
movie is going to be a hit or not. Therefore, if they could
sell futures on it, they would take away the reward of the
smash hit, but they would also eliminate the crash of the total
dud.
So it seems to me that the bottom line here is that we are
not really talking about a commodity. We are talking about each
individual unique product, and the very people who would
benefit from commodity futures trading would of necessity have
to be excluded because they could manipulate it.
Mr. Berkovitz. I think your point is well taken. An oil
company is another example. The people inside an oil company
are allowed to trade on what they believe will be the price of
oil. They may have specific knowledge about whether a field is
coming on or not. They might have superior knowledge of what is
going on in the oil market, but presumably those traders do not
have knowledge of exactly what the price on the New York
Mercantile Exchange would be. So, per se, it is not illegal or
unlawful for somebody with knowledge about the commodity to
trade on the commodity.
Mr. Goodlatte. Sure. But like we said earlier, one barrel
of oil is not much different than the next barrel of oil. But
one motion picture is completely different than the next one.
And then it is also subject, wouldn't you say, to
manipulation by people who are not actually engaged in the
production of the movie? For example, movie reviewers or
entertainment companies that can play up the movie on their
television networks, or on the Internet, or in other
marketplaces? They also could say, ``Well, let's buy some
futures in this movie, and then let's really push the heck out
of this movie to try to drive up the box office.'' Or, ``Let's
buy futures, and then let's pan the movie and see if we can
drive it right down through the floor and make a profit on
selling the failure of the movie.''
I don't trade in commodities, so I don't know the puts and
options and so on that are involved here. But nonetheless, it
seems to me that a lot of people could try to profit from this
and manipulate it, whereas there is only so much you can say
about an ear of corn or a barrel of oil, or a quantity of some
other source of energy or food, or even a currency like the
Euro dollar or other things.
Mr. Berkovitz. Indeed, the concerns that you have mentioned
about the potential for manipulation, the different
characteristics of these contracts that you have mentioned, we
will be looking at all that very closely in the product review.
We have initially, as a condition of the approval of the
exchange itself, have the firewall. But whether that is
sufficient or not in light of these particular contracts is
something that we are going to be looking very closely at to
address those very concerns that you have raised.
Mr. Goodlatte. Thank you, Mr. Chairman.
The Chairman. Thank you. Chairman Peterson.
Mr. Peterson. Thank you, Mr. Chairman. So in your view or
the Commission's view, the movies are a commodity?
Mr. Berkovitz. We are looking at indeed whether to approve
these as contracts for future delivery.
Mr. Peterson. So if you decide, if you approve this, then
you are deciding they are a commodity?
Mr. Berkovitz. If we were to approve it.
Mr. Peterson. And apparently you are thinking about having
anybody who knows anything about this prevented from trading in
it, from what I understand?
Mr. Berkovitz. I want to draw the distinction. The current
firewall is between the people who actually know what is the
number of the box office receipts.
Mr. Peterson. I understand. But there has also been
discussion of trying, excluding anybody that has anything to do
with the movie business.
Mr. Berkovitz. We are considering whether the current
exclusion is broad enough.
Mr. Peterson. So what you are basically talking about,
then, is authorizing gambling. I mean, maybe it should be
regulated by states or something. I mean, if you include
anybody that is involved in this, then the only people you will
have left are people that are gambling on this, basically.
Right? I mean, I am just trying to understand what is going on
here.
Mr. Berkovitz. If we determine that the contract, with
whatever conditions that may be placed on it, satisfies the
conditions of the Commodity Exchange Act and our regulations,
then it will be permitted to be traded on these exchanges, if
we make that determination for these products.
Mr. Peterson. So can there be other derivatives created off
of these, then? If these are approved, would you be able to
have credit default swaps be set up to further make bets
against what is going to happen or to protect?
Mr. Berkovitz. Well, if somebody created an instrument that
would fit the definition of a swap under current law, we would
have to look at the instrument. But that might be something
that would not be within our jurisdiction, because it would be
excluded from our jurisdiction if it fit the definition of
swaps and it was traded by people who could trade the swap, the
eligible contract participants. So it would certainly be
possible to create a swap derivative.
Mr. Peterson. Is that being done now at all?
Mr. Berkovitz. I wouldn't have knowledge of that.
Mr. Peterson. I mean, they raise money to finance these
movies. I don't know, I guess that would be one thing. I don't
know who can tell us that.
Mr. Berkovitz. Presumably, under current law, if somebody
were to create a swap rather than a futures contract based upon
movie box office receipts, and sell it to only the people who
met the statutory criteria, sophisticated parties, called in
the Act, eligible contract participants, then that would not be
something if they traded it under the--according to the way the
Act specifies, that would not be something within our
jurisdiction. They could do that. That would be outside the
CFTC's jurisdiction.
Mr. Peterson. Unless we pass a bill here.
Mr. Berkovitz. Exactly.
Mr. Peterson. And the Senate apparently, in the bill that
they have moved out of the Agriculture, Nutrition, and Forestry
Committee, has put a prohibition on these contracts. Is that
correct?
Mr. Berkovitz. That is my understanding.
Mr. Peterson. Have you looked at the language of that?
Mr. Berkovitz. We haven't seen the final language. We
understand that that provision is in there, but we haven't seen
the final language. It was just reported out yesterday.
Mr. Peterson. And we can do that, the Senate, in
legislation? We can ban a particular type of contract?
Mr. Berkovitz. You can exclude. Right now in the Act onions
are excluded from the definition of commodity. So, certainly,
Congress can put it in the definition of commodity and Congress
can take it out.
Mr. Peterson. That is how they have done it. They have said
that movies are not a commodity.
Mr. Berkovitz. I believe that is what they have done for
the box office receipts, I believe they have taken it out of
the definition of commodity.
Mr. Peterson. Thank you, Mr. Chairman.
The Chairman. Thank you. The chair now would recognize the
gentleman from Missouri, Mr. Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Mr. Berkovitz, can you give me a definition of what you
believe a movie or a motion picture that would be something
that you could put on the exchange?
Mr. Berkovitz. The definition of a motion picture? We have
not--CFTC has not undertaken to define what a motion picture
is.
Mr. Luetkemeyer. To me, that is a pretty important point.
We have a motion picture now. It can be anything from what we
believe is the big blockbuster, Avatar, all the way down to--it
listed here a while ago a documentary, X rated movies,
cartoons. And by your box office receipt thing, it has to be on
600 movie screens. We have made-for-TV movies which generate
income from the standpoint that they are put on TV and
advertisers pay to have their advertisements shown during a
showing of that movie. Is that going to fall under the
definition here of somebody that could actually trade a
contract on a movie that is being made for TV; and, if we don't
generate enough advertising revenue to pay for the production
of the movie, that the producers are covered? Is that something
that could also be construed here to fall under your definition
of movie?
Mr. Berkovitz. The contract terms--when I talk about our
product approval, the approval of the contract terms, each of
these contracts, they are contracts for future delivery. They
have specifications in the contract, what can be traded, which
types of movies can be traded. And--I don't have the
application right in front of me, but it is specified in the
application. So that is part of what we are reviewing, is what
are the movies or what may be that will be the subject of these
contracts, whose box office receipts will be something that
will be put on the exchanges of contract for future delivery.
So that is something we are looking at, what is going to be
subject to these box office receipts.
Mr. Luetkemeyer. Well, to me it seems like that is--you are
going to have to nail down the definition of what a motion
picture is, because I think you can construe it to be any of
those things that we just mentioned. I mean, we are talking
about documentaries which take a lot of monies to produce
sometimes; X rated films, somebody is going to go out there and
produce one of those and want to protect themselves; you have
cartoons. All those things are types of motion pictures that if
they fall under your definition here of 600 movie screens, I
mean, can you look at a TV screen as a movie screen?
I think that at this point your terminology is going to
have to really be nailed down a little bit more confining. I
mean, right now we have this language so broad that that whole
list of things we are financing everything that can be put on a
movie screen, including what goes on a TV, in my judgment, from
what you see here. It is very concerning to me.
Right now, is there a defined market? Is there some folks
out there that really want to trade in these things right now?
Or is the Cantor Group just hoping that there is going to be
something happening? Is there really a defined group out there
that is looking to try and take the risk off of these folks?
Mr. Berkovitz. I think the witnesses on the second panel
might be in a better position to answer that. Our role is to
determine whether, in fact, these products, and some of the
issues you have described, meet the specifications in the Act.
Mr. Luetkemeyer. Let me ask this question then. What do you
see as an inherent problem from your standpoint at the CFTC?
Mr. Berkovitz. Our role is to ensure that any contracts
that are traded on our regulated facilities are not susceptible
to manipulation; that there are appropriate position limits on
these contracts to ensure that no single entity has too great a
share of the market and then can influence the prices by having
too great a share; or--and that the settlement process, the
process for determining that the final price of these
contracts, the box office receipt number, that that process has
integrity and that is a reliable number and the market can have
confidence that it is accurate. And that is really our
statutory role, that we have been directed to do under the Act.
Mr. Luetkemeyer. Mr. Peterson asked a while ago, and a
couple other folks referred to, the numbers of people who have
access to the movie production, whether it be the actors or
anybody who works on the sets, the writers, whomever. All those
folks at this point are not prohibited from being able to
participate in this? Are you looking to try and do that?
Mr. Berkovitz. We are looking to draw the appropriate
firewall, if you may, between the people who have actual
knowledge of the box office receipt numbers who will know what
that price is, and to ensure that they will not be able to
trade or give information to others who are trading. Whether
that is the full extent of the separation, that is something
that we are looking at in this product approval process.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
The Chairman. Thank you. The chair recognizes the gentleman
from Georgia, Mr. Marshall.
Mr. Marshall. Thank you, Mr. Chairman. I was out for a
little while meeting with some folks, so I may be asking
questions that have been already asked and answered. If I do, I
apologize for that.
It is hard for me to see who takes the other side of this
product if you don't exclude insiders. So the movie is in
production, something occurs, it looks like it is just not
going to produce. Basically, the house is on fire but we are
the only people who know it, so we are going to rush out and
buy insurance. Well, I would be a fool to be the other side of
that deal, and I think the market would pretty quickly conclude
that this is too dangerous and could really get stuck as a
result of the fact that people will have unique knowledge about
whether to buy or to sell concerning this particular product.
And so from a packaging perspective, I could see those who
are interested in offering the product trying to sanitize it so
that it behaves more like regular futures and commodities that
you wouldn't have inside information along those lines. I am a
little surprised, though, that the CFTC is, as part of the
approval process, coming up with this firewall concept. Can you
give us examples of other products where you have firewalls? Is
this sort of a new concept for these products? Or are there
other products where you have firewalls? I know CFTC personnel
specifically can't invest and other people who have unique
knowledge, the owners of the exchange, things like that. But
beyond that, can you pick a commodity where the CFTC has
imposed some sort of firewall concept like this?
Mr. Berkovitz. I believe it is a new type of condition.
Mr. Marshall. Well, I don't like the fact that--we are very
clumsy with our efforts to legislate in this arena. Witness the
fact that we have an exception for onions, for God's sake. I
don't think we really want to set up some regime where
everybody is running to us because they are worried that some
product might be approved inappropriately by the CFTC. And so
we start adding to the list. It is now onions and now it is
movies and now it is whatever. I don't know what it is going to
be.
So it seems to me the CFTC needs to help us out here in
coming up with some principle, or the parties here need to come
up with some principle that can guide the CFTC and guide
Congress in concluding: Yes, this is an appropriate product, or
no this is not an appropriate product. And I just don't see how
firewalls cut it. It is a license to lie is basically what it
is. It is hard for me to believe that the other side to the
deal, being sophisticated parties, would believe that the
firewalls would actually work. That you think you need a
firewall suggests that you are worried about all kinds of
manipulation issues. It is one thing for the party that is
putting together the product to feel like it needs to have a
firewall because nobody is going to buy the product otherwise.
It is another thing for the CFTC to say there has to be a
firewall. That suggests to me that the CFTC has a very limited
confidence in the product; or, the CFTC is worried about
manipulation, that this is an extraordinary--too focused, maybe
too much of a rifle shot kind of product here, where it would
be just too easy for people to manipulate the price and,
consequently, the market, that very small market.
So I would like you guys to come up with some principle
other than firewalls. I mean, if firewalls don't exist for any
other commodity, it seems to me a big stretch for the CFTC to
say, well, we are going to come up with this concept with
regard to this particular commodity, without maybe a broader
discussion with Congress about the CFTC's appropriate role, and
whether or not the CFTC should be about the business of
approving products with firewalls.
You know, it gets close to sort of wandering into, there is
a big difference, or at least historically, as I understand it,
a big difference between the SEC's and CFTC's work. Where these
exchanges have been concerned, we want insider information. It
is all price discovery stuff. So whatever information you can
get, you bring it to the table. Where the SEC is concerned, we
are worried about insider trading. They have actually got
authority to pursue insiders. And you are kind of setting up an
insider trading regime within the CFTC without having gone
through some legislative process to determine whether or not
the CFTC's role should be changed.
I am just expressing my concern in light of the fact that
there doesn't appear to be any other product ever approved by
the CFTC or any exchange that has this firewall concept in it.
Thank you, sir.
The Chairman. Thank you, Mr. Marshall. You have made some
points that we have been hearing about. So I appreciate that.
At this time we would like to recognize the gentlelady from
Colorado, Ms. Markey.
Ms. Markey. Thank you very much, Mr. Chairman.
So obviously this is brand-new territory, and there is a
lot of concern, a legitimate concern, raised here this morning.
And let me just take a little different vein.
You have expertise at the CFTC with traditional commodities
that are traded, and this is a new product. What kind of
expertise do you have on hand right now with your current
staff? And how do you plan on developing the expertise that you
are going to need in-house to make sure that these products are
not susceptible to manipulation?
Mr. Berkovitz. Our first defense, of course, will be the
exchanges themselves. They are required to police their own
markets, that is a condition of our approval of the exchanges;
that they have surveillance and they have anti-manipulation
processes in place. And both of the exchanges I believe have
contracted with the National Futures Association to undertake
that, who has the expertise to do this. They do the
surveillance, market surveillance programs for a number of
exchanges.
So the exchanges are the front lines in this, and they have
submitted their programs to us and that has been part of the
approval process. And then on top of that, the CFTC
surveillance program is in addition to that. And, indeed, to
address that very concern, the market surveillance systems that
they are required to have pursuant to the designation criteria,
and the core principles are something that we have looked at
and found that they are adequate.
So it is not just the CFTC by itself and our staff who will
be overlooking these contracts. It will be the exchanges and
the National Futures Association also.
Ms. Markey. And of course, as you know, Congress is looking
at legislation to regulate derivatives. So you will already
have a lot more on your plate within the next year. And then
this is taking on additional work and an additional commodity.
What are your staffing levels like right now, and with the
exchange, in order to handle all this additional work
regulations that are going to have to be written, staff that
has to get up to speed on new products?
Mr. Berkovitz. The Congress and the Administration have
been very supportive of increasing the CFTC resources in the
past few years to meet these additional responsibilities, both
in terms of the current volume of futures trading and number of
contracts continue to increase; with new products coming on,
and then, as you mentioned, with the legislation, which will
require substantial new resources. And I believe that is in our
budget request.
So it is a very real concern that the agency have adequate
resources to undertake both these new markets within existing
authority, as well as the new authorities that we may get under
the legislation.
Ms. Markey. Thank you, Mr. Chairman, for holding this
hearing. And I yield back.
The Chairman. Thank you. The chair recognizes the gentleman
from Minnesota, Mr. Walz.
Mr. Walz. Thank you for being here, Mr. Berkovitz. I
appreciate it. I think all of us are trying to get a handle on
what is happening here. It is an interesting discussion, and an
important one, because the need is always there for financial
instruments and innovation, and trying to balance those things
out. I am interested to hear from Mr. Jaycobs and the folks
from Cantor, kind of an impeccable timing of bringing up a new
financial instrument in this environment. But I think that is
the nature of it, and we have to be open to be able to hear
that.
A couple questions I have in watching this and trying to
understand your position, not just on this issue, but a little
broader. Do you see yourselves as just a passive pass-through
to make sure the rules are enforced exactly as you interpret
them? Or do you see yourself to anticipate and be more
proactive against those? I am kind of getting the feeling, it
seems to me that--and this may be the proper role. I am trying
to understand it. That it is just passive, that these are the
rules, and they fall within the rules so we have to do it.
Mr. Berkovitz. I would describe it as a very active
enforcer of the rules that we have. We have the rules and we
have to follow the rules. We try to be very proactive,
anticipating and looking ahead, to avoid problems, rather than
simply looking behind.
Mr. Walz. I want to make sure that I fall on the right side
of this. Do you see it, is it the appropriate role of the CFTC
to determine if there is a need for this product? Or is that
for the market to determine, those folks who are coming to you?
Mr. Berkovitz. It is not within our purview to determine
whether indeed there is a need or not.
Mr. Walz. So that might be kind of at the heart of this. I
think some of us are trying to grapple, is there a real need
for this, what is it for, and all of that. But asking you to do
that is an inappropriate position to put you in. Am I correct?
Am I summing that up right?
Mr. Berkovitz. That is not something that is one of the
criteria for approving these products or not.
Mr. Walz. I think we are all struggling with this. And it
may seem like a very simplistic question, because I am trying
to understand this and trying to understand the definition of a
question. I don't want to go down the road that the President
did at one point on a pejorative towards Las Vegas. But there
is a very specific reason for that. And I am trying to
understand how this is different than a wager. And I say, for
example, is this a bad example of--something like the Minnesota
Vikings. They field the team, they put it together. And is
there a future trading on how well they do this year? Is that
different? Or is that a wager to determine whether they win the
Super Bowl or not?
Mr. Berkovitz. That is nothing that is traded on any of our
futures.
Mr. Walz. Is it different than this, though, by definition?
Is it different than the movies futures? You know, you have a
product. You have investors that get in it. You can buy into
the studio right now. You can get dividends off that on a
regular exchange on the big board. You can do all that. But the
performance of it tends to be based on more of a wager because
of all of these factors people brought up. That is what I am
trying to understand, if this is the appropriate place for it.
I think it would be--I am trying to see this. I think it would
be appropriate for me, on what I know as a casual observer of
movies, about which ones are going to hit big and which ones
aren't. But that is wagering, it seems to me. I don't know. I
am trying to get that from your expertise on this. It is
somewhat subjective.
Mr. Berkovitz. We don't really approach the question from
that perspective. Somebody comes in with an application and
say, ``We would like to trade the contract for future delivery
or an option on a future for a certain commodity.'' And we look
at that application. We are proactive in whether, indeed, the
contract meets the statutory standards, whether it is
susceptible or not to manipulation, what are the appropriate
limits again and the integrity of the process. So we do a very
thorough active review of that as it is presented to us.
Mr. Walz. So you are operating inside the framework you
were given, and I think that is probably appropriate. I think
some of these questions are for the next panel.
I thank you for your patience and your willingness to help
us understand this. I yield back.
The Chairman. Thank you. The chair recognizes the gentleman
from Oregon, Mr. Schrader.
Mr. Schrader. Thank you, Mr. Chairman. I guess I am biased,
because I am one of the few Members that do not worship at the
grail of liquidity and derivatives in this august body of ours.
And while I appreciate what you do and CFTC has a stellar
record, it is going to take some convincing to me that this is
a good idea. What I have heard so far is it is going to be up
to us to decide yes or no, passing legislation, create another
onion exemption. I think that is unfortunate. But I see this as
ripe for manipulation. I see no overriding public interest in
this at all. Frankly, the people that are most affected don't
like it, from what I have gathered so far. I guess we will hear
more about that, going forward.
To be honest, I think it would be sheer folly. We are in
the middle of the worst derivative crisis this country has ever
seen since the Great Depression. We are going to create another
instrument, one that the public is going to see as, frankly,
legalized gambling. I think the person who votes for this sort
of thing would be absolutely insane. But maybe I could be
convinced otherwise. I look forward to the rest of the
testimony. Thank you. I yield back.
The Chairman. Thank you. Mr. Berkovitz, at the University
of Iowa, the College of Business operates the Iowa Electronic
Markets. While originally created as a teaching tool for
students, this market is now open to non-students and includes
trading in elections futures from presidential races to control
of Congress to individual races. Small market, with investors
limited to $500. But it is a market nonetheless. The Iowa
Electronic Markets operations under a No Action letter provided
by the CFTC, where the CFTC says it will not take action
against the university for offering political futures contracts
on their exchange. It seems to me that elections contracts
raise many of the same concerns we will hear from the next
panel. What is the price discovery or hedging service the
contract provides? What is the ability of the industry
insiders, in the case of elections that would be pollsters,
consultants, media, using their knowledge to trade or
manipulate these markets? And what is their utility? For
example, is an elected official ever going to short his own
election? And granting No Action relief to the Iowa Electronic
Markets, did the CFTC look at these issues? And why are these
markets permitted?
Mr. Berkovitz. My understanding on the Iowa Electronic
Markets is this is being done and overseen by the University of
Iowa as an academic and a research undertaking. There is a
dollar limitation on it. It is being supervised by the
university. My understanding, it is not for profit as well.
Under those circumstances, the CFTC granted the No Action
letter to enable it to operate.
The questions that you have raised, though, in terms of the
broader, beyond Iowa, are questions that do concern the
Commission. In 2008, the Commission issued what is called a
concept release, sort of like a discussion paper. It was in the
Federal Register notice, inviting public comment on some of
those very questions: What should the Commission's position be
with respect to these, what they call prediction markets, where
you can theoretically predict the outcome of an election or
over events?
And what should the regulatory position towards these
markets be? Should we have an active role and regulate them
like futures contracts? Are they inherently different from
futures contracts? We have numerous public comments on that,
and we are still reviewing that issue at the Commission.
The Chairman. Any other questions from anybody on the dais?
Seeing none, thank you very much for sharing. And we would like
to excuse you at this time and invite the other panel to take
their place.
Thank you, gentlemen. We will just go through each and ask
you to make your statement, if we could. And we will ask that
you consider the 5 minute rule. We would like to hear from you,
and then we will have an exchange of questions.
So we would like to start off with Mr. Jaycobs, President
of Cantor Futures Exchange, New York.
STATEMENT OF RICHARD JAYCOBS, PRESIDENT, CANTOR FUTURES
EXCHANGE, L.P., NEW YORK, NY
Mr. Jaycobs. Thank you, Chairman Boswell, Ranking Member
Moran, and Members of the Subcommittee. Good morning. I am
Richard Jaycobs, President of the Cantor Futures Exchange.
We have been working on the development of a futures
exchange for box office receipts for over 2 years, but it
wasn't until the last 4 weeks that we received any attention at
all on the subject. And I welcome the opportunity to help
alleviate the concerns and put into the proper context what we
are building, how it works, and what benefits can be achieved
through this.
I would like to emphasize three points about the economic
purpose and the integrity of futures contracts on box office
receipts. First, for the private and institutional investors
who have invested up to $8 to $10 billion of private money in
films, futures contracts can be an important risk management
tool just as they are in agriculture, energy, and many other
industries. Movie futures will make more capital available at
lower cost and, as a result, create American jobs.
Second, Cantor Futures contracts are an effective pricing
tool. The anticipated box office revenue of a motion picture is
the basis upon which many decisions and commitments are made.
By establishing this exchange, a market mechanism is created to
provide independent judgment of that anticipated revenue, and
it gives participants in that market and others better
information. For example, screen allocations by movie theaters,
distribution terms by independent distributors can be
negotiated in the full transparency of a public price.
Third, as a regulated futures exchange, we observe all
market activity. Together with the National Futures Association
and the CFTC, we have proper and prudent safeguards against
manipulation. Cantor Exchange takes the issue of market
integrity and transparency very seriously. Our parent company,
Cantor Fitzgerald, was founded in 1945, and has extensive
capital market experience. Cantor supports this Committee's
efforts and goals for financial regulatory reform through
greater market transparency, competition, and centralized
clearing for financial markets.
We are proud of our long record as a responsible market
participant and a reputation as a caring corporate citizen in
the aftermath of the 9/11 tragedy. In the wake of our nation's
financial crisis and the debate on financial reform, any new
financial product clearly should come under scrutiny.
Since 2000, CFTC has designated more than 10 new exchanges
with the creation of over 1,000 new futures contracts. As an
experienced and expert regulator, the CFTC is well equipped to
consider the public utility of new futures contracts and to
ensure that any proposed futures contract meets the public
policy, anti-manipulation, and fair competition requirements of
the law. The box office contract will not proceed without CFTC
approval and the legislation on this issue is not needed.
The MPAA has said that movies futures are not legitimate,
that they create an online platform for gambling, and that they
are susceptible to manipulation. These are inaccurate and
overreaching statements. The revenue generated by millions of
moviegoers can be determined directly from the published
reports of distributors or estimated from the electronic sales
records.
Initially, Cantor intends to use the box office numbers
released by the studios; however, if the accuracy of the studio
data appears to be manipulated, we will be able to detect this
by comparing it to electronically captured sales records.
Publicly available information enables the market to develop
reliable estimates of a film's future box office potential, and
in fact, several commercial entities already exist to make box
office forecasts based solely on public information.
The MPAA has also said that futures contracts based on box
office receipts have no economic purpose. However, Lionsgate
Entertainment, one of the most successful film distributors in
North America that is not a member of the MPAA, has said in its
letter to the committee, ``A market in domestic box office
receipts would substantially widen the number and breadth of
financing sources available to the motion picture industry by
lowering the risk inherent in such financing.'' This is a key
point. While the six MPAA members may not appreciate the value
of film futures, other studios, producers, distributors,
exhibitors and investors certainly do. Many sound, commercially
important regulated markets would not exist today if large
entrenched interests could simply have blocked their creation.
The community of private and institutional investors who
currently finance a significant percentage of domestic film
production have no access to a risk mitigation tool. They have
no voice here in front of this panel today. They have no trade
association that represents their interest. We believe this
group alone satisfies the requirement for a group of hedgers.
In closing, better transparency is a critical component of
a well-functioning market. Futures exchanges have proven their
worth by bringing transparency and greater price discovery to
market participants. The box office contract is designed to
accomplish that same goal. When fully implemented, the market
for these contracts will benefit all participants in the motion
picture industry by providing additional capital at lower cost.
In closing, what I would like to reference now is that
injected into the regulatory reform debate in the Senate of
course is the language prohibiting this contract. We obviously
would like to express our view that we oppose that. Thank you
for the opportunity.
[The prepared statement of Mr. Jaycobs follows:]
Prepared Statement of Richard Jaycobs, President, Cantor Futures
Exchange, L.P., New York, NY
Thank you Chairman Boswell, Ranking Minority Member Moran, and
other Members of the Subcommittee. I appreciate the opportunity to
appear today and to submit written testimony on the application of the
Cantor Futures Exchange, L.P. (``Cantor Exchange'') to the Commodity
Futures Trading Commission (``CFTC'') for designation as a contract
market, and to discuss the public utility, transparency, and risk
management benefits of Cantor Exchange's proposed movie box office
futures contracts. Cantor Exchange's futures contracts are designed to
bring risk management, transparency and financial flexibility to a wide
range of participants in the film industry, similar to the role of
regulated futures markets in agriculture, energy products, financial
instruments, and other sectors of the marketplace.
Introduction to Cantor Fitzgerald and the Cantor Exchange
I am here today in my capacity as the President of the Cantor
Futures Exchange. Our parent company is Cantor Fitzgerald, which began
as an investment banking and brokerage business in 1945. Following the
loss of 658 of its 960 New York-based employees in the 9/11 World Trade
Center attacks, Cantor rebuilt to become one of the leading and most
widely-respected global financial services firms, recognized for its
leadership in serving institutional clients in the fixed income and
equity markets and for capital markets investment banking. Driven to
succeed in order to help the families of its employees who perished on
September 11, Cantor provided over $180 million to the families over
five years, including healthcare benefits for 10 years for the families
that needed it. In addition, to commemorate those who were lost, Cantor
and its affiliates forego all their revenues each September 11,
donating the full amount to charities that help wounded veterans,
children with medical and special needs, and other worthy causes.
Turning a tragic day into something positive and uplifting, these
annual Charity Days to date have generated over $50 million for
charitable organizations. Over the past eighteen months, as the
financial markets experienced substantial turmoil, Cantor has added
hundreds of new jobs, continuing its expansion and growth during a most
difficult time in the global capital markets.
Cantor Fitzgerald is one of 18 primary dealers authorized to trade
U.S. Government securities with the Federal Reserve Bank of New York.
Cantor Fitzgerald has been a major participant in the futures markets
and has itself sponsored futures exchanges in the past. Indeed, Cantor
Fitzgerald has been involved in operating futures exchanges since 1998.
Cantor Exchange's affiliation with Cantor Fitzgerald underscores Cantor
Exchange's capability and expertise to professionally operate, finance
and monitor a well-run, efficient, federally regulated futures
exchange.
Cantor Exchange's Movie Box Office Futures Contract
Cantor Exchange has submitted an application to the CFTC to
establish a futures market for contracts linked to the domestic box
office receipts (``DBOR'') of upcoming film releases. These contracts
will be cash-settled at a value that is directly indexed to the dollar
value of movie tickets sold in the U.S. and Canada that consumers
purchase over a period of approximately 4 weeks.
The goal of Cantor Exchange has always been to assist the motion
picture industry by expanding the breadth and depth of financing
sources available to the industry. Enlarging the potential sources of
film financing will lower the cost of making a film, help create
American jobs, and contribute to stabilizing large and small members of
the industry alike as they face the challenge of raising financing in
the high-risk endeavor of filmmaking.
We believe that a critical element in this effort is a public,
transparent, and appropriately regulated futures market. It's important
to point out that the film industry consists of many participants. In
addition to the major studios, they include mini-majors and other
smaller studios, independent producers and distributors, theater owners
and investors. I've talked with a great number of them in the past
weeks and months, and it's absolutely clear that there is wide and deep
support for the ability to hedge theatrical risk and that hedging
capability will drive a fundamental improvement in film finance.
Our box office receipt contract is a straightforward hedging
vehicle. It is an important design feature of our contract that box
office receipts are a real and knowable value, based upon credible
marketplace data. DBOR contracts are structurally identical to cash-
settled futures contracts on many economic indices that similarly
provide for cash payments based on real underlying economic value. In
the case of DBOR contracts, settlement is based on the aggregate box
office receipts of the underlying film as reported by the distributor
of each film and captured by Rentrak Theatrical.
DBOR contracts are not a direct investment in film, but rather a
cost effective means to hedge the extraordinarily high risk of the
movie-going public's willingness to pay between $5 and $15 to watch any
single film. Some films, like ``Avatar'', generate audiences and
revenue that not only have strong openings but sustain their financial
strength over a protracted period, whereas the audience for films like
``Gigli'' and others evaporated quickly as consumers shift their
preferences to better movies. The transparency offered by a regulated
public market and the ability to hedge risk has indisputably been shown
to result in reduced capital costs and greater competition, and that is
the function and value that we propose to bring to the marketplace.
We believe one of the immediate beneficiaries of our DBOR futures
contract will be investors who provided the capital investment to make
these films and are locked into multi-year, illiquid investments. Then,
we expect the transparent public pricing and commercial potential of
DBOR contracts will be recognized by theater owners to help reduce
revenue volatility across their business by hedging their exposure to
film-release volatility. We believe that every segment of the motion
picture industry will ultimately find value in using box office receipt
futures to hedge risk and broaden access to less expensive financial
resources.
While the Motion Picture Association of America, the MPAA, has
raised concerns about our contract's usefulness as a hedging vehicle,
it's often been the case in the history of the markets in our country--
the oil and aluminum industries are notable examples--that industry
participants that initially resisted change came to see the futures
market as an instrumental element of their industry's business and
financial practices.
Comprehensive Regulatory Review Process
Cantor Exchange has been working with the CFTC on its application
to become a designated contract market. For over two years, Cantor has
worked diligently with two staff teams of the CFTC to comprehensively
demonstrate why box office futures satisfied the CFTC's Core Principles
as required by the Commodity Exchange Act, including the ability to
adequately prevent market manipulation and enforce equitable access and
trading rules. I want to emphasize this point: our proposed exchange
has proper and prudent safeguards against trading on inside information
consistent with CFTC requirements. Indeed, these issues had been the
subject of intense scrutiny by the professional staff of the CFTC and,
by all accounts, had been successfully addressed in the application
process.
Our application was formally submitted to the CFTC on November 28,
2008. A public comment period on our exchange was held by the CFTC
during January 2009 and no comments were received. A second public
comment period on the subject of box office receipt contracts was
available to the industry in October 2009 when Media Derivatives
applied for designation and again no comments were received. The CFTC's
review of Cantor Exchange's application is substantially complete and a
decision on our application is expected this month.
Despite receiving no comments during either public comment process,
we are here today at the first ever Congressional hearing on an
exchange application in the history of the CFTC because a segment of
the motion picture industry has raised public policy objections at the
eleventh hour to any form of futures contract based on domestic box
office receipts. We think it is clear that the assertions of the MPAA
are groundless.
The law and regulations of the United States are clear and
unequivocal about fair trading rules, market surveillance, compliance
and enforcement to ensure financial integrity and transparency of
futures markets. As an expert agency and regulator of futures markets,
the CFTC is well-equipped to consider the public utility and
transparency that box office receipt contracts will bring to the motion
picture industry. The CFTC has adequate authority to ensure that any
proposed futures contract meets the public policy, anti-manipulation,
and fair competition requirements of current law. The CFTC does not
need further legislation or regulation to make an appropriate
determination of this issue.
Since enactment of the Commodity Futures Modernization Act in 2000,
the CFTC has designated over ten additional futures exchanges as
contract markets, including Trend Exchange (Media Derivatives) on April
16, 2010. The CFTC has also registered at least nine clearinghouses as
``derivatives clearing organizations'' during that time. Countless new
products have been filed with the CFTC since enactment of the CFMA,
with the majority ``self-certified'' by exchanges for immediate
trading. None of these innovative exchanges or the products that they
self-certified under the watchful eye of the CFTC has been associated
with any form of systemic risk or financial stress.
We expect that the creation of futures contracts based on box
office receipts could dramatically lower financing costs for motion
pictures; we expect that futures contracts could act as an engine for
overall growth in the motion picture industry; and we expect that small
and independent firms and financial investor partners would benefit
considerably by having a hedging vehicle.
We did not expect, however, the inaccurate, over-reaching and
extraordinary claims of gambling, manipulation, and commercial damage
made by the six largest studios' trade association, the MPAA, on March
23. Through its unfounded and insupportable assertions, the MPAA
essentially has impugned all futures trading, attacking the practices
of the energy, aluminum, agricultural products and other industries as
equivalent to gambling and marketplace manipulation.
Cantor Exchange appreciates the opportunity to address these
assertions with the Subcommittee. The primary purpose of my testimony
today is to reinforce to the Members of this Subcommittee the sound and
sensible answers that were presented to CFTC staff over the last two
years. In so doing, our hope is that the Subcommittee recognizes the
careful, thorough and considerable effort that both Cantor Exchange and
the CFTC have put forward to ensure that Cantor Exchange and the DBOR
contracts meet the letter and the spirit of the Commodity Exchange Act
and, just as importantly, represent a positive innovation for the
motion picture industry.
Economic Purpose of Box Office Contracts
The motion picture industry is undergoing radical transition
brought about by changes in film distribution technology, the Internet,
and the ongoing financial crisis. All of these factors have combined to
partially destabilize this very important American industry. The number
of motion pictures produced in 2009 dropped dramatically by 12%, the
first decline since 2003. Bank financing for films has all but ceased,
over ten independent film companies either ceased doing business or
consolidated their operations over the last 24 months, and the number
of jobs lost by the film industry is estimated to be in the thousands.
A public market for futures contracts based on domestic box office
receipts will not by itself reverse these trends. However, DBOR
contracts will provide a fully transparent and highly regulated
marketplace where the risks of film investing can be shared and
financing costs can be lowered.
There are currently no mechanisms for firms in the motion picture
industry to hedge risk associated with new film releases and,
accordingly, there are no open and transparent markets for such
transactions. A panoply of banks, institutional investors, and
individuals place capital into various film financing vehicles and are
exposed to unhedged box office risk. Other participants in the industry
including distributors, theater owners and film studios themselves also
have substantial un-hedged exposure to a film's box office performance.
Investing in film production and distribution is extremely risky.
Motion picture finance has failed to find a sustainable investor base
due to the great uncertainty of film performance at the box office.
Particularly in times of economic uncertainty, the high variability and
risk of returns means that identifying sources of film financing
quickly becomes difficult.
The ability to finance films and manage the risks associated with
film finance varies greatly. The major studios may be least affected by
financial stress. Owned by large corporations, they benefit when fewer
films are produced and there is less competition for movie goers, and
they have the greatest leverage in negotiating revenue splits with
theater owners.
Weakest among the risk bearers include the financial investor who
places capital in a multi-year film fund, the small theater owner who
commits screens to major studios based solely on representations of
those studios, and the production company that has little control over
the marketing and distribution of its film. We submit that these
commercial interests, combined with non-MPAA studios, represent a large
enough and significant hedge community to meet the requirements for
economic purpose under the Commodity Exchange Act.
In addition to the extensive support for futures contracts we have
identified amongst this section of the industry, there also is support
by some of the larger players in the motion picture industry. Michael
Burns, the Vice Chairman of Lionsgate, one of the leading independent
film studios with a major presence in producing and distributing motion
pictures, submitted a letter on April 16 to the House Committee on
Agriculture in support of DBOR futures. Mr. Burns indicated that the
regulated futures market proposed by Cantor Exchange ``would allow a
diverse group of motion picture industry participants, including
studios, film distributors, theater owners, investors and other
financial intermediaries within the motion picture industry to manage
their risk and exposure to new film releases.'' Mr. Burns added ``We
believe a market in domestic box office receipts would substantially
widen the number and breadth of financing sources available to the
motion picture industry by lowering the risk inherent in such
financing.'' We also understand that despite the National Association
of Theater Owners signing various letters of objection, individual
theater owners representing almost 20% of all theaters in America
wished to see DBOR futures made available and not restricted as a
result of any regulatory or legislative action.
With respect to price discovery, the MPAA asserts in its March 23
letter that DBOR contracts would not serve this public purpose;
however, the MPAA subsequently submitted another letter on April 8 in
conjunction with other film industry associations which explicitly
recognizes that commercial transactions are affected by the pricing of
film revenue contracts. Specifically, the April 8 letter stated that
``[m]any prices for downstream licenses and other sources of revenue
are driven in part by box office gross''.
Transparency of information can only be a positive for any market.
For eight years, Cantor Fitzgerald's virtual entertainment marketplace,
the Hollywood Stock Exchange (``HSX''), has found that its hundreds of
thousands of participants have not negatively impacted the virtual
market domiciled on HSX.
In contrast to unfounded claims by the MPAA, and because of the
many economic interests and legitimate hedgers that have directly or
indirectly expressed support for the existence of a market in box
office futures, we submit that this market should be allowed and
encouraged to exist.
Box Office Contracts Have Safeguards Against the Risk of Manipulation
Cantor Exchange and its DBOR contracts will be monitored and
policed like any other CFTC regulated market. To support its own
compliance efforts, Cantor Exchange has engaged the National Futures
Association (``NFA''), the industry-wide self-regulatory organization
for the U.S. futures industry, to provide the exchange with self-
regulatory services to monitor trading and protect against market
manipulation and other abuses. NFA has demonstrated its ability to
safeguard and protect the public interest in markets as broad and
diverse as carbon futures markets and the foreign exchange markets.
The final settlement value of a DBOR contract represents the movie
ticket purchases of millions of American consumers over a period of
approximately four weeks. These purchases are reported by movie
theaters, tabulated by Rentrak Theatrical, and published by studios.
Therefore any effort to manipulate the DBOR contract's final settlement
value would require tens of thousands of ticket sales to be under or
over reported. It is hard to accept that such a large scale reporting
gap could go undetected by all these commercial entities. For example,
studios compare pop corn and soda sales to ticket sales as a check
against under reporting. Even if such a fraud was attempted using box
office futures, the beneficiaries of any such manipulation of the final
settlement value would be quickly detected by Cantor Exchange, the NFA,
and the CFTC. As Lionsgate's Mr. Burns indicated in his letter to the
Committee, ``Lionsgate is comfortable that the market for futures on
box office receipts can be adequately policed regarding material non-
public information and attempted market manipulation. The Cantor
Exchange, under the CFTC's rules, will restrict trading by those with
material non-public information relating to film releases.''
Manipulation is often associated with trading on material, non-
public information. Clearly, certain institutions that may have an
economic interest in hedging with DBOR contracts will have access to
material non-public information relating to the underlying film title.
This is not different from the situation in other public markets where
trading activity is walled off from those who have material nonpublic
information.
Currently, the entertainment industry has no such barriers and has
expressed concern about how such barriers might impact their
operations. Cantor Exchange would like to emphasize three key points on
this issue: (1) information barriers will not be required unless an
entity is actively using the market; (2) having knowledge of the
artistic content or prior viewing of a film does not constitute
material non-public information; and (3) Cantor Exchange will work to
assist any firm that wishes to prohibit its employees from trading. For
example, Cantor Exchange does not permit trading by any employee of a
FINRA or CFTC regulated entity unless that employee has the written
permission of his employer's compliance department.
Commercial Value of DBOR Contracts
As I noted, the financing and distribution of motion pictures is
undergoing a period of enormous technical and financial change. Studios
largely control the distribution of films and are uniquely able to fund
the large advertising budgets so crucial to a film's box office
success. Recently studios have abandoned many of their boutique
divisions that distributed independent film, focusing instead on
blockbusters.
However, digital distribution of motion pictures will make it
easier for movie theaters to show smaller independent films. The
missing element for independent film makers and distributors is a means
to evaluate the commercial potential of their film and secure financing
against that potential. This is exactly the role that a futures market
based on box office receipts can play.
The financing of motion pictures is now coming from many new
sources including corporate sponsors who may back individual film
projects as part of their brand marketing. As the sources of film
financing become more fragmented, the need for a regulated and
transparent futures market increases.
Hollywood studios have hedged their film making risk for many
years, for example, by buying insurance against bad weather during
outdoor filming. In spite of its glitz and glamour, the motion picture
industry is relatively opaque. We suspect that the MPAA is primarily
concerned that a transparent market in film revenues will detract from
its influence and control of market information, hence its disingenuous
claims that futures trading has no commercial value.
We also recognize that the MPAA's concern seems to be a knee-jerk
reaction to change, just as companies in the oil, aluminum and other
industries initially opposed the establishment of futures markets, but
now find them to be useful and customary aspects of their industry's
commercial practices.
There is no question that a public market for DBOR contracts will
shine a brighter light on the motion picture industry. Allowing a
greater number of market participants to signal their expectations
about the market by allocating their capital will result in a more
accurate assessment of value. We believe this greater transparency
could benefit many participants in the industry. For example,
purchasers of downstream licenses pay prices based on box office
receipts or based on expected box office receipts if contracted in
advance. DBOR contract pricing could constructively benefit those
negotiations by providing new information to the downstream
counterparty that currently has to rely on less public and less
transparent sources.
Conclusion
Enlarging the potential sources of film financing will lower the
cost of making a film, help create American jobs, and contribute to
stabilizing large and small members of the industry alike as they face
the challenge of raising financing in the high-risk endeavor of film
making. A marketplace that enables film makers to raise capital at a
known price will reduce risk and increase the likelihood of bringing
their product to market.
The MPAA asserts that its objection to DBOR contracts is based on
its belief that those contracts will not provide a genuine market for
hedging risk or contribute to price discovery. As my testimony has
shown, these critiques are misguided.
It is ironic that while transparency in financial markets is widely
endorsed in legislation and Congress is promoting regulated futures
exchanges and centralized clearing, the MPAA's objections would result
in less transparency, increased counterparty credit risk, and fewer
financing options.
Since the early stages of our process to establish the Cantor
Exchange, we have actively sought out the input of a wide range of
individuals and entities throughout the motion picture industry. Many
of those we have reached out to have expressed interest in the concept
of DBOR futures contracts. We have received considerable useful
feedback and have continued to refine our business plans and strategy.
An April 8, 2010 press release by the Futures Industry Association,
the leading trade organization for the futures industry, urged that the
potential introduction of film revenue contracts should be ``applauded
rather than criticized''.
We encourage the Subcommittee to ensure that the CFTC continues its
diligent work to review and allow transactions to be executed and
cleared in regulated and transparent venues. The legislation is already
in place to allow Cantor Exchange to operate a futures market in DBOR
contracts in accordance with the Commodity Exchange Act, and its
application should be approved promptly.
Greater transparency, reduced counterparty risk, and broader
participation are precisely the benefits that Congress, economists and
others have cited in recommending improvements in the financial
markets. During the financial crisis of 2008-2009, most agree that the
futures markets performed their function properly. We urge the
Subcommittee to support creation of this new, constructive, federally
regulated futures market that will enhance the motion picture
industry's transparency, market integrity, and ability to effectively
manage commercial risk.
We believe our application for contract market designation and for
approval of the futures contracts based on box office receipts is
clearly in the public interest. Our innovative proposed futures
contracts on box office receipts offer many in the motion picture
industry the ability to hedge their commercial risks and will be used
for price discovery purposes. Although not all interests in the motion
picture industry may be inclined to trade box office contracts for
these purposes, others stand to benefit greatly from their
availability. This has often been the case at the time a new class of
futures contracts was introduced.
Prohibiting futures on motion pictures by changes to the Commodity
Exchange Act or by new laws or regulations could deny this critical
industry a tool available to manage capital and allocate risk more
effectively. While all forms of financial innovation should be
carefully assessed to determine their value to the marketplace and the
public interest, we are extremely confident that the current Commodity
Exchange Act and CFTC regulations fully and adequately address all the
issues that have been raised by certain groups within the motion
picture industry for the Subcommittee's consideration.
On behalf of Cantor Exchange, thank you for this opportunity to
discuss how our proposed futures contracts will bring new levels of
risk management, transparency and financial flexibility to the motion
picture industry.
The Chairman. I now recognize Mr. Swagger, Chairman and
Chief Executive Officer, Media Derivatives of Scottsdale. Mr.
Swagger.
STATEMENT OF ROBERT S. SWAGGER, CHAIRMAN AND CEO, MEDIA
DERIVATIVES, INC., SCOTTSDALE, AZ
Mr. Swagger. Thank you, Chairman Boswell and Ranking Member
Moran for inviting us here to testify. I am Robert Swagger,
Chairman and CEO of Media Derivatives. Media Derivatives is a
small, privately funded entrepreneurial business that has
followed the processes and procedures established in the
Commodity Exchange Act, and in so doing, has created jobs
during a challenging time in the U.S. economy.
As an individual who was born in the Midwest and has
experienced the benefits of futures markets to the agricultural
industry, and in particular, as an entrepreneur who helped
found an ethanol plant that its very survival was a direct
result of the use of futures contracts, I have founded MDEX for
the purpose of creating risk management tools for the
entertainment industry. Note, the concepts of creating such
tools was a direct result of my and my team's extensive
involvement in the entertainment industry. We believe that the
development of such products is consistent with the major
thrust of the Congress' enactment of the Commodity Futures
Modernization Act of 2000 which sought to promote, among other
things, innovation with respect to risk management tools and
futures contracts.
On September 25, 2009, MDEX filed its application to become
a designated contracts market. At the time of its filing, MDEX
agreed to separately file its proposed products for approval
rather than self-certifying. In early March 2010, MDEX filed
its first product for review. On the eve of the expiration of
the CFTC's 180 day review period and more than 4 months after
the close of the comment period for DCM application, various
entertainment industry associations filed general objections.
Most of the objections are the same objections that Congress
and this Subcommittee in particular has heard for decades. The
objections have been addressed by CFTC staff throughout the
rigorous review process.
The objectors have contended that the reputation and
integrity of our industry could be tarnished by allowing
trading in the movie futures contracts. This is patently false.
MDEX has no interest in disparaging the reputation and
integrity of Hollywood. The objector statements could apply to
every industry that has a product upon which a futures contract
is listed, such as U.S. Government and Treasury futures, the
housing industry and housing futures, the insurance industry
and weather futures, the listing of aluminum futures and the
aluminum industry, the agriculture industry and the listing of
corn, wheat, soybeans, and other futures.
The notion that regulated futures contracts tarnish an
industry and is tantamount to legalized gambling is outdated
and baseless. MDEX is not seeking to establish an opaque OTC
market such as what already exists, rather MDEX seeks to bring
the same tested benefits of futures contracts such as
transparency, price discovery, liquidity, and centralized
clearing in a regulated environment.
The contracts that MDEX seeks to list are not dissimilar to
other futures and options contracts. The contracts allow
parties with financial interests in the movie production and
revenue chain to hedge the risks. Such groups include original
screenplay owners, debt and equity investors, investment banks
syndicating a financing slate, talent involved in the film,
studios both MPAA and independents, banks and lenders, insurers
of talent and movies, theaters, distributors and co-promotional
marketing partners.
The products proposed by MDEX would provide a viable means
of broadening the financial tools available to a very
significant segment of the economy in an efficient, reliable,
and tested model.
In designing its products, MDEX has worked closely with the
CFTC staff to reduce if not eliminate the likelihood of
excessive speculation in the retail use of its products. MDEX's
contracts specifications require each contract to be fully
funded. In other words, there is no leverage component; thus,
reducing excessive speculation.
At the same time, because they are fully margined and
essentially cleared by a CFTC regulated clearinghouse, there is
no credit risk. In all material respects, MDEX's contracts
obviate risk, they do not create it.
In working with the CFTC for over 11 months and approving
MDEX's DCM application, the CFTC found that both MDEX and the
CFTC, as well as the NFA have the expertise and resources
necessary to conduct market surveillance and compliance with
respect to futures based upon movie box office receipts.
Finally, it is critical to note that today on Intrade, you
can place trades on opening weekend box office results. The
market is offshore, open to the public, unregulated and employs
leverage. The greatest participants on Intrade are U.S.
citizens.
The unintended consequences of the objector's efforts is
likely to result in continuing to push market participants to
retail, leveraged markets that are subject to no oversight by
CFTC or Congress. Rather than push market participants
offshore, MDEX seeks to list and clear contracts in a fully
regulated and transparent fashion subject to comprehensive CFTC
oversight and sound risk management principles.
MDEX thanks the Committee for the opportunity to
participate in this hearing and answer any questions regarding
a proposed product of the MDEX DCM.
[The prepared statement of Mr. Swagger follows:]
Prepared Statement of Robert S. Swagger, Chairman and CEO, Media
Derivatives, Inc., Scottsdale, AZ
I am Robert S. Swagger, Chairman and Chief Executive Officer of
Media Derivatives, Inc., or ``MDEX.''
Thank you, Chairman Boswell and Ranking Member Moran for inviting
us to testify today. You have asked us to discuss our application to
list futures and options contracts based upon movie box office
revenues. We are pleased to offer our views on these important matters.
I. Introduction
MDEX was founded three years ago for the purpose of creating risk
management tools for the entertainment industry. MDEX is a small,
privately-funded entrepreneurial business that is seeking innovative
ways to manage risk, while attempting to create jobs in markets
including Illinois, Indiana, Arizona and California, where our offices
are located. One such risk management tool that we have developed,
based upon market research and feedback, is that of regulated futures
contracts based upon movie box office revenues.
MDEX has developed such a tool not in an effort to impose a risk
management process upon the entertainment industry, but in response to
a demonstrable need for producers, distributors, financiers and others
to hedge the enormous and rising costs--and thus risk--associated with
producing, marketing and distributing a major motion picture. Given
that a single motion picture can cost more than $100 million to
produce, the movie industry would appear to be an especially viable
candidate for risk management tools. We have taken extreme care to
design these products to ensure fair and equitable trading of the
contracts and the integrity of the final settlement process. MDEX also
looks forward to the opportunity to offer other risk management
contracts for the entertainment industry, which may relate to revenues
associated with, for example, music, video games and books.
We believe that the development of such products is consistent with
a major thrust of Congress' enactment of the Commodity Futures
Modernization Act of 2000, which sought to promote, among other things,
innovation with respect to risk management tools such as futures
contracts. The MDEX proposed products would encourage a transparent
market place to establish increased liquidity for future financing of
major films and other entertainment media.
II. Submission of Applications and Comment Periods; Bifurcation of DCM
and Product Applications
On September 25, 2009, MDEX filed its application to become
designated as a fully-regulated contract market, or ``DCM.'' As a
courtesy and in an effort to be proactive, MDEX submitted a draft
application to CFTC staff as early as May 18, 2009.
Shortly after the formal submission of its application, the CFTC
published the application for comment in the Federal Register on
October 6, 2009 and the comment period remained open through November
5, 2009.
Over the course of the past 11 months, MDEX worked closely with
CFTC staff to ensure that its products satisfy the statutory
requirements of the Commodity Exchange Act (the ``CEA''), including the
eight Designation Criteria set forth in CEA Section 5(b) and the 18
Core Principles set forth in CEA Section 5(d). MDEX has also submitted,
as part of and in support of its application, more than 100 documents,
including a statement of compliance with the CEA, its rules, a Trading
Facility and Disaster Recovery Plan, an agreement with the National
Futures Association relating to the exchange's disciplinary program, an
agreement with Minneapolis Grain Exchange (``MGEX'') relating to the
clearing of the exchange's trades, a comprehensive regulatory chart,
and many other documents requested by CFTC staff. MDEX commends the
CFTC and CFTC staff for their tireless and thorough efforts, and we are
pleased to say that, after an extraordinarily comprehensive review,
CFTC staff recommended to the CFTC that MDEX's DCM application be
approved, and the CFTC approved MDEX's DCM application on April 16,
2010.
Additionally, in a separate filing on March 4, 2010, MDEX requested
the CFTC to approve an MDEX futures contract based upon Opening Weekend
Box Office Motion Picture Revenues. Importantly, MDEX did not self-
certify the product listing. Rather, MDEX requested CFTC approval
following publication and an opportunity to comment in the Federal
Register. MDEX's product application remains under review by the CFTC,
and we are working closely with CFTC staff to ensure that any concerns
are adequately addressed.
On the eve of the expiration of the CFTC's 180 day review period--
and more than four months after the close of the comment period for the
DCM application--the MPAA and several other entertainment industry
associations (the ``Objectors'') filed various general objections to
the DCM and product applications and the notion of derivatives in the
entertainment industry. Critically, if MDEX had learned of the
Objectors' concerns four months ago, MDEX likely would not be
testifying here today consuming additional taxpayer funds, as well as
much-needed funds of a small business such as MDEX.
Most of the objections are the same objections that Congress, and
this Subcommittee in particular, has heard for decades, such as futures
contracts are a form of ``legalized gambling.'' Other product-based
objections may be more relevant, but nonetheless are misplaced or have
been addressed with CFTC staff, as MDEX will detail below.
Notably, the Objectors sought not only to challenge the product
listing, but also the DCM application. We strongly believed, however--
and we are pleased that the CFTC agreed--that a DCM application should
be viewed separately from any product application. To the extent that
the Objectors have concerns about the products, such concerns should
not have been levied in an effort to compel the CFTC to withhold its
approval of the DCM application--especially when the comments arrived
more than four months after the close of the comment period. We raise
these concerns because we believe that Congress is and should be
concerned equally about the process as well as the merits. From a
credibility and fairness perspective, matters of procedure need to be
honored if results are to be meaningful.
III. MDEX Seeks to Offer a Regulated, Transparent Risk Management Tool
to the Entertainment Industry
The Objectors have declared that ``the reputation and integrity of
our industry could be tarnished by allowing trading in the movie
futures contracts in a manner which allows them to be viewed as the
economic equivalent of legalized gambling on movie receipts.'' \1\
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\1\ Letter from Objectors to Chairman Gary Gensler, CFTC, dated
March 23, 2010.
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Nothing could be farther from the truth, and MDEX has no interest
in disparaging the reputation and integrity of Hollywood. Notably, the
Objectors' broad and populist statement could apply to every industry
that has a product upon which a futures contract is listed. It could
apply, for example, to the U.S. Government and the listing of Treasury
futures; the housing industry and the listing of housing futures; the
insurance industry and the listing of weather futures; the listing of
aluminum futures and the aluminum industry; and the agricultural
industry and the listing of corn, wheat, soybean and other futures. The
notion that regulated futures contract tarnishes an industry and is
tantamount to ``legalized gambling'' is not only outdated, but
parochial and baseless.
In fact, as witnessed during the financial market turmoil of 2007-
2008, there is broad consensus that the futures markets not only
performed admirably, but that futures contracts in no way contributed
to the financial market turmoil. If anything, the consensus is that
futures contract should serve as a more prominent risk management tool.
Importantly, the Administration and many Members of Congress have
proposed to require that standardized over-the-counter (``OTC'')
derivative contracts be executed and/or cleared on an entity regulated
by the CFTC.
To be clear, MDEX is not seeking to establish a market for the
trading of motion picture products in an opaque OTC market. Such a
fragmented market already exists, albeit in a nascent form. In this
market, participants bilaterally enter into hedges using OTC options.
These transactions are unknown to other market participants, regulators
or Congress. Rather, MDEX seeks to bring the demonstrable benefits of
futures contracts--such as pricing transparency, liquidity and
centralized clearing in a regulated environment--to the highly
uncertain and variable outcome of movie box office revenues.
As discussed more fully below, MDEX believes, based upon its market
research that the need for such a risk management tool exists. The
function of hedging or, more broadly, risk management, is a fundamental
underpinning of the derivatives markets and is weaved into the fabric
of the CEA. The legislative history of the CEA and its predecessor
statute, the Grain Futures Act of 1922, is replete not only with
references to the commercial importance of trading commodity futures,
but that commercial parties should be able to look to properly
functioning commodity futures markets for market information and
products that facilitate marketing, financing and distribution
decisions.\2\
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\2\ Grain Futures Act, ch. 369, 42 Stat. 998 (Sept. 21, 1922). See
also, 73 Fed. Reg. 25669, 26672 (May 7, 2008); S. Rep. No. 93-1131, at
12 (1974).
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Moreover, as a risk management tool, the economic efficacy of
futures contracts, despite the recent financial market turmoil, remains
beyond reproach. While futures contracts may involve risk--and
particular types of derivatives and trading strategies may involve
substantial risk--there is little doubt that derivatives can be used to
perform critical hedging functions.
MDEX sought to become a DCM to bring the benefits of futures
contracts to the entertainment industry. In seeking to promote price
transparency, liquidity and hedging opportunities, MDEX also seeks to
ensure the protection of customer funds. In this respect, MDEX plans to
use an intermediation model of transaction execution in which all
customer trades are executed by CFTC-registered futures commission
merchants (``FCMs'') and all customer funds are maintained in
segregated accounts. Further, all transactions executed on MDEX will be
cleared through a CFTC-registered designated clearing organization, the
Minneapolis Grain Exchange.\3\
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\3\ As part of its regulatory responsibilities, the CFTC monitors
FCMs and clearing organizations with respect to the financial integrity
of the commodity futures and options markets.\3\ For example, CEA
Section 4f(b) and the CFTC's financial and related record-keeping and
reporting rules, such as CFTC Rules 1.20-1.30, 1.32, 1.36 and 1.49, are
part of a system of financial safeguards that includes exchange and
clearinghouse risk management and financial surveillance systems,
exchange and clearinghouse rules and policies on clearing and
settlements, and financial and operational controls and risk management
employed by market intermediaries themselves. Two primary financial
safeguards under the CEA include the requirement that FCMs segregate
from their own assets all money and property belonging to their
customers and the imposition of minimum capital requirements for FCMs
and IBs.
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A transparent marketplace that allows institutional/professional
traders to share in the substantial financial risks assumed by various
participants in film financing would by no means cause harm to the
integrity of the industry. Furthermore, there would be no increased
costs for those Objectors who would choose not to participate in the
exchange. Those studios that elect to participate in our markets will
of course be subject to MDEX rules, including importantly, rules to
assure that trading in our markets is fair and equitable. The costs a
studio may incur to comply with exchange rules will likely be more than
offset the financial benefits of prudent risk management using MDEX
products. Markets in innovative new products should not be prevented
due to unfounded fear and misunderstanding.
IV. Futures Contracts on Intangible Commodities are Permissible and
Already Exist
Based upon the Objector's comments, there appears to be confusion
as to whether the interests underlying MDEX's proposed contracts
constitute a commodity on which a DCM may list contracts for trading.
At the outset, it should be noted that the definition of
``commodity'' in CEA 1a(4) covers ``services, rights, and interests''
in which futures contracts are or may be dealt. That broad definition
covers the reported cumulative gross box office revenues for a movie
through its opening weekend that would underlie MDEX's Opening Weekend
Motion Picture Revenue Contracts. Although futures contracts are often
linked to an underlying cash commodity market, there is no requirement
that a cash market must exist, and the absence of an underlying cash
market for the our opening weekend box office revenue contracts is not
grounds to disqualify them from trading. To the contrary, the
definition of ``excluded commodity'' in CEA 1a(13), which was added
in 2000, expressly recognizes that a measure of economic or commercial
return or value such as that underlying the opening weekend contracts
is a permissible excluded commodity if it is based on one or more
commodities that have no cash market.
Intangible commodities have been based on a broad array of outcomes
and contingencies. Today, for example, the CFTC regulated market of the
North American Derivatives Exchange lists binary contracts based upon
many and diverse economic events. Moreover, the U.S. Futures Exchange
(``USFE''), as a DCM, listed binary event contracts regarding whether
the CME would buy the CBOT; another contract regarded whether the
InterContinental Exchange would buy the CBOT. Notably, in listing these
contracts, the USFE ``self-certified'' that the contracts comply with
the CEA, and CFTC staff did not take any action to abrogate the listing
of the contracts. Other exchanges have listed similar contracts, such
as total insurance claims filed for hurricane damage.
V. MDEX's Proposed Contracts Serve an Important Economic Purpose
The contracts that MDEX seeks to list are not dissimilar to other
futures and options contracts and, based upon MDEX's research with
interested segments of the industry, portend to serve an important
economic purpose in allowing parties with financial interests in the
movie production and revenue chain to hedge the risks associated with
producing a major motion picture. There is a broad group of potential
participants with exposure to a film that are natural shorts, or even
natural long hedgers, including:
Original screenplay owners;
Debt and equity investors;
Investment banks syndicating a financing slate;
Talent involved in the film;
Studios;
Banks and lenders;
Insurers of talent and movies;
Theaters;
Distributors; and
Co-promotional marketing partners whose results are
inherently tied to success at the box office.
In addition, a host of other businesses stand to be impacted by the
performance of movies and thus may have a legitimate need for such risk
management tools.
Traditionally, the entertainment industry has found ways to hedge
the risk associated with delay or cost overruns in the production and
delivery of film product, some more efficient than others, through so-
called ``completion bonds,'' and negative insurance. However, there
have been very limited means to minimize and manage performance risk.
Just as entertainment entities, like many businesses, have used
foreign exchange and interest rate hedging to limit potential risks,
the products to be offered by MDEX will provide a viable means of
broadening the financial tools available to a very significant segment
of the economy in an efficient and tested model. It is hard to imagine
that the corporate parents of the studios do not have a keen interest
in limiting the potential significant downside risk of a poorly
performing picture. To spend $500,000 to create the floor for loss on a
picture that is spending $65,000,000 in prints and advertising seems
like a very reasonable business judgment.
With respect to those who are involved in the financing of films,
the box office future contract would provide senior debt lenders with a
tool to hedge the potential under-performance of films. In today's
financial climate, lenders are likely to be unwilling to take box
office performance risk even on a large portfolio of films if tools
exist to aid them. Traditionally, this has been performed through so-
called slate financings, a tool that has been severely limited by the
current financial climate.
The availability of risk management contracts can provide a level
of confidence and free-up financing capacity. For instance, the opening
weekend box office product would provide to these parties a tool to
hedge performance of future films in the slate financing should the
performance of the initial releases be at a level that is lower than
anticipated in the financier's underwriting criteria. This would reduce
the overall volatility of the slate and would encourage lenders to once
again be lending. As lenders provide debt to film slate financing, it
should improve equity returns and thereby encourage equity investors to
enter the market. Additionally, equity investors would not only have
the opportunity to hedge their positions in the way similar to that
used by the senior debt investors, but they would also have the
opportunity to improve their returns by ``going long'' on their film
slate thereby boosting overall returns and attracting additional
capital to what is currently a capital starved entity.
VI. MDEX's Futures Contracts Do Not Promote Excessive Speculation and
Do Not Rely Upon Leverage
Over the past few years, much has been written about excessive
speculation, and the Objectors have joined the general choir. In
designing its product, however, MDEX has worked closely with CFTC staff
to reduce--if not eliminate--the likelihood of excessive speculation
and the retail use of its products.
MDEX has created contract specifications that minimize such
potential outcomes by specifying a relatively high notional value
coupled with a requirement that each contract be fully funded, or fully
margined. In other words, there is no leverage component. MDEX's
contracts thus do not avail themselves to speculation. At the same
time, because they are fully margined and centrally-cleared by a CFTC-
regulated clearing house, there is no credit risk. In all material
respects, MDEX's contracts obviate risk; they do not create it.
VII. MDEX's Futures Contracts Are Not Susceptible to Manipulation
The Objectors have raised a concern regarding possible insider
influence on compiling the public box office figures in order to affect
final settlement prices for MDEX products, as well as possible actions
that a film studio or distributor might take on the use of a movie's
advertising budget to influence daily pricing of the contracts.\4\
These concerns are relevant, but MDEX has addressed them through its
product design, processes and procedures.
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\4\ See Letter from Objectors to Chairman Gary Gensler, CFTC, dated
March 23, 2010.
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Clearly, a fundamental purpose of the CEA is to prevent
manipulations in the commodity futures and futures options markets.\5\
With respect to exchanges, this purpose is embodied in CEA Section
5(b)(2), Designation Criterion 2, which provides that the board of
trade:
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\5\ See CEA 3(b) and 9(a)(2).
shall have the capacity to prevent market manipulation through
market surveillance, compliance, and enforcement practices and
procedures, including methods for conducting real-time
monitoring of trading and comprehensive and accurate trade
reconstructions.\6\
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\6\ CEA 5(b)(2), 7 U.S.C. 7(b)(2).
Further, CEA Section 5(d)(3), Core Principle 3, provides that the
board of trade ``shall list on the contract market only contracts that
are not readily susceptible to manipulation.'' \7\ In approving MDEX's
DCM application, the CFTC has declared that both MDEX and the CFTC have
the expertise and resources necessary to conduct market surveillance
with respect to the commodities upon which MDEX seeks to list futures
contracts. In working with the CFTC over the past 11 months, MDEX has
taken the steps necessary to ensure that its opening weekend contracts
will not be readily susceptible to manipulation. MDEX has satisfied
these concerns through product design and various processes and
procedures.
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\7\ CEA 5(d)(3), 7 U.S.C. 7(d)(3).
---------------------------------------------------------------------------
With respect to product design, MDEX's proposed opening weekend box
office products are short-term contracts that are only listed for
trading four weeks in advance of a movie's release. Four weeks prior to
a movie's release, the market has a significant amount of public
information at its disposal to render trading decisions, and marketing
plans are well into the execution phase. Theater screens are set for
the showing of the movie and only minimally adjusted in the final weeks
prior to opening. Movie theater screens are finite real estate, and
with the competition among movies at any given point in time, large
numbers of screens are simply not available for a last minute changes.
Importantly, MDEX rules require that the opening weekend revenue
products cease trading prior to a movie's release in theaters. This
serves to remove the concern regarding the earlier availability of box
office information to the studio/distributor than the public.
Further, a key aspect of product integrity addressed by the CFTC
and MDEX is the determination of the box office revenue figure used in
establishing the products' expiration prices. In meetings that MDEX has
held with major studios, it has been expressed to us that the studios
are very sensitive to public expectations for box office revenues
accuracy and reliability. In support of this studio position, MDEX
presented information and developed rules and processes to ensure the
integrity of its expiration prices. In particular, MDEX has developed a
``Motion Revenue Contracts Box Office Revenues Validation and
Verification Processes,'' which includes:
Ensuring that the studio/distributor's publicly reported box
office number fits within a pre-set standard deviation derived
from data provided by the industry leading data provider--
Rentrak--that collects box office revenue information directly
from the theaters;
Maintaining up to date studio/distributor and Rentrak data
for all wide-release movies and using the data to periodically
adjust the standard deviation;
Requiring the studio/distributor to provide evidence to
support its public box office number when it falls outside the
standard deviation level;
Requiring MDEX to determine an appropriate box office level,
using Rentrak and studio/distributor data, in which to
establish the final expiration prices, when the studio/
distributor cannot justify its box office number; and
Weekly verification of the Rentrak process for collecting
theater box office data.
In addition, MDEX has adopted a series of Firewall and Restricted
Participant Review protocols to prevent the improper use of
information. Under the protocols:
Communication is prohibited between the individuals
responsible for or having input into the studio/distributor's
decisions to trade such Contracts (the ``trading group''), on
the one hand, and its employees who are responsible for
compiling and/or computing the gross box office revenues
publicly disseminated by such studio/distributor for its motion
pictures regarding the studio/distributor's positions in any
such contracts or the trading group's decisions or discussions
with respect to establishment of such positions. The disclosure
prohibition on these employees also extends to disclosing the
information to any other parties, except as necessary, in
performance of the employee's responsibilities.
Certain employees within a studio/distributor and companies
that collect box office revenues are prohibited from trading
MDEX box office products.
Studios/distributors that participate in MDEX markets are
required to adopt procedures to monitor the communications and
enforce the trading prohibitions.
MDEX will periodically review the studio/distributor
procedures and require them to attest that the procedures are
included in internal control reviews.
MDEX will routinely review a studio's/distributor's expired
movie contracts for patterns between expiration prices and
positions to determine if there may be issues with firewall
procedures.
When a party applies to the exchange for trading access,
MDEX will require the party and his clearing firm to identify
whether he may be subject to trading restrictions under the
MDEX rules.
All of the foregoing procedures and processes have been
painstakingly addressed and examined by CFTC staff. The staff, in
recommending the approval of our application, understands and agrees
with the efficacy of the procedures and processes.
Moreover, from the perspective of investor protection, the CEA also
strictly prohibits actual and attempted manipulations by market
participants. The prohibitions against manipulation of prices are set
forth in CEA Sections 6(c), 6(d) and 9(a)(2).\8\
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\8\ 7 U.S.C. 9, 13b, and 13(a)(2). CEA Sections 6(c) and 6(d)
authorize the CFTC to issue a complaint if it ``has reason to believe
that any person . . . is manipulating or attempting to manipulate or
has manipulated or attempted to manipulate the market price of any
commodity, in interstate commerce, or for future delivery on or subject
to the rules of any registered entity.'' 7 U.S.C. 9, 13b. CEA
Section 9(a)(2) makes it is unlawful for ``[a]ny person to manipulate
or attempt to manipulate the price of any commodity in interstate
commerce, or for future delivery on or subject to the rules of any
contract market, or to corner or attempt to corner any such
commodity.'' 7 U.S.C. 13(a)(2) (2002). Together, CEA Sections 6(c),
6(d), and 9(a)(2) prohibit both manipulation and attempted
manipulation.
---------------------------------------------------------------------------
Notably, the CEA does not prohibit insider trading by market
participants in the commodity futures and options markets, based upon
the premise that barring insider trading would defeat the market's
basic economic function of allowing traders to hedge the risks of their
commercial enterprises.\9\ In other words, virtually every commercial
hedger has some amount of inside information.
---------------------------------------------------------------------------
\9\ See, e.g., Testimony of Commission Chairman Phillip McBride
before the SEC/CFTC Jurisdictional Issues and Oversight: Hearings on
H.R. 5447, H.R. 5515 and H.R. 6156 Before the Subcommittee on
Telecommunications, Consumer Protection and Finance of the House
Committee on Energy and Commerce, 97th Cong., 2nd Sess, Part 1 at 21
(1982); A Study of the Nature, Extent and Effects of Futures Trading by
Persons Possessing Material Non-Public Information (Sept. 1986).
Trading on material non-public information is prohibited under the CEA,
but only with respect to three general categories of persons. First,
the statute prohibits CFTC Commissioners, employees and agents from
trading on non-public information. CEA 9(a)(4), 7 U.S.C. 13(a)(4).
The statute similarly prohibits CFTC Commissioners and CFTC employees
from delivering nonpublic information to third parties with the intent
to assist them in conducting trades; the CEA also forbids individuals
who receive this information from trading on it. CEA 9(d), 7 U.S.C.
13(d). Finally, the CEA prohibits employees and board and committee
members of a board of trade, registered entity, or registered futures
association, from willfully and knowingly trading for their own or on
behalf of any other account, futures or options contracts on the basis
of any material non-public information obtained through special access
related to the performance of their duties. CEA 9(e), 7 U.S.C.
13(e).
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VIII. Contracts Based Upon Movie Box Office Currently Trade on
Unregulated Foreign Markets
Finally, it is critical to note that, as we speak, unregulated
foreign markets trade products based upon movie box office revenues and
related measures. For example, on Intrade, a market based in Ireland,
you can place trades on the opening weekend box office results of Iron
Man 2 or Date Night. This market is open to the public, unregulated and
employs leverage. The unintended consequence of the Objectors' efforts
is likely to result in continuing to push market participants to
retail, leveraged markets that are subject to no oversight by the CFTC
or Congress.
Rather than push market participants offshore, MDEX seeks to list
and clear contracts in a fully regulated and transparent fashion,
subject to comprehensive CFTC oversight and sound risk management
principles.
IX. Conclusion
MDEX has allocated substantial efforts and resources to develop its
DCM and entertainment risk management products. MDEX recognizes--as
many within the entertainment industry recognize--the unique and
growing risk management challenges facing the entertainment industry.
MDEX looks forward to the opportunity to allow market participants in
the entertainment industry to determine whether MDEX's proposed product
is suitable as a risk management tool.
Media Derivatives, Inc. thanks the Committee for the opportunity to
participate in this hearing and answer any questions regarding a
proposed product of the MDEX DCM.
The Chairman. Thank you.
The chair would now like to recognize Mr. Pisano, president
and interim Chief Executive Officer for Motion Picture
Association of America.
STATEMENT OF A. ROBERT PISANO, PRESIDENT AND INTERIM CEO,
MOTION PICTURE ASSOCIATION OF AMERICA, INC., WASHINGTON, D.C.
Mr. Pisano. Thank you, Mr. Chairman, Mr. Moran, and Members
of the Committee. Thank you very much for allowing us to be
here today.
I am appearing today on behalf of the six companies that
are represented by the Motion Picture Association, but also on
behalf of a really unprecedented coalition of members of the
industry who are traditionally, frankly, warring parties. You
have present at this table representatives of labor and
management, representatives of exhibition and distribution, and
representatives of large studios and small independent
producers. To envision all of these groups together on a single
issue is almost unimaginable, but it is this issue that has
brought us together.
The second thing I would like to say is I come before you
as a representative of a trade association, but also as someone
who has actually spent 25 years in the movie industry. I have
been an executive at Paramount, MGM, I was head of the Screen
Actors Guild. And in the course of my career in the industry, I
have probably been associated with the production, financing,
distribution and marketing of well over 200 films. And so I
come at this from the standpoint of someone who has actually
been in the industry and is deeply concerned about it.
We have a way of marketing movies in the industry in which
we say, ``From the producer up,'' or, ``The director up,'' and
I am tempted to say this movie, this particular movie, this
particular idea, should be marketed as from the producers who
brought you the derivative debacle, and I don't mean that all
derivatives are bad. What I do mean is this derivative falls in
that category of synthetic, fictional instruments designed
solely for speculation or gambling.
My first point, and Congressman Goodlatte made it earlier,
there is no market for movie box office receipts. In fact,
movie box office receipts reporting were created by my company
in the 1980s as a way of marketing our movies. We wanted to be
able to say that we had the number one movie of the weekend.
You can't buy them; you can't sell them; and equally important,
you can't take delivery of them because nobody makes them
available. They are simply an indication of public support.
Second, as Congressman Goodlatte also pointed out, this is
a unique product. The functional equivalent of writing a
commodities contract in a traditional way would be to write
that contract on a cow or an ear of corn. And I dare say if
such a contract came before the CME, it would be excluded.
So you have these two factors: No market, no buying and
selling; a unique product, and to me that gives you the
potential for manipulation because the very people who are
buying and selling it are people who are not part of the
industry, have no stake in it, and are only speculating. So
that, in turn, raises the possibility of harm to the industry
because a short position against a movie reported on an
exchange with an aura of authenticity will become a self-
fulfilling prophecy. People will stay away from the box office
because the price of the movie in the futures market has gone
down. I submit to you that is both subject to manipulation;
and, frankly, it is subject to hurting both the industry and
the individual movie.
I can speak about the injury to the industry, and my
colleague, Mr. Harbinson, will speak about the harm to the
creators, the people who actually create the movie, the
directors, the writers, the actors. They work on one movie, and
to have that subject to speculation and arbitrary trading in
order to affect the outcome is something that should not be
permitted.
So we have no price, no market, a unique product, subject
to manipulation, subject to harm. What do we have here? I
submit to you we have wager, gambling over and under betting.
That is something that more properly belongs in Las Vegas, no
offense to Las Vegas, and regulated by the gambling laws. It
should not be put in the clothing of a commodity.
And so we urge the Committee to urge the CFTC to deny the
applications for the contracts and we urge the Committee at
conference to support the amendment in the Senate financial
reform bill prohibiting trading in these kinds of agreements.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Pisano follows:]
Prepared Statement of A. Robert Pisano, President and Interim CEO,
Motion Picture Association of America, Inc., Washington, D.C.
Thank you, Chairman Boswell and Ranking Member Moran, for the
invitation to provide testimony before the Subcommittee on General Farm
Commodities and Risk Management of the House Committee on Agriculture,
regarding proposals to designate contract markets that will provide a
mechanism for trading futures and option contracts in motion picture
box office numbers. My name is Robert Pisano. I am appearing today and
providing oral testimony on behalf of the Motion Picture Association of
America, Inc. (``MPAA''). However, these prepared remarks are submitted
as the collective views of The Directors Guild of America, Inc.
(``DGA''), the Independent Film & Television Alliance (``IFTA''), the
International Alliance of Theatrical Stage Employees (``IATSE''), and
the National Association of Theatre Owners (``NATO''), as well as the
MPAA and its member companies, Paramount Pictures Corporation, Sony
Pictures Entertainment Inc., Twentieth Century Fox Film Corporation,
Universal City Studios LLLP, Walt Disney Studios Motion Pictures, and
Warner Bros. Entertainment Inc., which represent perspectives from all
corners of the motion picture industry.
I have spent virtually my entire career in the film business, first
as a partner of a major law firm working on entertainment matters
before joining Paramount Pictures as executive vice president and
general counsel in 1985. At Paramount, I was responsible for all legal
and legislative affairs, as well as labor relations and business
development. I was a member of the Office of the Chairman and the
Operating Committees of the studios' international theatrical, video,
and pay television distribution and exhibition joint ventures. I left
Paramount and joined Metro-Goldwyn-Mayer in 1993 as Executive Vice
President and then became Vice Chairman, when I had the
responsibilities of chief operating officer. Immediately before joining
MPAA, I was National Executive Director and CEO of the Screen Actors
Guild. My views, my opposition to futures trading in box office
receipts, reflect not only the views of the MPAA and its members, and
the film industry coalition allied with MPAA on this matter, but also
my long experience engaged in the financial and business aspect of the
film industry.
The Commodity Futures Trading Commission (``CFTC'') currently has
before it applications to approve or deny two proposed commodity
futures contracts and a commodity option contract that are designed to
allow the contracts' users to bet on the level of gross motion picture
box office numbers for single and unique motion pictures (``the
proposed contracts'' or ``the contracts''). We strongly oppose approval
of these proposed contracts because they are nothing more than gambling
contracts that lack any of the characteristics of legitimate futures
contracts, fail to serve any public interest, and will harm all parts
of the motion picture industry. Descriptions of the terms of the
proposed contracts are included in Attachment A to these remarks.
Legitimate commodity futures contracts invariably are designed to
serve the interests of the industries that use the underlying
commodities by providing a means to discover prices and hedge commodity
price risks. Consistent with this, Congress has declared in Section
3(a) of the Commodity Exchange Act (``CEA''), 7 U.S.C. 5(a), that
transactions covered by the CEA ``are affected with a national public
interest by providing a means for managing and assuming price risks,
discovering prices, or disseminating price information.'' CEA Section
3(b), 7 U.S.C. 5(b), further declares that it is the ``purpose of
this Act to serve the public interests described in subsection (a) . .
. .'' It is service of these public interests that distinguishes
legitimate, lawful futures contracts from gambling contracts that are
either proscribed as crimes by the Federal Wire Act or regulated by
state gaming authorities.
The proposed contracts, which are sponsored by Media Derivatives,
Inc. (``MDEX'') and The Cantor Futures Exchange L.P. (``Cantor''),
serve no public interest and, to the contrary, can significantly harm
the motion picture industry and impose new, substantial costs that do
not exist today. A Cantor affiliate currently operates a website known
as The Hollywood Exchange that lets users of the site engage in make-
believe, non-monetary bets on the success of particular motion
pictures. The request for CFTC approval of the proposed futures
contracts is a transparent device to convert such make-believe, online
betting into a for-profit wagering service, thereby circumventing the
criminal proscriptions of the Federal Wire Act.
The CEA, however, does not authorize the CFTC to license gambling
contracts that fail to serve the public interests required for every
lawful futures contract. And, in light of the existing significant
strains on the CFTC's scarce resources in regulating legitimate futures
and derivatives markets, those resources should not be diverted now to
policing gambling on motion picture box office numbers.
A. The Proposed Contracts Provide No Price Discovery or Hedging Service
to the Motion Picture Industry; They Are Simply Betting
Instruments
The motion picture industry is distinctly different from industries
that have use for legitimate futures contracts. First, in the motion
picture industry, there is no cash market in any ``commodity''--no
articles or interests are traded among buyers and sellers for which a
futures market is needed or desirable for price discovery.\1\ Second,
the product of the industry is an artistic or entertainment product
that derives its value not from any intrinsic utilitarian use, but from
emotional sentiment. Whether a motion picture will connect with an
audience has proven quite difficult to predict, and in some instances
sentiment for a motion picture can prove to be quite fleeting. There is
no set formula for success, which depends on the totality of such
things as artistic intangibles, marketing, release date, opening
locations, and the national mood, fears, and fascinations at a
particular time. Significantly, studios must invest virtually all of
their capital up front. Accordingly, post-production, studios have
natural incentives to avoid any action that can threaten an audience's
interest in or reception of a motion picture.
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\1\ Motion picture box office numbers are outside of the legal
definition of a ``commodity'' under the CEA because (a) no rights or
interests are traded in motion picture box office numbers, (b) such
numbers (as announced by Variety) do not value any other traded
article, good, right or interest, and (c) such numbers are not beyond
the control of certain industry insiders. All of the commodities
specifically enumerated in CEA Section 1a(4), 7 U.S.C. 1a(4), are
traded in cash markets, and the requirement that futures prices reflect
the legitimate forces of supply and demand of an underlying cash market
further requires that futures contracts be permitted only to the extent
that they reflect the valuation of articles, rights and interests that
are traded. In addition, box office numbers are not within the CEA's
definition of ``excluded commodity'' because they are within the
control of or, at a minimum, highly influenced by, a small group of
entities (i.e., producers, distributors and exhibitors) that control,
among other things, the number and location of theaters in which a
motion picture is shown, the number of screens and size of screens on
which a motion picture is shown, and the marketing budgets for a motion
picture. See CEA Section 1a(13)(iv)(I), 7 U.S.C. 1a(13)(iv)(I).
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Third, unlike most other products that are the subject of futures
contracts, the value of an individual motion picture is not priced in
open bidding among a large contingent of interested parties. Rather, a
relatively small number of entities (the studio, the exhibitors, and
marketers) have inordinate impact on the potential for box office
numbers in the opening weekend and beyond for any particular motion
picture. Their private decisions as to release dates, opening
locations, number of theaters, number of screens, size of screens, and
marketing budgets can significantly impact box office numbers in the
early weeks of showings. Those decisions can be in flux up to the
opening release and beyond, and much of the information regarding those
decisions is closely held and protected from public dissemination.
Fourth, unlike all other industries that use futures contracts, the
motion picture industry has no constituents that would be natural long
hedgers--no one has a risk of loss if a motion picture is wildly
successful. Accordingly, there is no natural price competition in any
purported ``market'' for box office numbers.
Neither of the sponsors contends that their proposed contracts
offer any price discovery function. Studios receive information on box
office numbers directly from exhibitors and others, including Rentrak
Theatrical (``Rentrak''), a private company that compiles information
on box office numbers from many, but not all, exhibitors. The public
generally receives estimates of gross box office numbers from reading
stories in the general press based on figures announced by the studios
and Rentrak.
Moreover, the bets made on the proposed contracts would not be a
reliable indicator of box office numbers, because much of the material
information affecting such numbers is non-public. Bettors would not
have access at any time to much of the material information affecting a
motion picture's box office performance (e.g., marketing budgets,
distribution agreements), because it generally is not publicly
available. Trying to forecast box office numbers prior to a motion
picture's release without the benefit of the non-public information
that is closely held by studios and other motion picture industry
insiders is arbitrary.\2\ Significantly, none of the means used to
assess the legitimacy of futures pricing based on supply and demand
would exist for the proposed contracts. Prior to the publication of
estimates of box office numbers for the first weekend release, there is
no cash market pricing, no additional months of futures market pricing,
and no actual cash market transactions against which to measure the
legitimacy of the futures price.
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\2\ Marketing and distribution plans are never made public. Prior
to release, traders could see trailers, TV spots, and print, online,
and outdoor advertisements. However, the marketing spend itself and the
break-down of spend by media are not public and would be difficult to
determine as an outside observer, particularly as marketing varies by
location.
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Further, non-public business decisions regarding motion picture
marketing and distribution plans that affect box office numbers can and
do occur up to and throughout the release of the motion picture, with
studios constantly adjusting their distribution patterns and marketing
spend to take account of consumer acceptance of a film. Although a
preliminary plan is prepared in advance of approving a motion picture
for production (i.e., well before a release date is scheduled), the
plan remains subject to change and in fact is continually adjusted
until the motion picture is released and beyond. Marketing changes
generally can be made within a day and in some cases almost
immediately, in terms of changing marketing materials, their placement,
or their relative frequency of use.\3\
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\3\ The press does report the number of screens on which a motion
picture will be released (but usually only within a week of release)
and may report changes in screen count earlier if it becomes known that
the scope of release has been significantly increased or decreased for
a motion picture, but this information alone, without knowledge of
other material, non-public information, is wholly inadequate to
reasonably predict box office numbers.
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The proposed contracts have no appeal or use with respect to the
public interest criterion of hedging. Studios mitigate their financial
risk at the pre-production stage or early in the production stage by a
host of techniques, including partnering with other companies to share
the risk, diversifying projects across different segments of the
viewing audience, selling downstream rights early to cover costs, and
raising capital in private and public markets to effectively syndicate
the risks. Studios further mitigate their financial risk by balancing
their slate of motion pictures with a variety of types of pictures (new
films and remakes; low budget and high budget; teen and adult; comedy
and drama and horror, etc.).
Although it may appear in theory that establishing a short position
in a futures contract could be a ``hedge'' against poor box office
performance, in the reality of the marketplace, selling a motion
picture ``short'' after production would invite catastrophic collateral
consequences, both for the particular film's success and future
relationships with financiers, directors, actors, exhibitors and
others. Commercial interests involved in a motion picture will not run
the risk of negative publicity by creating even the potential for
accusations or rumors that it was ``betting against'' the success of
its own picture by ``shorting'' it in a futures market. Moreover, there
is a legal concern that such shorting transactions could generate
claims of violating standard mutual covenants in industry contracts
with exhibitors, directors, actors and others that prohibit
disparagement of the work.
For independent producers, whose films are often released in the
U.S. by the major studios, which control marketing and release plans,
mitigating financial risk may be even more difficult. Independent
producers secure financing on a film-by-film basis with different
investors for each film and rely heavily on the distribution
commitments of foreign distributors before production of the film even
begins. Those minimum commitments, along with any government incentive
programs, are collateralized by financial institutions and other
investors, which loan the producer the production budget. Independent
producers rely on the proceeds of foreign distribution to pay back the
production loan, and therefore any hedging by U.S. distributors could
harm not only independent producers, but also the dozens of financial
and commercial partnerships they must build worldwide to secure
financing for each film.
Theater owners similarly have no incentive to bet against a motion
picture. They do not want to be perceived as betting against the
product they will be offering and they have other means to mitigate
risk. By virtue of the Paramount Antitrust Consent Decrees entered into
with most of the major motion picture studios about 60 years ago, the
studios license on a theater-by-theater and picture-by-picture basis.
Motion picture licenses are not tied one picture to another. Doing so
would be a violation of the Paramount Antitrust Consent Decrees and, in
any case, also would raise antitrust considerations. Therefore, no
exhibitor is obligated to license any motion picture. If an exhibitor
chooses to license a motion picture, the rental for that license is
negotiated separately, and any concern that the exhibitor may have
regarding the public's interest in the motion picture (i.e., potential
success) will be reflected by the percentage of the rental the theater
owner agrees to pay based on those negotiations. Motion picture rental
is paid as a percentage of the gross numbers of tickets sold.
Significantly, underscoring the fallacy that the proposed contracts
are even close to being legitimate futures contracts, the sponsors'
contract rules effectively and, for Cantor's contracts, expressly,
prohibit trading by studios and other insiders, thus precluding any
potential for hedging whatsoever.\4\ These rules are unique among all
futures contracts. They bear witness to the fact that the proposed
contracts, unlike legitimate futures, do not in fact price
``commodities'' that are traded in a market, but, rather, are bets on
the value for a single product (the motion picture), which can be
substantially influenced through the actions of relatively few
insiders. The sponsors' rules suggesting the use of an ``Information
Barrier'' as a means to avoid the proscription of insider trading
provide no assistance in permitting hedging. Such a barrier requires
futures traders for a studio to be cordoned off from any information
within the studio that would provide the basis for determining hedging
needs and strategy. Studio and other industry insiders who have the
ability to materially affect the level of box office numbers also
likely would be wary of trading in the proposed contracts in any event,
because doing so increases the potential of incurring significant legal
costs in having to respond to inquiries from governmental
investigations and/or private claims if futures prices gyrate.
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\4\ Cantor's filing on April 14, 2010 with the CFTC of a proposed
contract based upon ``The Expendables'' expressly prohibits any person
in possession of material, non-public information from trading in the
contract until the information has become public. Examples of such
information cited in Cantor's rules include, but are not limited to,
changes in release date or the promotion or advertising budgets, number
of theaters showing the film, and actual box office receipt statistics
following release. Cantor's rules purport to require studios and other
entities to adopt policies to ensure that their officers, directors,
employees, and agents, including authorized traders, do not trade on
the basis of material, non-public information.
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As a practical matter, any decisions by a studio to hedge any risk
would need to be cleared with senior management, who necessarily have
intimate knowledge of all financial and contractual information
relating to a motion picture and under the sponsors' rules would not be
permitted to interact with traders. In this connection, box office
numbers data are very important and sensitive information that is
shared within a studio with, among others, key mid-level marketing
personnel, the General Counsel's Office, and senior management. No
studio is arranged or intends to reorganize itself so as to separate
the management and reporting lines of persons with access to the box
office numbers data and the persons who compile or compute those
figures. It makes no sense to do so and would prevent a studio from
utilizing the box office numbers data in the most efficient manner.
B. The Proposed Contracts Will Harm the Motion Picture Industry
Currently, studio estimates of box office numbers do not impact
anyone; they are of no consequence to the public's interests. However,
the CFTC's approval of the proposed contracts will create: (a) burdens
for motion picture financing by creating new, but unreliable and non-
economic, prognostications of a motion picture's success, (b) conflicts
of interest for studio employees and independent contractors by
creating a means to bet against the success of motion pictures, and (c)
new legal risks for studios in, among other things, announcing
estimates of box office numbers and having to police the use of inside,
non-public information affecting box office numbers that could be
material to bettors' trading decisions.
The pricing on the proposed contracts creates a greater risk of
depressed box office numbers because such pricing, although lacking any
reliable economic basis, could harm a motion picture's prospects by
negatively affecting financiers' and audiences' perception of it.
Because the ultimate breadth of distribution can be revised up to the
time of release and afterward, the proposed market could affect
distributors' ability to secure screens if the pricing of contracts
signals a sentiment of negative box office results. The harmful effect
of negative publicity is not limited to theater showings. Many prices
for downstream licenses and other sources of revenue are driven in part
by actual box office receipts. Motion pictures slated to open in
limited theaters (which can easily meet the threshold requirements of
the proposed contracts of 600 theaters for MDEX and 650 for Cantor) and
then broaden based on word of mouth could be ruined by futures pricing
that casts them in the false light of a ``failed'' opening.
The impact of piracy could be amplified by these contracts because
trading in the proposed contracts also creates a new means to try to
profit from theft of studios' confidential motion picture materials,
thereby increasing the likelihood of such theft and exacerbating our
industry's existing widespread motion picture piracy problems. For
example, a person who steals a motion picture or motion picture
creative materials, in finished or unfinished form, before its release
could short the contract and then post it on the Internet to hurt box
office numbers. Similarly, a person armed with critical inside
information might use it to profitably trade in the proposed contracts.
Nothing in the sponsors' publicly available materials about their
contracts begins to suggest how either will be able to detect and
prevent such manipulative conduct. Given the rise of the Internet and
other technologies, piracy and leaks of confidential information are
growing threats to the motion picture industry. The CFTC should not
provide any additional incentives for motion picture piracy and
stealing intellectual property by approving the proposed contract
applications.
Approval of the contracts also creates a whole host of new
financial and legal costs and burdens that do not now exist. Once a
contract is traded in box office numbers estimates, the announcement of
such estimates has consequences for bettors. This, in turn, creates
legal risk for studios in announcing their estimates--where none exists
now--because mistakes that are currently meaningless could now be
portrayed as impacting bettors' financial results from their contracts,
thus giving rise to private claims for damages for negligence,
misrepresentation, or even, given the minimal pleading requirements for
commencing actions, manipulation. The cost of litigating even
unmeritorious claims could be substantial and cause studios to cease or
significantly alter the practice of public announcements.
Approval of the proposed contracts also will require studios and
all other industry participants that have the power to affect futures
pricing to institute and police anti-insider trading compliance regimes
for the proposed contracts. It is problematic whether any prohibition
on insider trading would need to take into account inside information
held by persons who are not subject to the control of the studios. In
the event that the studio is distributing an independent film, the
potential for many more insiders outside of the studio's control is
enormous. There are many industry participants who have access to
material, non-public information and could try to use that information
to profitably bet on the proposed contracts. There are many insiders,
for example, in studio marketing and distribution departments and upper
management and in exhibitors' finance, marketing and contracting
departments, who have access to such material, non-public information
as actual box office data, internal forecasts, advertising strategies
and spending, and release patterns.\5\ Exhibitors also have a right to
see a motion picture prior to licensing it in the U.S.\6\
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\5\ Other insiders who could possess material, non-public
information range from financiers and their advisors, potential
distribution partners, talent, crew, agents and other representatives,
special effects and other post-production vendors, trailer houses,
festival screening committees and the employees, families, and friends
of all these people. Insider trading also could implicate insider
trading proscriptions of the Federal securities laws, where a movie's
box office success could be material to the market value of its
producer's publicly traded securities. Also, the rise or fall of an
independent production company's release could have a material impact
on its future ability to function; trading in such a picture's
prospects could doom not only that picture, but future pictures and, in
the worst case, the entire company. The proposed contracts thus could
be used by insiders as surrogates for their companies' securities in
order to profit from inside information.
\6\ Although certain members of the public may see a motion picture
prior to its theatrical release, and their reactions may become public
through social media and social networking technologies, much of this
information remains non-public.
---------------------------------------------------------------------------
Even if a studio's compliance system is designed and executed to
perfection, it is possible that, at some point, the CFTC or the
Department of Justice will investigate a suspicion of possible
manipulation of the proposed contracts, causing large legal expenses
for the industry. The studios would be put to great expense to comply
with the investigation. Moreover, studios and other industry insiders
would be natural targets for strike suits by disappointed traders.
Further, the negative publicity that could flow from rumors or
announcements of an investigation and from strike suits would be
damaging to the industry parties involved. These are risks and costs
that do not now exist and the industry will receive no benefits from
the contracts to offset these substantial risks and costs.
These essential public interests reflect a legislative intent that
futures contracts provide economic value beyond pure speculation.
Consistent with this, the contract market designation criteria and core
principles requiring that contracts not be readily susceptible to
manipulation and that a designated contract market (``DCM'') prevent
manipulation are founded on the principle that futures contracts are
tied to legitimate cash markets, serve an economic purpose for those
markets, and that futures prices should reflect, in the CFTC's oft-used
words, the ``legitimate forces of supply and demand'' in an underlying
cash market. The Appendices to the CFTC's rules governing contract
market designation specifically require, among other things, that a
board of trade applying to be approved as a DCM shall submit a
``description of the cash market on which the contract is based'' and
the ``designated contract market should collect data in order to assess
whether the market price is responding to the forces of supply and
demand.'' Similarly, CEA Section 4(a), 7 U.S.C. 6(a), expressly
condemns ``excessive speculation'' and authorizes the CFTC to prohibit
it.
These features of the CEA unambiguously demonstrate Congress's
intent that, for futures contracts to be lawful, they must provide
price discovery and hedging functions and not simply be an outlet for
speculation. The Commodity Futures Modernization Act of 2000 may have
relaxed the procedures for designating contract markets, but it did not
extinguish or even change the statute's central requirement that
regulated futures contracts meet those criteria.
The proposed contracts cannot serve these public interests. It is
undisputed that they will not provide a means of price discovery;
indeed, MDEX and Cantor do not even argue that their contracts serve
this public interest. Nor, as discussed below, will the proposed
contracts in fact be used for hedging. Rather, they are simply a means
by which the sponsors of the contracts seek to serve their own private
interests and the private interests of persons who would like yet
another outlet for speculative pursuits. Such activity should not
receive the sanction of the Federal Government or take up any of the
government's scarce regulatory resources especially where, as here, the
contracts would be harmful to the industry they purport to serve.
C. Reports of Box Office Numbers Are Not Free From Error
Box office estimates largely have been a marketing tool; they were
not created to support financial trading. The practice in the motion
picture industry is to report estimates of weekend gross box office
numbers on Sunday, based on projections informed by numbers received
for Friday and Saturday showings. Variety publishes those estimates on
Monday, as do many major newspapers and media sources. Those estimates,
which are generated by the studios, are based in part on non-public and
undisclosed projections and assumptions that can vary from motion
picture to motion picture and from studio to studio. Variety provides
this disclaimer about the information it publishes:
``Variety publishes data compiled by Rentrak Theatrical, which
collects studio reported data as well as box-office figures
from North American theatre locations. Any information provided
by Rentrak has been obtained from sources believed to be
reliable.
However, Rentrak does not make any warranties as to the
accuracy, completeness or adequacy of this information and
data. The user of this data agrees Rentrak, its officers and
employees will have no liability arising from the use or
disclosure of this information and data. To submit any
questions to Rentrak, please e-mail:
[email protected].''
See: http://www.variety.com/index.asp?layout=b_o_layout&dept=Film
(emphasis added). Those estimates, as with estimates of all types, can
be flawed, although traders rely on them--see the articles from Variety
about errors in estimates of weekend box office numbers for the past
two consecutive weekends in April 2010, which are attached hereto as
Attachments B and C.
The box office receipt information Rentrak compiles from the
exhibitors that have agreed to provide that information to Rentrak is
itself incomplete, and we understand that the percentage of the total
box office numbers that is reported by exhibitors to Rentrak can vary
materially from motion picture to motion picture depending on how many
exhibitors within its universe of reporting exhibitors are showing a
particular motion picture. We understand that many exhibitors record
box office numbers electronically and then provide the aggregate
information to Rentrak through an electronic feed, but also that many
exhibitors tabulate their numbers manually. However, some exhibitors
never report to Rentrak, either automatically or manually.\7\
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\7\ Our understanding is that not all exhibitors provide
information to Rentrak and, therefore, the completeness of Rentrak's
tabulations for any particular motion picture for any particular
period, as measured against the entire universe of box office numbers
for a motion picture for that period, can vary based upon the number of
screens on which it is shown by exhibitors that provide their
information to Rentrak.
---------------------------------------------------------------------------
Typically, studios, upon receiving Rentrak exhibitor-based figures,
in turn conduct their own information gathering and analysis to develop
their estimates that may be publicly announced in the press. As
Variety's disclaimer indicates, the studios' Sunday announcements of
weekend motion picture box office numbers information in Variety
include the studios' estimates. The studios' information gathering and
analysis may vary from one company to another and is closely held
proprietary information, but it can include, for example, communicating
with some of the exhibitors that are not included in the Rentrak
figures and even those exhibitors that are included in the Rentrak
figures if their information appears to be potentially inaccurate or
incomplete.
Even the studios' box office estimates announced subsequent to the
Sunday estimates are unaudited and never capture 100 percent of box
office numbers. None of the data reported to Variety, the Rentrak
compilations, or the studio estimates are used to settle transactions
between exhibitors and distributors. Those transactions are settled by
reporting of actual gross box office receipts between the contract
parties, on a non-public basis, and subject to their contractual
accounting and audit rights and obligations. In addition, it should be
noted that neither Rentrak nor studio figures adjust for U.S./Canadian
exchange rates. Further, studio-announced figures may include data
reported to the studio by a third-party distributor where U.S. and
Canadian theatrical rights are held by different entities.
D. The Proposed Contracts Are Susceptible to Manipulation and Price
Distortions
In the first instance, the lack of any legitimate economic measure
of valid pricing before the Rentrak numbers are announced prevents any
ability to even identify a manipulated price. Further, the potential
box office numbers for a single motion picture can be materially
affected by individual industry participants in a variety of different
ways that would be exceedingly difficult to detect. Exhibitors that
contribute to the Rentrak numbers could, either intentionally or
accidentally, misreport their data. A distributor could determine
within the period following a motion picture's release to reduce or
increase the number of theaters that would show the motion picture. A
distributor for a variety of reasons could determine to substantially
reduce or expand its marketing budget, which can materially affect box
office numbers. A major exhibitor could decide to show the motion
picture on smaller or larger screens, which can materially affect
audience interest and capacity. We respectfully submit that the
sponsors have no effective means to detect or prevent such conduct or
to determine whether it was undertaken for valid business reasons,
rather than to manipulate futures prices.
Futures prices for individual motion pictures also are susceptible
to manipulation by false market rumors. In the unique circumstances of
the motion picture industry, it would be virtually impossible to
identify the sources of such rumors or to prosecute any alleged
manipulation by false rumors, because such rumors would typically be
based on opinions relating to a motion picture's artistic or
entertainment merit rather than verifiable facts. There already are
plenty of rumor mills with respect to the quality of motion pictures
and many of them are in the online environment. These range from
reviews by members of the public who have attended screenings,
professional reviewers, press reports relating to rumored or perceived
``trouble'' on motion pictures (multiple writers, talent defections,
re-shoots, postponed release dates, etc.), and reports of the quality
of footage that have leaked pre- or post-release. There is no effective
way to police such rumors or reliably determine their source. These
sorts of rumors can depress or increase box office performance.
Therefore, the ability to profit from rumors by trading in the proposed
contracts would intensify any incentive to spread false rumors in a
manner that the sponsors could neither detect nor control.
I wish to thank once again Chairman Boswell and Ranking Member
Moran for the invitation to provide testimony, and I will be happy to
respond to questions from Members of the Subcommittee.
Attachment A
The Proposed Contracts' Terms
A. The Cantor Contracts
The Cantor contracts are complicated, and to some degree uncertain,
trading instruments, and their material terms can vary from one motion
picture title to another and even without notice to traders at the time
trading commences.\8\ Generally, however, the Cantor submission states
that its contracts would provide a means to bet on gross domestic box
office numbers of select motion pictures released in the United States
and Canada, ``as compiled by Rentrak Theatrical and/or Nielsen EDI and
published in Variety Magazine (or such other publicly available source
or sources as may be designated by the Exchange from time to time).''
\9\ This description is confusing because the information about gross
box office numbers as published by Variety Magazine is not the same as
the information ``compiled by Rentrak'' from exhibitors. (Rentrak's
compilations from exhibitors do not account for 100% of gross box
office numbers, and the percentage of the total box office numbers
reflected in the figures it collects from exhibitors can materially
vary from motion picture to motion picture.)
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\8\ See Cantor Rule I-1, Definition, ``First Trading Day'' (noting
First Trading Day ``will be specified in each DBOR Contract''); Cantor
Rule II-3(b) (discussing fluid DBOR Determination Period).
\9\ See Cantor Rule I-1, Definitions, ``DBOR'' and ``Rentrak
Theatrical.'' (Emphasis added.) Rentrak Theatrical is a unit of the
Rentrak Corporation. See www.rentrak.com. Nielsen was acquired by
Rentrak and no longer separately reports motion picture box office
numbers. Accordingly, our comment will address reporting by Rentrak
only.
---------------------------------------------------------------------------
The Cantor submission states that each motion picture will be the
subject of its own separate contract, and Cantor will decide in its
discretion the motion pictures for which it will list futures contracts
on its platform.\10\ The Cantor contracts will call for traders to bet
on the gross Domestic Box Office Receipts (``DBOR'') over the ``DBOR
Determination Period.'' The DBOR Determination Period runs from the
date of the motion picture's opening until 4 weeks after the motion
picture first qualifies for ``wide release'' status as defined by the
Cantor rules.\11\ Those rules define ``wide release'' status to occur
once a motion picture is shown simultaneously on the same day in 650
theaters.\12\ The ``Final Settlement Price'' will be a fractional
equivalent of the gross DBOR over the DBOR Determination Period.\13\
---------------------------------------------------------------------------
\10\ Cantor Rule II-10.
\11\ If the motion picture fails to achieve wide release status
prior to the end of the 12th Release Week, the DBOR Determination
Period will conclude at the end of the 12th Release Week. Cantor Rule
II-3(b).
\12\ Cantor Rule I-1, Definition, ``Wide Release.''
\13\ Each contract will be settled at the equivalent of one
millionth of the gross DBOR for the United States and Canada showings
over the DBOR Determination Period--i.e., if the gross DBOR over the
DBOR Determination Period are $56 million, the Final Settlement Price
of the contract would be $56. Cantor Rule II-3(a). Upon settlement,
each buyer of Cantor contracts who holds them to maturity will be
entitled to receive, and each seller will be obligated to pay, one
millionth of the gross DBOR for the DBOR Determination Period. Cantor
provides the following example in Rule II-13(a): If an underlying
motion picture title has earned a DBOR of $56,455,000 during the DBOR
Determination Period, the Final Settlement Price would be calculated by
dividing $56,455,000 by 1,000,000 (equaling $56.455), and then rounding
such amount to $56.46.
A trader's profit or loss on a long position held until contract
expiration will equate to the difference between the contract price
when the contract was entered into and the Final Settlement Price.
Using the example above, if the buyer enters into a futures contract at
a price of $50 and holds the contract until expiration, the buyer's
profit would be the difference between $50 and $56.46. The seller of
such a contract at the price of $50 would lose the difference between
$56.46 and the $50 contract price. If a trader liquidates his or her
contract position prior to contract expiration, his or her profit or
loss will be the difference between the opening and liquidating
contract prices.
---------------------------------------------------------------------------
When trading on any particular Cantor contract will commence is not
clear from the Cantor rules; it appears that, at Cantor's discretion,
it could commence anytime between a year and one day before a motion
picture's release and presumably start dates could vary from contract
to contract.\14\ The time period of the DBOR Determination Period might
not be knowable at the time trading commences--that period could span
from 4 to 12 weeks, depending on if and when a motion picture first
qualifies as a ``wide release.'' \15\ Accordingly, at the time trading
commences, traders would not even have notice of the terms of their
bets. It also is unclear when trading will end. The chart accompanying
the latest Cantor contracts submission (for ``The Expendables'') states
that ``The longest trading period for a DBOR contract is a period of
four Release weeks.'' If trading must cease no later than four release
weeks after the opening, trading could be limited to a shorter time
period than the DBOR Determination Period. For example, theoretically,
trading would end 4 weeks after the opening, but the DBOR Determination
Period could be the first 6 weeks following release, if a motion
picture fails to qualify as a ``wide release'' until the third week
after its release. This can cause substantial uncertainty for pricing
and perhaps invite gaming. In contrast, the definition of ``Last
Trading Day'' in the Contract Terms and Conditions states that ``the
Last Trading Day shall under no circumstances be any earlier than the
Tuesday following the close of the DBOR Determination Period.''
Pursuant to this definition, trading could last as long as 12 weeks for
a motion picture that fails to achieve wide release status.
Significantly, under this definition, trading potentially could extend
beyond the DBOR Determination Period--after the settlement price is
known publicly or by those with inside information.
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\14\ It is not clear when trading will commence in relation to the
opening release, but it appears that there will be an Opening Auction
on the first trading day to determine an ``Equilibrium Price'' for the
commencement of trading. Cantor Rule II-11. The description of the
Opening Auction has changed during various iterations of the DBOR
Contract, and it is unclear exactly how the auction will work. While a
contract is open for trading, traders will be permitted to execute
trades 24 hours a day, seven days a week. Cantor Rule II-12.
\15\ See Cantor Rule II-3(b). For example, if a motion picture is
released in 500 theaters in Week 1, but is shown in 650 theaters in
Week 2, the DBOR Determination Period will be six weeks long, because
``wide release'' status will not have occurred until the second week,
and the Determination Period will conclude at the end of the fourth
week after wide release is achieved. If a motion picture never achieves
``wide release'' status, the DBOR Determination Period will be the full
first twelve weeks following the opening, and the Final Settlement
Price will be based on the DBOR over the full 12 week period.
---------------------------------------------------------------------------
B. The MDEX Contracts
MDEX's proposed Opening Weekend Motion Picture Revenue Contracts
(``the MDEX Contracts'') include a binary option and collared futures
contract. The MDEX contracts are designed to provide a means to profit
from bets on the box office numbers of the opening weekend for ``major
releases.'' MDEX's proposed binary option contracts would be issued
over a series of strike prices (tied to the level of first weekend box
office numbers as reported by Rentrak) that would be exercisable only
upon expiration (European style) and only if the strike price for the
reported first weekend box office numbers is reached. Upon successful
exercise, the purchaser would be entitled to receive $5,000 per option
contract.
MDEX's proposed ``collared futures'' contracts also would offer
exposure up to $5,000 to the outcome of a particular revenue period,
but are not binary and, therefore, offer a range of exposure for each
contract from $0 to $5,000. Instead of the strike price present in the
binary option contracts, collared futures contracts are based on a
range of Rentrak's tabulations of box office numbers, with any payouts
based on numbers falling below that range (paying nothing), within that
range (paying according to a preset formula), or above that range
(paying $5,000). If a movie's box office revenue comes within the range
of a collared futures contract, the revenue number is converted into a
revenue unit by dividing that range into \1/4\ increments, from 0 to
100, and then multiplying by $50.
Attachment B
Variety
April 13, 2010
`Titans' victorious at weekend box office
Final figures put 3D epic on top of `Date Night'
By Andrew Stewart
When the dust settled on Monday, Warner Bros.' 3D epic ``Clash of
the Titans'' had edged out 20th Century Fox's ``Date Night'' domestic
B.O. debut.
Preliminary estimates had ``Date Night'' winning the weekend, with
$27.1 million; Fox revised the figure downward to $25.2 million.
Meanwhile, ``Clash'' earned a revised $26.7 million, down slightly
from Warner's $26.9 million estimate. The 3D epic dropped 56% in its
soph sesh and has cumed $110.2 million.
Paramount and DreamWorks Animation's ``How to Train Your Dragon''
followed closely, with $24.9 million. The toon slipped only 14% in its
third frame, for a total haul of $92.1 million.
``Dragon'' scored 65% of its weekend take from 2,165 total 3D
locations, while ``Clash'' saw approximately 50% from 1,632 3D runs.
``Clash,'' which isn't playing on Imax 3D screens, was able to top the
box office even with a substantial number of filmgoers opting for the
2D version.
Fox originally had predicted a 34% drop for ``Date Night'' from
Saturday to Sunday, but said the comedy ended the weekend with a steep
49% decline. Studio attributed the drop to the final day of the Masters
on Sunday, saying the golf tourney siphoned auds from the comedy's
targeted older demo.
Most of the frame's other adult-oriented films, including
Lionsgate's ``Why Did I Get Married Too?'' and ``The Bounty Hunter''
also took steep hits on Sunday.
The Masters played heavily to older auds, skewing toward male
viewers, but also with a surprisingly strong femme aud. The ``Date
Night'' demo was similar, with 52% females to 48% males, and about 60%
of the aud over 25.
Despite its second place finish, ``Date Night'' is off to a solid
start, with the popularity of stars Tina Fey and Steve Carell helping
it exceed ``The Bounty Hunter's'' $20.7 opening weekend on March 19.
Family pics like ``Dragon'' fared best on Sunday, with the toon
slipping 38% that day. ``Dragon'' may lose auds as kids head back to
school after spring break, but Par said it expects the toon to hold
steady until the studio launches 3D ``Shrek Forever After'' on May 21.
Attachment C
`Kick-Ass' slays `Dragon'
Another swap at B.O. top
By Andrew Stewart (http://www.variety.com/
index.asp?layout=bio&peopleID=3844)
For the second consecutive week, the top two spots at the domestic
box office have swapped places, with this week's No. 1 position going
to Lionsgate's superhero comedy ``Kick-Ass.''
Pic's revised weekend figures held steady on Monday at $19.8
million, while Paramount and DreamWorks Animation's 3D toon ``How to
Train Your Dragon'' dropped from its estimated $20 million to a revised
$19.6 million.
The B.O. shuffle comes a week after Warner Bros.' ``Clash of the
Titans'' was renamed the B.O. champ with its weekend actuals, ousting
20th Century Fox laffer ``Date Night.''
In its soph sesh, ``Date Night'' saw a solid hold of 34%, claiming
the No. 3 spot with $16.7 million, while actuals for ``Clash'' totaled
$15.5 million. Cume for ``Date Night'' stands at $48.7 million;
``Clash'' has reached $132.6 million in its third frame.
Without any major tentpole releases entering the market in the past
two weeks, solid holdovers have been pitted against aud-specific debuts
like ``Date Night'' and ``Kick-Ass.''
``Kick-Ass,'' about an average teenager who dons a superhero
persona, played best among young males, with a 60-40% male-female
split. The pic's healthy launch could bode well for ``Kick-Ass'' in
repeat frames, as Lionsgate hopes fanboy enthusiasm will help fuel
strong word of mouth among wider demos.
`` `Kick-Ass' is fantastic, highly original entertainment, and our
marketing and distribution teams have brilliantly positioned it for a
long and successful run,'' Lionsgate prexy Joe Drake said in a
statement. ``That kind of run is precisely what we are seeing on the
international front, where `Kick-Ass' has demonstrated a very strong
hold at the box office.''
The film has grossed some $13.8 million internationally, since its
early bow overseas April 2.
Meanwhile, ``Dragon'' saw a strong hold in its fourth frame,
slipping just 21%. The toon's 3D component helped boost holdover
potential, which accounted for 65% of the weekend take on 56% of the
total location count.
``Dragon,'' whose cume reached $158.3 million as of Monday, should
have a clear playing field until Par/DWA's ``Shrek Forever After'' is
released May 21.
The Chairman. Thank you. We would like now to recognize Mr.
Harbinson, international representative, International Alliance
of Theatrical Stage Employees and on behalf of the Directors
Guild of America.
STATEMENT OF SCOTT HARBINSON, INTERNATIONAL
REPRESENTATIVE, INTERNATIONAL ALLIANCE OF
THEATRICAL STAGE EMPLOYEES, ELLICOTT CITY, MD; ON BEHALF OF
DIRECTORS GUILD OF AMERICA
Mr. Harbinson. Thank you, Mr. Chairman. I am very happy to
be here. Chairman Boswell and Ranking Member Moran, I
appreciate this opportunity to appear before you. My name is
Scott Harbinson, and I am an International Representative for
the International Alliance of Theatrical Stage Employees. I am
here today representing both IATSE and the Directors Guild of
America.
I hope my presence, along with that of others in the
industry, will underscore the grave concern we have about the
impact of movie futures contracts which are pending before the
CFTC.
IATSE is a labor union that represents 110,000 technicians,
artisans and craft persons in the entertainment industry who
work in live theater, motion picture production, and trade
shows. The DGA represents over 14,000 directors and members of
their directorial teams who work on feature films, scripted
television, news, sports, commercials, documentaries, and new
media both here and abroad.
The realities of our business are not easily deciphered by
those outside of it. The glitz and glamour of the international
blockbusters give rise to misperceptions about our industry. So
let me just begin with a few of the realities which I hope will
shed light on our concerns about the MDEX and Cantor Exchange
futures applications.
The majority of the people working on the creative side of
our industry earning middle class incomes do not hold regular,
full-time Monday-Friday jobs. Ours is a freelance business.
People move from one employer to another, and from one
production to the next. Our business model recognizes and
accounts for that significant uncertainty by providing another
form of security to help people in between jobs either directly
or through contributions to our multi-employer health and
pension plans. This takes the form of residuals which come from
the exploitation of our work in secondary markets such as DVDs,
free and pay television, and new media.
Not surprisingly, there is a high correlation between box
office success and downstream revenues, and hence the residuals
generated in these markets. The ability to trade on a film's
box office receipts through movie futures exchanges, exchanges
where shorting a film can be extremely lucrative, puts the
commercial success of the film at even greater risk. This new
risk will not be generated by people who spend years and
invested millions of dollars in making the film; rather, it
will be generated by those who are likely to have no real stake
in seeing a film succeed. Their goal is simply to make money
for themselves.
What will follow will be diminished downstream revenues.
When that happens, it is our members and their health and
pension contributions that suffer. Additionally, the lower film
revenues dampen reinvestment which leads to decreased
production and fewer jobs in the future. The image of
speculators profiteering on our industry to the detriment of
working men and women has an uncomfortably familiar ring to it.
The people who work on a film put a great deal of talent,
craftsmanship, time and energy into making motion pictures.
Directors, in collaboration with many other talented
individuals, can spend years of their lives putting a film
together. While the studios have a slate of films each year, a
director only has a single film. It is highly improbable that a
director would purposely seek to undermine his own work by
shorting it, and most directors have no need to bet the over on
their pictures because their personal service agreements
generally contain provisions for awarding strong box office
performance.
Other talented individuals who collaborate on the making of
a motion picture also have a similar commitment to the final
work--the cinematographer, the editor, the production designer,
just to name a few. A successful film is recognition of their
talent and hard work as well. And with the funding of their
pension and health plans dependent on the picture's success,
they too have no reason to bet against their own work.
Movie making already has enormous appeal outside of the
industry, and to introduce this new exchange would simply be
encouraging mischief at best and criminal conduct at worst. It
is not hard to envision certain people approaching individuals
working on a film to try to secure potentially material
nonpublic information, information that they will use to shape
the value that they assign to that movie's contracts in the
future. Films, both big and small, would be adversely affected
by the exchanges in different ways. Larger productions, with so
much riding on them, are often being worked on until the very
last moment, making them especially vulnerable to a sudden
blast of negative publicity. Smaller films have little
financial cushion and the impact of rumor and negative
speculation can be ruinous to these worthwhile projects.
In this business, there is no magic formula for success,
regardless of the hard work and talent involved. For every
unexpected hit, there is a corresponding flop. That is the risk
that both those who finance motion pictures and those who
create them acknowledge on each and every film, but at least
those assuming the risk have a bona fide relationship with the
work and a stake in the successful outcome of a film. Those
involved in the exchanges will not.
In closing, we understand what the existing legal standard
is for establishing a futures market. But as a matter of public
policy, if the stakeholders large and small have no interest in
hedging the risk through a futures market, which admittedly
serves no price discovery function, then the government
shouldn't sanction it. If the stakeholders have no intention of
participating in these futures markets, then the markets will
be left to the gamblers. If the CFTC does not have the
authority to deny the applications to create movies futures
contracts, then we believe Congress should act to address this
issue directly. Thank you for your consideration.
[The prepared statement of Mr. Harbinson follows:]
Prepared Statement of Scott Harbinson, International Representative,
International Alliance of Theatrical and Stage Employees, Ellicott
City, MD; on Behalf of Directors Guild of America
Thank you, Chairman Boswell and Ranking Member Moran for this
opportunity to appear before you. My name is Scott Harbinson and I am
an International Representative of the International Alliance of
Theatrical and Stage Employees (IATSE). I am here today representing
both IATSE and the Directors Guild of America. I hope my presence,
along with that of others in the industry, will underscore the grave
concern we have about the impact of the ``movie futures contracts''
which are pending before the Commodity Futures Trading Commission.
IATSE is the labor union that represents technicians, artisans, and
craftspersons in the entertainment industry, including live theater,
motion picture and television production, and trade shows. IATSE was
formed in 1893 and has over 110,000 members. Through its international
organization and its autonomous local unions, IATSE represents the
behind-the-camera crafts on over 90% of all motion pictures with
budgets over $1.5 million produced in the United States.
The Directors Guild of America represents over 14,000 directors,
and members of what is called their directorial team, who work in
feature films, scripted television, news and sports, commercials,
documentaries, and in new media. DGA members live and work throughout
the United States and abroad.
Ours is perhaps the most heavily unionized industry in the country,
providing good, middle-class jobs with pension and health benefits for
tens of thousands of Americans. Our industry is also one of the few
that can be counted on to turn in an international trade surplus year-
after-year.
However, the realities of our business are not easily deciphered by
those outside of it. The glitz and glamour, the international
blockbusters, can give rise to misperceptions about our industry. I
fear that the misperception that there is easy money to be made in
Hollywood is what we are addressing today. So let me begin with just a
few of the realities, which I hope will help shed light on our concerns
about the MDEX and Cantors Future Exchange applications.
First, the majority of people who work on the creative side of our
industry, earning middle class incomes just like most of your
constituents, do not work as regular full-time staff at a Monday
through Friday job. Ours is a freelance business--people move from
employer to employer and from production to production, often on a
daily or weekly basis, and always with an eye on their next job. Our
business model recognizes and accounts for the reality of significant
uncertainty and insecurity by providing for another form of security to
help people in-between jobs, either directly or through our industry
health and pension plans. This takes the form of payments, called
residuals, which come from the exploitation of our work in secondary
markets such as DVDs, free television (including broadcast and basic
cable), pay television, and most recently new media. Not surprisingly
there is a high correlation between box office success and downstream
revenues, and hence residuals, generated in these markets.
Unlike other business ventures, the commercial success of a motion
picture defies quantification or reduction to a formula. Introducing a
large new variable into the production equation poses a significant
danger. The ability to trade on a film's box office receipts through
movie futures exchanges--exchanges where the creation of a negative
perception of a film can be extremely lucrative to those ``shorting''
it--puts the commercial success of the film at an even greater risk.
And, this new risk would not be generated by the people who spent years
and invested millions making the film, rather it would be generated by
those who are likely to have no real stake in seeing the film succeed
so they can share in the reward--their goal is to make money for
themselves. Looking further down the line, if this ``manufactured''
negative perception succeeds in hurting the film's box office, then
what follows will be diminished downstream revenues. When that happens,
it is our members, the individual employees and their health and
pension plans that suffer. Additionally lower film revenues dampen
reinvestment which leads to decreased production and fewer jobs in the
future. So, at the end of the line, people who have no stake in the
vitality and economic health of the industry will make money and the
working people who invested their talents will bear the greatest
impact. The specter of speculators pillaging our business to the
detriment of working men and women has an uncomfortably familiar ring
to it in today's economy. We hope this will not be set in motion
against our industry on your watch.
Second, a film on the screen--from conception to post production--
is a complex and hard won process. The people who work on a film put a
great deal of talent, craftsmanship, time and energy into making that
motion picture. Let me offer some perspective on the roles of the
director and the craftspeople and technicians. It is universally
recognized that feature film is a director's medium and for that reason
the director's investment is unique. Directors can spend years of their
lives putting a film together, in collaboration with many other
talented individuals. While the studios have a slate of films each
year, the director only has his or her single film. So of course the
success or failure of an individual film can have a huge impact on the
director--not just economically but also in terms of their reputation
and stature, both now and in the future. Outside of sports franchises,
few businesses are so clearly identified with a single individual. So
when derivatives are sold one identifiable person is not as greatly at
risk as they are here.
From this perspective, it is highly improbable that a director
would purposely seek to undermine his/her own work at the exact time
when there is the greatest at stake in its success. And, most directors
have no need to ``bet the over'' on their pictures because their
personal services agreements generally contain provisions rewarding
strong performance at the box office, whether in the form of box office
bonuses or profit participation, or both. This is in addition to
enhanced residuals income driven by better box office performance.
While other talented individuals who collaborate in the making of a
motion picture might not have quite the same stake as the Director,
most have a similar commitment to the final work. The Cinematographer
who shot the film, the Editors who put hundreds of thousands of frames
together, the Production Designer who brings the ``look'' of the film
to life, just to name a few--the film is also a recognition of their
talent and hard work as well. And, with the funding of their health and
pension plan dependent on a film's success they too have little reason
to ``bet against'' their work.
A film employs hundreds of people at any given point in time.
Movies most closely resemble the military in terms of their precise,
highly regimented structure. And, as you would expect with the process
of creating something from nothing, there are disruptions all along the
way . . . and most people have limited or incomplete information about
what is going on. Movie making already has great appeal to
``outsiders,'' and to introduce this new exchange into the mix you are
simply encouraging mischief at best and criminal conduct at worst. It
is not hard to envision certain people approaching individuals working
on a film to try to secure potentially material non-public
information--information they will use to shape the value they assign
(or give others to assign) to that movie's contracts in the future.
In addition it is common industry practice to hold screenings/
previews of a film to which members of the public are invited before
the film is finished. Hundreds of people view the incomplete film and
make comments. It is easy to see how a preview that does not go well
can become a factor in ``betting'' on its box office--and tanking a
film before it even gets to the screen.
It is the bigger movies--the very ones that will be on the most
screens--that are the most likely to be worked on until the very last
moment. The bigger the movie, the bigger the anxiety, the later the
final okay is given. Because so much is riding on them and because of
this they have a very high vulnerability. At the other end of the
spectrum, the lower and mid-size budgeted films--the Junos, the Hurt
Lockers, the Little Miss Sunshines--have a different but equally as
important vulnerability. They have little margin of error--with tight
financing and schedules, they face their own unique ``ups and downs''
throughout production and it is far easier to harm their financial
success through misplaced rumors or perception that they are worth
betting against at the box office. In short, the possibilities these
exchanges create for mischief and even disruption of the filmmaking
process are unlimited--and in our warp-speed Internet age--impossible
to control.
Third, it is well understood in our business that there is no hard
and fast ``formula'' for success regardless of the hard work and talent
involved--in fact success for any motion picture is never a foregone
conclusion. All of the percentages and numbers these two groups present
to discuss the viability of their exchange obscure an important fact--a
film is not a fully-formed object created in a vacuum. Each one is
different and unique and nobody knows going in if it will connect with
the audience. For every unexpected hit there is an unexpected miss.
That is the accepted risk that both those who finance motion pictures
and those who create them recognize and undertake with each and every
film. But at least everyone involved in that risk has an actual
relationship to the work and a stake in its success. Those involved in
these exchanges will not. These exchanges are in effect the same as
trading in wheat from a single farm. You bet against the farm and you
burn it down. We are hard pressed to think of any other commodity for
which the hedging actually threatens the underlying product itself.
Such futures contracts would be childishly easy to manipulate or
corrupt to increase the value of short positions. This is particularly
true for risky, low-budget motion pictures where there are many
individuals who would be able to materially affect the success of the
film. There is no such corollary in any other futures market that I am
aware of.
We understand what the existing legal standard for the
establishment of a future market is. As a matter of public policy, if
the creators, craftspeople, theatre owners and producers--both large
and small--have no interest in hedging their risk through a futures
market, which also admittedly serves no price discovery function, then
the government should not sanction it. If the commercial and creative
interests in the film industry have no intention of participating in
these futures markets, then the markets will be composed of gamblers--
many of whom will be playing with a card up their sleeve--wagering
against the success of a film. If the Commodity Futures Trading
Commission does not have the authority to deny the applications to
create these two futures exchanges and contracts, we believe Congress
should address this issue directly. Thank you again for your
consideration and for listening to our perspective.
The Chairman. Thank you. We have just been notified there
will be votes, but we will finish your presentation and get
into some questions.
We now recognize Mr. Schuyler Moore, partner, Stroock &
Stroock & Lavan, LLP.
STATEMENT OF SCHUYLER M. MOORE, ADJUNCT PROFESSOR, UCLA SCHOOL
OF LAW; ADJUNCT PROFESSOR, UCLA
ANDERSON SCHOOL OF MANAGEMENT; PARTNER, STROOCK & STROOCK &
LAVAN LLP, LOS ANGELES, CA
Mr. Moore. I am here in my role as an academic, not as a
partner at Stroock & Stroock & Lavan. I am an Adjunct Professor
at the UCLA School of Law, and I am Adjunct Professor at the
UCLA Anderson School of Management. I am an author of the book
called The Biz which is about the financing of the film
industry and a book called Taxation of the Entertainment
Industry. And I plead guilty to perhaps starting this entire
concept in an article I wrote 7 years ago about this precise
concept, about structuring investment based on box office
results.
It is my belief that this is an absolutely standard, run-
of-the-mill necessary technique for film financing. It is the
next step in a long evolution, and the first thing I want to
get out of the way is every investment in film is gambling. The
studios gamble. Investors gamble. That is the industry. We all
accept that. It is legal. Film is gambling. We should put that
beyond us.
Second, the studios have hedged film risk for 30 years. It
is what I do for a living. Co-productions, split rights
transactions, presales, slate financing. In the last 8 years
alone, there have been over $10 billion of slate financing and
every single one is a way for the studio to get off risk and
unload the risk on investors. Every single one. This is what
the studios have done for years and years. Every technique I
have mentioned, co-productions, split right transactions,
presales, slate financing is all to get off risk.
What this exchange offers is an efficient, transparent way
for the studios to get off risk. When they figure it out, when
they understand it, they will do it and they will do it in
droves, just like they do the current slate financing in
droves. For the same reason that they did $10 billion of slate
financing, they will be doing $10 billion of hedge financing.
They always resist what is new. They resisted television. They
resisted video. They resisted video on demand. New things scare
people. The government itself objected when interest rate swaps
were first suggested, and now it is a trillion-dollar-a-day
market. So there is a fear of something new, but the truth is
this is the way the world has been working.
I read an MPAA submission that said the studios won't do
it, and they do do it. That is what they do. I read one
position that said they couldn't do it because they have anti-
disparagement clauses in their contracts. Every time they do a
hedge transaction on the slate deals, they are betting against
their film. This isn't new, okay.
From the investors' perspective, it is absolutely needed
because there is a pullback in investment in Hollywood due to
the fear of opaque Hollywood accounting, whether it is true or
not. It is the image.
You can't stop investors from investing in films. They are
investing in films. You are worried about investors gambling,
they are doing it now on a single film basis, on a slate basis.
They are buying stocks in film companies. They are gambling.
All this does is it creates an efficient, transparent market
where they can look up in the paper and figure out what their
investment is worth the next day, just like they look up and
see what the stock price is the next day. This is absolutely
needed. It will create a huge market for the studios. They will
come to appreciate this once they understand it.
I have heard arguments against it based on manipulation.
First of all, the first comment is studios can ignore all
manipulation if they don't want to be in the market. What do
they care if it is being manipulated, right, just stay out of
the market. If they are in the market, the only ones, the real
ones that can manipulate it is the studios by shorting their
own film and tanking it, like the film The Producers. I don't
think that is something that will happen. I think the studios
would lose more on the film and in good will and on their stock
price than they would make by shorting their own film. I have
no fear of that.
The other thing I have heard, oh, my God, Dr. Evil will
sneak into the lab and steal a print to go on the Internet to
ruin box office receipts. That risk is so--it is as much a risk
as Dr. Evil will put smoke bombs in theaters to keep down
attendance. It is just not realistic. So I don't think
manipulation is a serious issue.
Insider trading is a bugaboo. There is no legal impediment
on insider trading on a commodities exchange, period, or a
farmer wouldn't be able to trade corn futures, right, because
as an insider he knows his crop is bad. It is the same thing in
the industry. There is this firewall that I frankly think they
shouldn't have done. The actual reporting of box office is
self-regulating. There is an efficient mechanism in place.
There shouldn't be a firewall because that has gotten people
off into this red herring of oh, my God, insider trading. There
should be absolute, no prohibition on insider trading in my
view. And certainly there is no legal prohibition on it.
I would like to address the real reason why everyone is
against this is the singular focus that, oh, my God, it is
going to trade back. When you look it up, there will be bad
trading. Oh, my God, bad buzz about a film and therefore, no
one will go to it and the industry will fall apart.
Number one, there is already so much buzz about a film the
moment it starts production. There is a website called
aintitcool.com. There is a website called rottentomatoes.com.
There is a Hollywood Stock Exchange that has been around for 10
years that hasn't affected a single box office result. They use
play money but you can look up and see how a film is tracking.
There are real exchanges that do this offshore where you can
look up and see how a film is tracking. So there is not just a
buzz now but a roar of prerelease publicity news information
about a film, and this is going to be a drop in the bucket.
What they are overlooking is how about the good news when a
film is tracking well? By the way, it should be tracking more.
I would think overall most films better than flat, and so maybe
that will spur attendance and so it will turn out to be a wash.
So I don't think this whole bugaboo of bad films is warranted.
[The prepared statement of Mr. Moore follows:]
Prepared Statement of Schuyler M. Moore, Adjunct Professor, UCLA School
of Law; Adjunct Professor, UCLA Anderson School of
Management; Partner, Stroock & Stroock & Lavan LLP, Los Angeles, CA
1. I am an adjunct professor at the UCLA School of Law and the UCLA
Anderson Business School, teaching film financing. I am the author of a
book called The Biz: The Basic Business, Legal, and Financial Aspects
of the Film Industry and a treatise called Taxation of the
Entertainment Industry.
2. I may have started this box office exchange (the ``Exchange'')
concept in an article I wrote titled ``Raising Film Financing by
Betting the Box,'' that was published in the Entertainment Law Reporter
in May 2003. A copy of that article is attached.
3. Value of the Exchange for Hedging for Studios
3.1 Hollywood has hedged performance risk a myriad of ways for
many years.
(a) Co-Productions among studios (sharing the budget and
splitting the world between domestic and foreign);
(b) Split-rights transactions, where all foreign rights are
pre-sold to a consortium of foreign distributors;
(c) Pre-sales, where film rights are sold for up front fixed
payments (and less on the back end); and
(d) Slate financing transactions, where investors co-finance
50% of the cost of a slate of films for 50% of the profits.
3.2 This Exchange offers a transparent, efficient hedging
technique. It will vastly lower hedging transaction costs. Once the
studios understand it, they will embrace it strongly in lieu of
inefficient hedging techniques they currently use.
3.3 One of the submissions by the MPAA stated that the studios
would not use the Exchange to hedge due to contractual and practical
constraints on disparaging their own film, and hedging would be viewed
as disparagement. However, this identical argument could be made with
respect to every form of hedging, and as set forth above, the studios
have used various hedging strategies for years.
4. Value of the Exchange for Investing in Hollywood
4.1 Investors have been taking the significant risk (for both
profit and loss) of investing in films for many years:
(a) Investing in stock of film companies, including options,
calls, etc.;
(b) Investing in particular films;
(c) Investing in slate financing transactions (over $10 billion
of such investments were done from 2002-2008).
4.2 This Exchange offers a transparent, efficient investing
technique. It will vastly lower investing transaction costs. Most
importantly, it completely eliminates the fear of opaque ``Hollywood
accounting,'' even if unjustified. Just as an owner of public stock can
look in the paper to see the value of their shares, the owner of a
position on the Exchange could look at the box office results in the
paper and know if the value of their investment.
4.3 The Exchange is not gambling, since investors can make
informed decisions based on what they think of the prospects of a
particular film. It is no more gambling than owning stock is.
5. True Reason for Studio's Objection to the Exchange
5.1 I believe that the real reason for the knee-jerk opposition of
the studios to the Exchange is their fear that there' will be widely
publicized ``criticism'' of a film in the form of the quoted price on
the Exchange. If a film is trading ``low,'' the public might not want
to go see that film.
5.2 The answer to this concern is that there is already widely
available ``buzz'' (if not a roar) of public criticism (good and bad)
on films, including numerous popular blogs (aintitcool.com and
rottontomatoes.com) and, most importantly, the Hollywood Stock Exchange
(hsx.com), which has run exactly this type of Exchange for years (but
with no real cash), and Intrade runs this type of Exchange for actual
cash. Thus, there has always been and will always be a plethora of
publicly available criticism (both good and bad) on films. In all
events, fear of bad buzz is not grounds for stymieing new, efficient
means of investment.
5.3 In addition, any unwanted bad publicity from short positions
on some films will be made up for by good publicity from long positions
on other films.
6. Alleged Fear of Manipulation
6.1 The studios have mentioned fear of manipulation as a grounds
for objection, but this can't be their real concern since they don't
have to participate in the market at all, so they could be completely
indifferent to manipulation. Indeed, when the issue is raised at all,
the risk is that the studios, not the public, will manipulate the
Exchange.
6.2 The only possible manipulation would be if a studio went short
on the Exchange and then intentionally tanked its own film (e.g., ``The
Producers''). But this will not happen in practice, since it is highly
unlikely that the studio will make more profits on the Exchange than it
loses on the film and in future good will (and its stock price).
7. Alleged Fear of Insider Trading
7.1 The studios have mentioned fear of insider trading as a
grounds for objection, but once again, they don't have to participate
in the market at all, so they could be completely indifferent to any
alleged insider trading.
7.2 In any event, I don't believe that insider trading laws apply
to futures exchanges, and for good reason; oil and studio executives
really don't have much better information than what is otherwise widely
known and available, and their guesses of future oil or box office
prices are often wide of the mark. The truth is that no one knows how
well a film will perform before it opens. As the great screenwriter
William Goldman said, ``No one knows anything,'' and that certainly
goes for the prognostication of box office results.
7.3 If insider trader laws applied here, then farmers would not be
able to trade corn futures, since they would be ``insiders.''
8. Alleged Fear of Increased Piracy
8.1 One of the objections raised was that someone buying a short
position would attempt to pirate the film in advance and put it on the
Internet to reduce box office results. The actual impact on box office
results of such piracy are so miniscule that no one would be seriously
tempted to attempt piracy for this reason.
Attachment
Raising Film Financing by Betting the Box
By Schuyler M. Moore
This article suggests a model for film companies to (a) limit their
risk on films and (b) raise film financing. But first, some background:
Many film companies want to reduce their risk on films, particularly
large budget ones. Reducing risk avoids the company going down for the
count if the film flops, and it permits the company to spread precious
cash over a wider number of films. Perhaps the most common way to
achieve risk reduction at present is to enter into split-rights
transactions, where two or more companies co-finance a film, with one
taking domestic rights, and one or more taking foreign rights. Even
when these deals involve a sharing of profits between the two
territories, the net result is to give valuable distribution rights,
and about half the profits, to competitors. This approach has become
widespread, including for ``Titanic,'' ``Cast Away,'' ``The Hours,''
``Tomb Raider,'' ``XXX,'' and ``Terminator 3.'' While this approach
achieves the desired goal, it is somewhat like selling off the family
jewels as a hedge against volatility in the diamond market. Film
companies are in the business of owning and exploiting film rights, and
if there were a logical way to reduce risk while keeping the rights,
they would jump at it.
Historically, a great way to hedge risk while retaining film rights
was to raise equity through public or private film funds, starting with
Silverscreen for Disney in the 1980's. But these funds have long gone
the way of the dinosaur. While it is common to blame the demise of
these funds on the loss of the tax deduction for ``passive losses''
under the 1986 tax act, the passive loss rules generally do not apply
to corporate investors; if the transactions made sense, there would
still be a well-funded market for them. The true reason for the absence
of these funds is that most funds felt victimized by opaque Hollywood
accounting. Just watch investment bankers shudder when you offer them a
share of a film's net profits. Eddie Murphy's great quip--calling a
share of net profits ``monkey points''--best summarizes the vast public
perception of what it means to invest in films. It is for this reason
that the U.S. equity market for film financing has dried up.
Yes, there are still some equity investors out there, but they are
far and few between, ranging from random rich star-struck investors to
German or U.K. film funds. But because of Adam Smith's immutable law of
supply and demand, these equity sources often ask for more than film
companies are willing to pay. It behooves film companies to come up
with a solution that vastly increases supply, bringing prices down,
rather than muddling through looking for needles in haystacks. The
strong film companies can, of course, raise debt financing, but aside
from outright default, debt does not shift risk. What is needed is
equity financing.
So here's a suggestion for an approach that might revitalize the
U.S. equity market for films: End the accounting miasma, and tie the
investors' return directly to a percentage of the gross domestic box
office receipts to the theaters (``Domestic Box'') for the film. This
approach raises the curtain of negativity and doubt that surrounds
Hollywood accounting and leaves a spotlight on the glamour and thrill
of ``owning a piece'' of a film. Talk about transparent accounting--all
the investor would have to do is open the trades. Accounting statements
and audits would be history. The film company would pay the investors
the specified percentage of Domestic Box, even though there is only an
indirect link between Domestic Box and the film company's ultimate net
profits. From the film company's perspective, this transaction hedges
risk, which is exactly what it wants to do. To some extent, the
transaction resembles a simple wager about the box office results of a
film, and this is something everyone can understand to the point of
being common coffee klatch chatter, so it would open the investment
door to the general public. There is even an on-line service
(BetWWTS.com) that allows the public to place bets on the Domestic Box
of large films, and film companies should be tapping into this
potential financing source. It could be done across a slate of films or
film-by-film, with investors placing their bets on particular films of
their choice. Once the market became efficient, investors could place
their bets and invest up to perhaps the day before a film's release.
A simple example may best illustrate this suggestion: Assume that a
studio wants to produce a $100 million film, but it wants to limit its
risk to $50 million. One approach would be to sell off all foreign
rights to one or more other film companies for $50 million, but it will
lose foreign rights forever to competitors and with it about half the
potential profits from the film. Instead, it raises $50 million of
equity with a film fund that provides the investors with a payment
equal to 50% of the Domestic Box. If the film flops and comes in with a
Domestic Box of $10 million, the studio pays the investors $5 million,
keeps the $45 million balance of the investment, and is happy. If the
film has a Domestic Box of $100 million, the studio pays the investors
a break-even payment of $50 million, and the studio is happy because it
will keep worldwide rights and profits to a successful film. If the
film scores big and has a Domestic Box of $200 million, the studio will
pay the investors $100 million, and the studio is still happy because
paying an extra $50 million to the investors is cheaper than losing all
foreign rights and half the profits on this blockbuster forever to
competitors, which was the alternative.
More good news all around is the accounting and tax treatment of
the transaction. For accounting purposes, the investment will be
treated either (a) as a reduction in the cost of the film, with any
payment owed to the investor being added to the cost of the film when
accrued or (b) as equity, thus lowering the film company's debt/equity
ratio, which is an even better result than off-balance sheet financing,
which has no impact on the company's debt/equity ratio. For tax
purposes, the investment should be treated as a tax-free equity
contribution. There is some risk of the transaction being treated as a
taxable sale of a future income stream, but this result can be avoided
by structuring the transaction as a partnership for tax purposes with
the film company. Any loss should be deductible to the investors as an
ordinary loss, although any profit should be taxable as ordinary
income, not capital gain.
In all cases, the transaction will be treated as the offering of
``securities'' by the film company, so it must be careful to comply
with the securities laws. This is the one significant hurdle to
creating enough volume for an efficient market. In the beginning, the
easiest approach is to use only ``private offerings'' to ``accredited
investors.'' If the market and size of the offering justifies it, the
next step would be to do a registered offering, perhaps even with
public trading. (Imagine having to add ``Film Futures'' to the Chicago
Exchange.)
In order for these transactions to work, the investment must be
refundable with interest if the film does not end up with the promised
key cast and director or does not get a theatrical release on a minimum
number of screens by a specified date. Because the film company will be
required to make payments to the investors (whether due to the film not
meeting the promised conditions or based on Domestic Box) regardless of
actual net profits received by the film company, the company will have
to either (a) have a strong enough balance sheet to make the investors
happy or (b) hold the investment in escrow until the Domestic Box
results are in, precluding the investment from being used to cash flow
production. Even if the investment is escrowed, the investors still
will be relying on the film company to pay any amounts owed to them in
excess of the investment if the Domestic Box is high enough. These
factors militate toward making this transaction easier for the studios
(the rich get richer), but it is not beyond the reach of well-heeled
independents.
Would it work? Bet on it.
The Chairman. Mr. Moore, you are very much into this. Thank
you. We will have an opportunity to continue this during the
questions. We appreciate your testimony and thank you very
much.
I will just ask one quick question before we recess for
votes. I will address this to the first two witnesses. If the
big movie houses would stay true to their word and refuse to
participate, would your contract be viable?
Mr. Jaycobs. Yes. The answer is yes. There is an enormous
investor class that actually has investments, and to Mr.
Moore's comments, actually has investors here, and we think
that makes a very legitimate market all by itself.
We also have the Lionsgate letter that says if not the MPAA
members, the other smaller studios will participate. I was
recently at a film conference with small film producers who
were very enthusiastic about the concept.
I think the MPAA has done a very good job of bringing a
group together, but it doesn't represent the entire industry
and we will have a very successful market.
Mr. Swagger. To add to what Mr. Jaycobs shared, a notable
Hollywood individual once said, ``Where there is smoke, there
is a smoke machine.'' We believe that is certainly the case
here. There is viable use for this product and a wide group of
recipients looking forward to using this product.
The Chairman. Thank you. We are going to recess now until
these votes are completed. Sometimes they drag out a little
bit. The first one is a 15 minute vote, and there will be 5
minute votes. We will come back as soon as we can and try to
finish at that time. I apologize for the inconvenience, but
like you I have no control over that. We are in recess.
[Recess.]
The Chairman. We will call the hearing back to order. Mr.
Moran will be here shortly, and he said it is okay to commence
without him, so we will, in the interest of time. And I have a
couple more questions and then we will yield. So back again to
our first two presenters. Mr. Jaycobs, Mr. Swagger, how far
ahead of a movie premiere will you offer the contract on that
movie's receipts?
Mr. Jaycobs. In the case of the Cantor Exchange, the
provision is up to a year, but we expect it will be 6 months.
Mr. Swagger. In the initially proposed application, we are
looking at 4 weeks.
The Chairman. Okay. Who will be using these markets for
price discovery purposes or bona fide hedging, in your opinion?
Mr. Jaycobs. Again, to reiterate in my opening comments
many deals are negotiated on the basis of what a box office
potential will be. The amount of advertising that is justified
by a film will be reflected by the expectation of that box
office; the number of theater screens and seats that are
allocated to it will be based on that sort of decision.
So, again, I think of it in the farm context: If the price
of soybeans or cotton is high or low, there is an allocation
question that the farmer uses. And in our case we see those
same decisions being made here. If you know the box office in
advance, theater screens, advertising budgets, investments
decisions can be made using those prices.
Mr. Swagger. In fact, to add what Mr. Jaycobs shared. One
of the reasons for starting off with the box office weekend
product, is the sheer fact that there are so many contractual
obligations tied to the success of the box office, to the
television and satellite providers, what do they pay for that
and who gets the contract, to the DVD distributors and such.
There is a lot tied to the success of the box office. And,
again, the list of natural users, the original screenplay
owners, debt and equity investors, the investment banking
syndicates, the talent involved in the film, studios, both MPAA
and the other many studios, banks and lenders, insurers of
talent movies, theaters, distributors, and the promotional
marketing partners.
The Chairman. Thank you. Mr. Pisano, you heard me ask Mr.
Berkovitz about the Iowa Electronic Markets and the futures.
These markets are admittedly small, but they exist nonetheless.
And all your objections could apply to these contracts.
However, our democracy has managed to survive these election
markets. If we as Members of Congress could continue to spike
contracts where people invest on our elections, why cannot you?
And why are movies more special than elections?
Mr. Pisano. Well, first of all, I was unaware of the Iowa
situation. And I am advised that that has been the subject of a
No Action letter because of its educational purpose. As I
understand, it is part of the curriculum of the University of
Iowa.
The Chairman. Well, when it started out that was the
purpose. But then they let others invest in it. So that is
probably the reason for the question.
Mr. Pisano. Sir, first of all, betting on the outcome of an
election is a time-honored tradition in American politics and
British politics. And so I distinguish that from the situation
we have here, which is an attempt to cloak in the legitimacy of
a futures market something that is highly speculative and
something that has as its base, as its index, something that
doesn't exist. In an election, you know how many votes are cast
ultimately when the votes are tabulated.
One of the things I like to point out in terms of how the
movie box office reporting works, I think you asked the
question of Mr. Berkovitz. There are no real numbers reported.
What is reported are estimates based upon surveys and
electronic feeds from theaters. And, indeed, the very tracking
service that the exchanges propose to rely on, Rentrak, which I
am very familiar with, for a number of years has in its terms
of service a disclaimer in terms of the use of the information
and the reliability of the information, because it is just
that: It is an estimate, a pretty accurate estimate. But no
money changes hands anywhere in the industry based on what is
reported in Variety by Rentrak. Also, no money changes hands in
terms of the contracts that are downstream based on what is
reported in Variety. Indeed, those downstream contracts, for
example, television contracts, pay television contracts, those
are negotiated years in advance and they are based on film
rentals, which is the individual share between the theater
owner and the studio when it is ultimately settled up. And that
is never reported publicly because that is personal private
information between the two contracting parties.
The Chairman. Well, thank you. At this time I would like to
recognize Mr. Marshall.
Mr. Marshall. I was struck by your testimony, Mr. Moore. It
was, as the Chairman described to me anyway, enthusiastic and I
thought probably pretty authoritative. I don't think we are
really competent to make this judgment. I think it is something
that needs to be left to the CFTC and the experts within the
CFTC. And I certainly think it is clumsy at best, probably
inappropriate, for us to just start listing different products
that are not to be subject to futures.
What I am interested in is sort of general guiding
principles. And you mentioned that you didn't think it was such
a good idea to have the firewall so insider information, no
matter where it comes from, is available. You don't worry that
the effect of that will be to cause manipulation in
inappropriate ways and effectively undermine the attractiveness
of the investment from the perspective of people who, ``Know
doggone well they are not going to be the ones, they are going
to get the insider information and know which way this thing is
going to move.'' They will be dumb and they will be the chumps
at the other end of the deal.
So without the firewall and with the presence of insider
information, in such a narrow rifle shot kind of inquiry, what
is going to be the success of this particular venture? Would
there be a market at all?
Mr. Moore. I believe there would be. I believe that the
same comment could be made with respect to every market: That
there are people with more information and some with less. And
that is, in fact, the basis for our capitalistic system. That
is the basis for a free market exchange. The same could be said
with respect to farmers being insiders because they know on the
ground whether or not there are crop infections, whether there
is infestation of locusts or something that before the----
Mr. Marshall. So your basic response would be, look, this
has been a valuable tool available to other kinds of investment
decisions. Make it available. Either the market will take
advantage of it or it wont. If the presence of narrowly focused
insider information with regard to the end result where box
office receipts are concerned for a particular product is a
worry, then the investors won't step up. Let the market figure
out what?
Mr. Moore. Yes. I would say there are two separate issues.
One is up until the release of the film. And there has been
confusion among the Members on this issue, so I would like to
be precise.
As to insider trading prior to release of the film, I
believe strongly there should just be no limits at all. That
is, let the market decide. And I believe that you want to
disseminate the information through pricing. And that is the
point. And in particular, number one, the truth is there are no
secrets in Hollywood. The moment that a film has some trouble
with it, it is instantly on the blogs, it is instantly in the
trades.
Second, the truth is in Hollywood nobody knows anything.
Nobody knows what that box office will do. The top executives
at the studio who have all the inside information in the world
are often wildly wrong on whether a film will flop or not.
There are just endless, countless examples of films that have
flopped that people thought were going to be huge and vice
versa. No one could have predicted Paranormal Activity, a
$200,000 film, doing as big as it was.
So as to that answer, let it go.
Mr. Marshall. Are these products essentially available now
in the OTC market offshore?
Mr. Moore. Yes, they are.
Mr. Marshall. And are they robustly traded?
Mr. Moore. I don't know whether they are robustly traded.
There is a company called Intrade that is offshore that is
unregulated, not governed by any U.S. laws that is permitted
box office betting going on right now.
Mr. Marshall. Mr. Jaycobs, Mr. Swagger, how about that? The
OTC market. Are there swaps, derivatives that do essentially
what you are proposing to do on the regulated markets?
Mr. Jaycobs. I mean, I don't draw the comparison quite as
closely with Intrade. I think that the statements that were
made earlier are more consistent with what we have seen, which
is that the hedging that is happening now is by transfer of
risk through the securities market, not through the futures
market. That is the mechanism we have seen.
Mr. Swagger. I completely agree with that. And the notion
that a CEO would not use this hedge; quite honestly, in our
work directly with many of the very constituents at the MPAA,
not only were they interested in this initial product, but they
were interested in working on the development of different
products that would also meet economic needs that they have.
And the ability to collect data was not available 5, 6 years
ago in the relative form that it is today. And I think that if
there is a concern about the value of that data that is being
collected, that is a greater concern than something that has to
do with CFTC regulation. If we are understanding from Mr.
Pisano that the MPAA is saying that his studios manipulate data
that is put in 10-Q reports for large corporate conglomerates
that own studios, that would be of great concern.
Mr. Marshall. Thank you, Mr. Chairman.
The Chairman. Thank you. The chair recognizes Mr. Moran.
Mr. Moran. Mr. Chairman, thank you.
I heard Mr. Jaycobs talk about CFTC and the public utility
of this exchange. And yet, we heard the General Counsel talk
about that is not one of the criteria in which the CFTC looks
at. So I want to explore with you and others on the panel, what
is the public utility? What is the public benefit of this
exchange and this kind of product?
Mr. Jaycobs. Well, it is twofold. There is the--what we
call in this industry the price discovery function. But what
other folks would say is, what is the box office going to
generate from an economic value point of view? And as we have
heard here, many decisions are made on whether that box office
is going to be strong or weak, or whether you take the risk of
that or not. And it is investment decisions made by individuals
in advance of even knowing what films would be produced with
the money that they have invested. It is screen allocations. It
is the budgets for advertising. There are a number of business
decisions that are being linked to that box office value.
Mr. Moran. And I assume, then, that the theory would be
that the market would then become much more efficient.
Investment decisions, location of theaters, decisions would be
made that were based upon more information.
Mr. Jaycobs. That is exactly right. If you have more
information. And, equally important, that that information can
be acted on in a financial transaction. So you can not only
have an opinion about the value, but you can actually take an
action to ensure that value. You put those together, and in
every other instance where we have futures markets, that has
been a great benefit to the underlying industry.
Mr. Moran. Mr. Pisano, do you have a counter argument to
that point?
Mr. Pisano. As I said earlier, Mr. Moran, nothing in the
movie business today is linked to the reports of box office. As
I said, those are simply estimates that we release--our studios
release and others, principally for marketing purposes. They
are not reported in the financial statements of the companies.
They are not reported to the SEC. They are estimates based on
the Rentrak system.
And, in addition, no one that I know of--and I have been in
this business for 25 years--makes the decision as to how much
money we are going to spend on a movie or how many screens are
going to get booked based on some artificial estimate of what
the box office will be based on a futures trade. So there is an
unreality to this market not linked in any way to how the
business actually works. And that is, to me, is part of the
danger of this proposal in that what it really does is invite
speculation.
In addition, according to the phone book-size set of rules
that the exchanges have published, the very people that would
have some information and might be able to rely on it are
prohibited from acting on it. So what--to put it in its
simplest terms--what we have is a market in search of a product
that the people who actually participate in the industry don't
want, but, perversely, it is going to impose liability,
reporting, and regulatory responsibilities that we don't want
and don't currently have, and even questionably whether the law
as it is written today has the power to impose it on the motion
picture producers and distributors.
Mr. Moran. Mr. Moore, I assume that you have an observation
about both of those answers. In addition to that, I wanted to
add the question about increased or decreased investment in the
movie industry. I think you indicate that, as a result of this
additional transparency of information, that we would see an
increase in investment. And I want you to explore that a bit
with me. But also, if someone could walk me through. Supposedly
we have some investor in my home State of Kansas who wants to
invest $100,000 in making a movie. How would this help or hurt
him or her's effort to make that investment decision.
Mr. Moore. I can tie all of this together and answer that.
It is the perfect question. I guarantee you that there will be
an enormous flood of financing into the industry for the
studios to create jobs for Mr. Harbinson and IATSE, to create
jobs for the guilds, to create more film production if there is
an exchange that permits trading based on box office results.
Because, number one, if you tell me the box office result of a
film, I can tell you with statistical certainty what the total
income to the studio will be from DVD and TV, because there is
a correlation between box office and the other revenue.
What I would say to your investor in Kansas is right now
they have a choice to put $100,000 down and invest it in either
a particular film, or they could invest in a slate of films.
And they are going to look at you and they are going to say, in
exchange for what? And the answer you will give them is, net
profits. And net profits is a very opaque accounting term in
Hollywood with a lot of ambiguity and a lot of litigation
behind it and a lot of uncertainty. And that uncertainty holds
back investment. That is what holds back investors.
If your investors in Kansas could hedge their risk in a way
that they could know with certainty that if the box office was
X, and they could look it up in the paper and they know what
they have earned the next day with certainty, they would have
that much more comfort, they would become free of the fear of
Hollywood accounting, and there would be a flood of funds of
financing for the market. I represent--this is what I do for a
living, and I can tell you I have had talks with my private
equity funds who would flood this market with financing if
there was a hedging opportunity available that they could
protect themselves. And, I mean, they have told me this. And, I
mean, hundreds of millions of dollars. There is no question
about it.
Mr. Moran. Thank you all very much. Thank you, Mr.
Chairman.
The Chairman. Mr. Kissell, questions?
Mr. Kissell. Thank you, Mr. Chairman.
Mr. Jaycobs--and I am probably going to repeat some of the
questions that have already been asked, but I am trying to once
again just understand this, and I kind of agree with Mr.
Marshall, that this is--while it is interesting to hear your
comments and your positions, this seems to be a decision best
left to the CFTC and their expertise of understanding this at
much greater levels than I would.
But, Mr. Jaycobs, why do you want to invest? Why do you
want to set this market up? These guys don't seem to want you.
Why not take your money somewhere else?
Mr. Jaycobs. Well, Cantor has had a well over 10 year
commitment to try to develop financing vehicles for the
entertainment business, broadly speaking. So this is part of
that commitment. We think that--very much to the Professor's
comments, we think that it is the transparency in a public
marketplace that enables us to do financing of films. Without
that, we are trying to create investment under the cloak of a
market where valuations are being determined arguably by Mr.
Pisano's organization as they assess what films are valuable
and what films are not valuable. So we think that having a
public, transparent marketplace is a predicate to doing all
forms of other investments. And, in that sense, I agree with
the Professor.
Mr. Kissell. And Mr. Pisano, and I know we have talked
about this. But why don't you want their help? They seem to
have some money there. The equity would seem to be something
that might leverage your investments. Why don't you want the
help?
Mr. Pisano. Speaking just for my members, we have perfectly
adequate tools to finance our motion pictures. And all those
tools have been discussed, so I won't go into it.
What we don't want to do, what we don't want to do is to
participate in a highly speculative, unreal, basically gambling
casino effort to raise money. That is not good for our
industry, it is not good for our companies. And, as Mr.
Harbinson said, it is not good for the creators who are
involved in the picture individually.
And, while one could postulate, theoretically, that new
financing opportunities are a good thing, I think they are a
bad thing when they are like the synthetic derivatives that
have driven down and basically almost destroyed the financial
structure. This is nothing more than synthetic speculation. I
am perfectly happy to have people make money who are
speculators, but there has to be a broad economic purpose. And
we simply don't see that here. But we do see opportunity for
abuse, manipulation, and the kind of financial chicanery that
has gone on in this country for the last 5 years, and that is
why we are opposed to it.
Mr. Kissell. Thank you, gentlemen, for your patience while
we were voting. Thank you for being here today. Mr. Chairman, I
yield back.
The Chairman. Thank you. Mr. Marshall, you had another
question?
Mr. Marshall. Mr. Moore, you alluded to reasons why MPAA
would not be interested in having this kind of credit facility
available. You say that the effect of this would be to enhance
dramatically the amount of investment that is available to fund
films; so, hence, it would be boom times in the film industry.
Besides just saying they are wrong in their evaluation of this,
which you clearly think they are, are there things about how
MPAA has structured the existing order of things that would be
disrupted by this, some sort of vested interest that is being
protected that you could perceive and share with us?
Mr. Moore. No. I really do believe that it is simply the
fear of bad tracking, and the fear that that will lower
attendance to a film. I think it is a fairly myoptic view,
without taking into account that there is going to be good
tracking that will increase attendance, and kind of ignoring
all the other benefits. And I also think it is just the fear of
what is new. I think that has been a historical trait of the
MPAA and the studios. I think they would ultimately come to
embrace this.
Mr. Marshall. So you don't see any attempt to defend turf
that exists right now, those sorts of things that--concerns
that sometimes come up when new products are offered?
Mr. Moore. I don't believe so.
Mr. Marshall. Mr. Jaycobs, Mr. Swagger?
Mr. Jaycobs. I can only rely on the comments Mr. Pisano
just made, that the major studios don't need this. They have
plenty of financing. They have very deep corporate pockets
standing behind them. I would point out that they have closed
several, New Line, Vantage, Miramax were closed, distribution
units that did small films underneath bigger studios. And if
you have a public marketplace that creates greater public
financing, the independent folks that we talked to, Lionsgate
is just an example of that. But it goes down to production
companies, they will all have the ability to get access to
funds that right now for the most part can come only from the
MPAA or its members.
Mr. Marshall. Mr. Swagger.
Mr. Swagger. I am sorry. Would you mind repeating the
question?
Mr. Marshall. Well, actually it is the same question I just
asked Mr. Moore. I am just wondering, in your opinion, Mr.
Moore, Mr. Swagger, Mr. Jaycobs, you are in favor of doing
this, making this credit facility available. Is there something
that you perceive MPAA is trying to protect, some existing
order of things, that would be disrupted by this that explains
why MPAA would be concerned?
Mr. Moore says no. He thinks it is a legitimate worry about
what would happen to the prediction of success or failure where
a movie goes, and the existing order would prefer to leave that
to critics and whatever else is presently around and not add
yet another thing speculating on success or failure. Mr.
Jaycobs is suggesting that there is a little more to it; that
MPAA would be perfectly happy with the existing order of
things, since financing is available for it but not for the
smaller ventures. This would create more financing for the
smaller ventures.
Mr. Swagger. I would completely agree with that statement.
If there is an action taken to prevent these products, the
action is really just saying there are six studios we want to
protect and we don't want to protect the rest of the jobs, the
rest of the talent that is out there. We have great people on
our board that have been involved with film financing, and this
is certainly a move--if indeed the constituents of the MPAA are
all really supporting this. What we have learned in directly
working with those constituents, they are very open to not only
this product but other products. So I would even disagree with
Mr. Pisano's statement that they are all opposed to this is a
direct conflict of what our experience has been.
Mr. Marshall. And in fairness, Mr. Pisano, if you could
give your perspective here.
Mr. Pisano. I was speaking on behalf of the MPAA member
companies. But we have in the record already a statement from
the Independent Film and Television Producers Association,
which represents 150 independent producers of film and
television. In fact, in terms of that organization, that is
probably the majority--the majority of the films produced every
year by their members, and they are opposed to it for all the
reasons which they have set out in their filing and I won't
repeat them. So it is not just the six studios who are opposing
this. It is the Independent Film Association representative
that are opposing it, also, for the very reasons set forth.
Mr. Marshall. Mr. Harbinson.
Mr. Harbinson. Well, I am a little different than the rest
of the panelists. I am a working person that represents working
men and women, so I bring a different perspective to this. But
from the perspective of the people I represent, it looks very
much like the Wall Street guys are trying to do for the motion
picture industry what they did for the real estate and mortgage
banking industry, and we don't want it. We don't want any part
of it. It has been very well articulated by the MPAA, it has
been articulated by us, and it has been articulated by the
independent producers. And I am hoping that the Committee sees
it that way and realizes that all this is is gambling for a
select few to make money at the expense of those of us who make
motion pictures.
Mr. Marshall. Mr. Moore, last word here in response to Mr.
Harbinson? We keep hearing this is just gambling, and Wall
Street and the reference to synthetic CDOs.
Mr. Moore. I hear it. But in truth and in fact, it will--
and I wrote this article 7 years ago and it is attached to the
material that I submitted to the Committee, that I believed it
then and I believe it now that we desperately need a
transparent, efficient market to generate substantial financing
for this industry. The wave of equity from New York and the
private equity funds for the last 5 years has dried up. It was
a total of $13 billion. It is gone.
Film--Mr. Harbinson should know that film production is way
down. Salaries are down. Prices are down. Profits are down.
Films are going bankrupt. MGM--Miramax is being sold at a--and
there are a number of other companies that are on the verge of
bankruptcy in the entertainment industry. They need financing.
This is a viable, efficient, transparent approach to bringing
substantial financing to Hollywood. It will help the unions, it
will help the guild, and it will help the studios.
Mr. Marshall. Thank you, Mr. Chairman.
The Chairman. Mr. Pomeroy, any questions?
Mr. Pomeroy. Yes, Mr. Chairman. Let me acknowledge at the
outset I know nothing about the motion picture industry or how
it is financed. I have been interested in the concept of the
futures trading relative to potentially assisting in adding
security to the investing, the highly risky investing in motion
pictures. To me, it seems like this could work fairly nicely.
You would have basically a hedge, you would put it out there,
and you would basically be able to put a block on your downside
exposure. This technique could bring more investors to the
party because they are going to have a position that they can
secure. They know their risk isn't unlimited.
Mr. Harbinson, I guess I would direct this one to you. It
seems to me like more participation in the investing in movies
would be to the interest of your members, and yet you have
taken a position against this proposal. Have you evaluated
whether or not this might be a means to get more investing,
and, therefore, more opportunity and, indeed, more
independence? I have a theory, utterly baseless other than my
own conjecture, that possibly some of the opposition from the
Motion Picture Association is because they are the bigs. And if
you have a backstop on risk, well, you have more potential
investing, you are going to maybe have more little ones. And
that is more competitive, in my argument. But, for your
members, that might be more work. I am puzzled with this issue
in that way. I would like your response on behalf of your
members, and then maybe toss it around a little bit.
Mr. Harbinson. I will answer you as best I can. As I said,
I am a union representative, and my normal bailiwick is
negotiating and enforcing collective bargaining agreements and
processing grievances, that sort of thing. So this is all kind
of new to me, and I am trying to get up to speed as best I can.
I think that our fundamental objection is that we are
practical people. If it looks like a duck and quacks like a
duck, it is a duck. If it looks like gambling, it smells like
gambling, it is gambling. We don't want to be--and you are
right. Mr. Moore was right. You know, the industry has
suffered, and it has suffered as a result of the financial
crisis that is now being dealt with. It may come as a surprise,
but we don't have great confidence in Wall Street to create new
wonderful things for our industry, particularly when we see
just how variable a motion picture's success could be. We are
concerned about the process being corrupted. We are concerned
about the process being manipulated. We have grave, grave
concerns over that. Would we like more work? Yes, sir.
Mr. Pomeroy. I hear you. I think there could hardly be a
worse time to consider a new realm of futures trading in light
of the abuse that has taken place in this whole arena. On the
other hand, it has long served a useful risk management role in
the marketplace for lots of things that are otherwise hard to
evaluate risk and how you price risk protection. So you do it
basically in an open exchange traded way, and the marketplace
determines how you reach a valuation and puts a valuation in
place.
I would like to hear from Mr. Jaycobs--and I know, I see my
time is up or just about, you have about a minute left to bring
your perspective to my conjecture here.
Mr. Jaycobs. Well, that is exactly our view. Is history--
this would be the only case in history where that result was
not achieved. And we have great appreciation for Mr.
Harbinson's guild and the other guilds. The decline in
production has been dramatic. The studios have shifted their
production to blockbuster type pictures away, as I just
mentioned, from the smaller films. And we also--I had the
pleasure to meet with some folks at the Directors Guild and we
had an opportunity to present our side of the story. Up to that
time, we hadn't. The folks at the Directors Guild explained to
us--and I thought it was a very simple concept. If we believe
that this will raise more money, and there are good arguments
for the industry and there are good arguments in that
direction. We would have to be convinced that there was not a
reputational risk that because a market was sold off unfairly,
that that reputational risk would look bad for our people. And
I fully understand that. I think that is where the CFTC's role
is so important here, is that we have to make sure for the
investors in the market, for the creative people involved in
the process, we have to make sure that we have a level playing
field for the entire market. The CFTC is expert in that role,
and we trust their judgment in working with us to come up with
a product that will achieve the greater good.
Mr. Pomeroy. I did think that reputational risk is an
interesting element. And, again, not having a background in the
industry, I thought the point made by Motion Picture
Association was interesting that you would have basically Wall
Street Journal coverage of the first weekend box office, the
shorts hit in terms of the futures, and basically you have
destruction of the picture in its first few weeks in the
marketplace. It would compound the risk already experienced by
a weak opening box office or maybe critical reviews. So I
understand that. I don't know that that is determinative,
though, on the question of whether or not this might be a
useful way to backstop risk for purposes of inducing additional
investment in U.S. produced films. We will continue to reflect
on it.
One question maybe to just--this is a quickie. As we look
at futures and exchange trading, do we sort through the many
facets of our economy and say, ``Well, you can futures trade
this one, you can't futures trade that one; you can futures
trade tire futures, but you can't future trade some other''--
you know what I mean, in that way? Is this a common approach?
As a Member of the Agriculture Committee now for many years, I
have not seen legislation that would identify an industry and
say, well, you can't do it for this one. Sure.
Mr. Swagger. I think Rich can add to this as well. From our
perspective, no new exchanges can start and be successful
unless they are into a new product market. Working at UBS as a
banker, working with one of the very constituents actually of
the MPAA, they were asking us if we would do slate financing,
which is let's finance maybe ten films in a package. And the
challenge with slate financing is simply you don't get the best
of the films in there. It is not economically a position that
we wanted to take when I was with UBS. In that same discussion
with that same studio, who is a member of the MPAA, to which
our name was derived from, we started talking about futures
contracts, opening up that dialogue, helping them to understand
there may be some new tools.
So personally, as an entrepreneur, I felt this was an
opportunity to take my hard-earned dollars--and Mr. Harbinson,
I am a working man myself, grew up on a farm and spent many
years of hard work, and also went through Officer Candidate
School in the Marine Corps. And my family grew up in the
automotive industry. I have created new jobs to serve a
specific market, the entertainment market. And the concepts
that we came out with are concepts that were brought from the
entertainment industry itself.
Now, granted, I don't have the years of experience Mr.
Pisano has in the entertainment industry. What I have is the
ability to bring talented people together. One of the top
people in movie financing from one of the top banks serves on
our team. One of the top producers who produced a lot of great
movies that each of you would know serves on our board. One of
the top individuals who built the most modern studio in
Hollywood is serving on our board and manages $200 million
revolving loan funds. We have a lot of talented individuals.
Pete Warzell, who works for us who had to step out used to be
the former Chairman of the National Association of Theater
Owners, NATO, one of the organizations that is supposedly
against us.
Before that, he was at AMD building a live program, he was
a president of United Artists and the chief operating officer
and said, I wish we would have had these products before.
Mr. Pisano and I were talking right before we came back
here. We were talking about an area called Century City.
Century City in L.A. is the result of a studio almost gone
bankrupt, a major studio, one of the MPAA constituents nearly
going bankrupt and having to sell off their whole entire back
lot. Had there been futures products to protect that industry,
not only would it have prevented something like that from
occurring, but it would indeed inject capital to help build and
create jobs. And at the end of the day, if the six constituents
at the MPAA don't want to use the product, that is fine. I am
willing to live or die on that sword. But we know--I didn't
start a business and invest millions of dollars on pure
speculation that a field of dreams, ``I am going to build it
and I hope they come.'' We build it on foundational knowledge
that there was a dynamic need for this industry.
Mr. Jaycobs. I don't know if we are over our time, but I
did want to answer. I think your question was history. I have
been a 25 year futures industry veteran, and so I have seen a
lot of new markets get created. And what I can say is common
among all of them is the industry that was--energy comes to
mind in particular, where a new futures product is introduced
and there is significant industry opposition. If we go back to
the early 1980s, the Seven Sisters were--and this has been
documented in a book. The Seven Sisters were opposed to the
idea of creating a NYMEX futures market even on a small scale
in the financial markets there was opposition, substantial
opposition to creating a 5 year futures contract for Treasury
bonds when there was a ten and a different one. And even those
interests all aligned to say we shouldn't have such a thing.
The only case in history that I can think of and is well
documented where Congress has stepped in and now started to
carve out is the 1958 case where it occurred in onions.
Mr. Pomeroy. Onions. If it weren't for onions, we would
pretty well let markets determine what makes sense or not
relative to the futures.
Mr. Jaycobs. That is correct. The philosophy always was, if
the product is poorly designed--again, dealing with the very
important issues of we cannot have manipulation, we must have a
fair playing field. But the commercial success, the question of
whether they will come or they will not come to the field of
dreams in Iowa has always been left to the--basically, to the
marketplace to determine.
Mr. Pomeroy. Thank you very much. And Mr. Swagger, very
strategic getting your farm boy background in before the
Agriculture Committee. We are way over time, you guys.
Mr. Swagger. May I just clarify one issue? There is a lot
of confusion with this smoke about gambling.
Mr. Pomeroy. Can you clarify this issue in 20 seconds?
Because the Chairman is about to gavel us down here.
Mr. Swagger. Absolutely. Thank you, Chairman Boswell.
Gambling, somebody takes on a risk. That is the studios.
That is people who finance the movies. Futures market, you
assume and spread out the risk. It is not gambling. It is
taking the risk that is there and existing and spreading that
out. And that is what a futures market has been, has always
been, and is in this situation as well.
Mr. Pomeroy. Thank you.
The Chairman. Well, thank you. It has been a very, very
informative discussion. But before I go to closing remarks, I
would like to recognize my Ranking Member, Mr. Moran.
Mr. Moran. Mr. Chairman. Thank you very much. Perhaps many
of us came here with preconceived ideas. I thought it was a
very useful hearing, something that we ought to do more in
Congress is get a perspective so that we can make correct
decisions. And I appreciate the witnesses' testimony and you
conducting this hearing today, and I look forward to analyzing
what I heard during the testimony. Thank you.
The Chairman. All right. Thank you. And I concur. I think
it has been very informative, and I appreciate the efforts you
made to come and inform us and share with us. We likely will
have some more questions as we go forward. It has been a
learning experience. And thank you for giving us your time
today. We apologize for the interruption for the votes, but
those things happen.
So at this point I would share that under the rules of the
Committee, the record of today's hearing will remain open for
10 calendar days to receive additional material and supplement
the written responses from the witnesses to any question posed
by a Member. This hearing of the Subcommittee on General Farm
Commodities and Risk Management is adjourned. Thank you.
[Whereupon, at 1:30 p.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Submitted Statement by Independent Film & Television Alliance
Thank you, Chairman Boswell, Ranking Member Moran and Subcommittee
Members, for the opportunity to provide a written statement to the
Subcommittee on General Farm Commodities and Risk Management of the
House Committee on Agriculture, regarding the applications currently
before the Commodity Futures Trading Commission (``CFTC'') to approve
or deny two proposed commodity futures contracts and a commodity option
contract sponsored by Media Derivatives, Inc. (``MDEX'') and the Cantor
Futures Exchange L.P. (``Cantor'') that are designed to allow the
contracts' users to bet on the level of gross motion picture box office
receipts on individual motion pictures (``the proposed contracts'' or
``the contracts''). The Independent Film & Television Alliance (IFTA)
opposes these proposed contracts because they serve no legitimate
public interest, would impose new and substantial burdens on small to
medium sized businesses and provide little, if any, of the so called
``benefits'' of hedging; thereby causing disproportional harm to the
countless business, financial and creative partnerships which make up
the independent motion picture industry.
IFTA is the nonprofit trade association for the independent film
and television industry worldwide. IFTA Members consist of over 150
independent production and distribution companies, as well as sales
agents, television companies and financial institutions from around the
world, the majority of which are U.S.-based producers and exporters.\1\
Over the last seven years, independent production companies have
produced nearly 80% of all U.S. feature films and producing on average
500 feature films per year. Since 1982, IFTA Members have been involved
with the financing, development, production and distribution of 64% of
the Academy Award Winning Best Pictures' including The Hurt
Locker, Slumdog Millionaire, No Country for Old Men, The Departed,
Crash, Million Dollar Baby, Braveheart, Lord of the Rings, Dances with
Wolves and Gandhi. In the past year, IFTA Members films have also
included The Twilight Saga: New Moon, The Last Station, Inglorious
Basterds and Tyler Perry's Madea Goes to Jail, to name just a few.
---------------------------------------------------------------------------
\1\ For a complete list of IFTA Members, visit www.ifta-online.org.
---------------------------------------------------------------------------
IFTA Members' collective worldwide sales for 2008 totaled over $2.8
billion, of which approximately $2.3 billion came from foreign (non-
U.S.) revenue; and $503 million from U.S. revenue, which is
approximately 18% of total worldwide revenue. Of the amount for export
revenue, $1.7 billion was generated from Europe, $129 million from
Latin America, $222 million from Asia.
IFTA is also a member of a coalition opposing these proposed
contracts that includes the Directors Guild of America, Inc. (DGA), the
International Alliance of Theatrical Stage Employees (IATSE), and the
National Association of Theatre Owners (NATO), as well as the Motion
Picture Association of America (MPAA) and its member companies
(``Coalition''). The Coalition has submitted a separate written
statement outlining its opposition of these proposed contracts and
Coalition members will participate at the April 22, 2010 hearing. IFTA
is filing this Statement individually to underscore the specific
concerns of the independent motion picture industry with respect to the
proposed contracts.
As a background, independent producers are those companies (apart
from the MPAA studios) that assume the majority of the financial risk
for the production of a film or television program and control its
distribution in a majority of territories worldwide. Independent
producers secure financing on a film by film basis with different
investors for each film and rely heavily on the distribution
commitments of foreign distributors before production of the film even
begins. For independents and MPAA studios alike, film distribution is
not a ``one shot deal'' as may be the case with agricultural futures--a
picture's long term revenue prospects (especially in foreign
territories) can be severely damaged by publicity generated around
artificial expectations of the performance of these contracts, which
looks at only a small window and only the U.S. release. Therefore, any
pre-release hedging by U.S. distributors (which are separate,
unaffiliated companies) could harm not only the independent producer,
but also the dozens of financial and commercial partnerships they have
built worldwide to secure financing for each film.
Despite statements to the contrary from proponents of these
schemes, most independent pictures would not be the subject of proposed
contracts because the picture will not meet the criteria such as a
simultaneous release in 600 or 650 U.S. theaters. Moreover, most
independent films are first theatrically distributed in the U.S. and
are released by the MPAA studios which control the marketing and
release plans including determining what type of a release (i.e.,
limited, platform, wide) will launch a motion picture; the independent
producer does not control the factors on which these exchanges base
qualifications. Even in the event that the independent picture meets
such criteria, since independent producers must pay back production
loans based largely on foreign revenues which are earned after the U.S.
theatrical release and could be harmed by negative publicity, they are
unlikely to engage in hedging that could jeopardize their previously
established financing and distribution relationships.
Further, these proposed contracts may not appeal to independent
producers as a risk management tool since independent producers already
exercise risk management in their financing and distribution models by
securing pre-production commitments from foreign distributors worldwide
known as ``minimum guarantees.'' Those minimum commitments by foreign
distributors along with any government incentive programs are
collateralized by financial institutions and other investors which loan
the producer the production budget. The financial institution or other
investors are granted an assignment of the copyright in the motion
picture until the production loan is paid back.
Any hedging by the U.S. distributor (again, a separate company
which is not affiliated with the independent production company) could
harm the long term prospects for a picture's worldwide distribution.
Since only about 18% of worldwide sales revenue is derived from U.S.
distribution and only a portion of that from U.S. theatrical
distribution, independent producers must rely on the proceeds of
foreign distribution to pay back the production loan and other
investors and so are unlikely to hedge on the U.S. theatrical release.
The existence of such schemes would place independent producers in the
difficult position of assuring their overseas distributors that the
foreign revenues will not be jeopardized by the U.S. distributor, but
could never guarantee that hedging would not occur or negatively impact
the long term potential of the Picture.
``Split rights'' deals in which one company controls U.S.
distribution and another company takes foreign rights are common in the
industry. A market that allows hedging on the domestic side creates
significant risk of harm to the company controlling the foreign rights
and damages the long term prospects for the picture. In the case of
split rights licensing arrangements in which an MPAA studio control
exclusive U.S. distribution rights, and another studio, or in the case
of independents, a network of distributors control the exclusive
foreign distribution rights, any hedging by the U.S. distributor could
critically damage the picture's foreign distribution rights. Any
negative publicity will disproportionally harm independent producers
and their foreign distributors, who are unlikely to avail themselves of
U.S. based hedge funds.
Any such exchange requires that insider knowledge and trading be
controlled in order to ensure integrity of market. Compliance
compatible with such controls may be impossible in the worldwide
reaches of the independent motion picture industry due to the sheer
number of potential insiders. Since many times foreign distributors are
investors in a picture prior to production and release, potential
insiders could be spread worldwide preventing enforcement of insider
manipulation or trading. Approval of the proposed contracts also will
require MPAA studios, independent production companies and all other
industry participants that have the power to affect futures pricing to
institute anti-insider trading compliance regimes for the proposed
contracts and this may ultimately impact the MPAA studios relationship
with independent producers to supply programming. In the event that the
studio is distributing an independent picture, the potential for many
more insiders outside of the studios' control is enormous. There are
many industry participants who have access to material, non-public
information and could try to use that information to profitably bet on
the proposed contracts.
Futures prices also are susceptible to manipulation by false market
rumors. ``Hollywood'' is referred to as a ``company town'' and there is
no shortage of media and speculation about this industry's main
product--motion pictures. There already are plenty of rumor mills with
respect to the quality of motion pictures and many taking place online.
In this environment it would be impossible to identify the sources of
such rumors or to prosecute any alleged manipulation by false rumors,
because such rumors would typically be based on opinions relating to a
motion picture's artistic or entertainment merit rather than verifiable
facts. What was once industry ``talk'', idle gossip or opinion could
have a more profound impact on our creative industry. For the
independent industry and its worldwide participants, there is no
effective way to reliably determine the source of such rumors. It also
remains unclear what legal duties and liabilities apply and for whom if
the base data fails to fully report or gather accurate data or if a
studio makes an inaccurate announcement of receipts. If an independent
motion picture is subject of a proposed contract and manipulation is
asserted, defending such suits would be financially devastating for an
independent producer.
It is for the reasons stated in this Written Statement and in the
Coalition's Written Statements that IFTA opposes such proposed
contracts. Thank you once again for the opportunity to outline the
critical concerns of the independent motion picture industry in
connection with these proposed contracts. IFTA respectfully urges that
they be denied.
______
Submitted Statement by Don M. Chance, Ph.D., C.F.A.; on Behalf of
Cantor Fitzgerald
My name is Don M. Chance and I am Professor of Finance and holder
of the James C. Flores Endowed Chair of MBA Studies at Louisiana State
University. I have been asked by Cantor Fitzgerald to provide a
statement and document to the United States Congress that would support
its request for approval of a new futures exchange in which contracts
would be based on the box office revenues of movies. While I am being
compensated for my service, I had independently established this
opinion as evidenced by my co-authorship of two articles over the last
two years on a similar financial instrument. In the spirit of full
disclosure, I provide the caveat that these remarks are my own and do
not necessarily represent the views of my employer, Louisiana State
University.
Qualifications
I hold a Ph.D. in finance from Louisiana State University and am a
CFA (Chartered Financial Analyst) charterholder. I have been an
internationally recognized scholar and consultant in the area of
financial derivatives for nearly 30 years. I formerly taught at
Virginia Tech, and I have authored three books on financial
derivatives, including one widely-used textbook currently in the 8th
edition, and another that is the required reading for the CFA
examination program, which is taken by over 120,000 candidates
worldwide each year. I have authored nearly 100 published articles,
most of which deal with derivative instruments. I have conducted
training programs for UBS, Thomson Financial, The German Society of
Financial Analysts, the International Federation of Banking of
Luxembourg, Goldman Sachs, and the World Bank. I am an advisor to
IndexIQ, a New York-based creator of exchange-traded funds, and to The
Governance Fund, a Minnesota-based investment advisor. Prior to my
academic career, I spent four years in commercial banking.
My specific qualifications for this matter derive from two articles
I co-authored. The first, ``Pricing an Option on Revenue from an
Innovation: An Application to Movie Box Office Revenue,'' was published
in 2008 in Management Science (Vol. 54, No. 5, pp. 1015-1028), a
prestigious interdisciplinary scholarly journal with extremely high
publication standards. The second paper, which extended some of the
work in the first paper and was targeted more toward practitioners,
appeared in Risk magazine (Vol. 22, May, 2009, pp. 80-86) and was
entitled ``Pricing Options on Film Revenue.'' Both of these articles
were co-authored with Professors Eric Hillebrand of Louisiana State
University and Jimmy Hilliard of Auburn University.
These two papers emanated from a long-term interest I have had on
how the entertainment industry has pursued means of hedging the
significant risk it faces in the music and films it produces. I will
provide a brief review of this subject in this document. The papers
demonstrate how to capture the statistical properties of revenues from
a movie and how to use that knowledge to create options that would pay
off based on how a movie performs. Although the instruments being
proposed by the new exchange are futures contracts, the essential
characteristics of options and futures are sufficiently similar such
that any differences in the context of this matter are trivial.\1\
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\1\ By way of clarification, an option enables a party to claim the
value of an asset or the payoff of an asset by paying a fixed amount of
money at a certain date. For this right, the buyer pays a fixed sum of
money, the option price, at the start to the counterparty or seller.
The counterparty/seller receives the up-front payment from the buyer
and must be willing to provide the payment or asset demanded by the
buyer, if the buyer so chooses. A futures is an agreement in which one
party commits to claiming the value of an asset or the payoff of an
asset by paying a fixed price at a certain date. The counterparty, or
seller, in a mirror image, agrees to deliver the asset or pay the value
of the asset to the buyer on the given date. Whereas an option is a
right held by the buyer and granted by the seller, a futures is an
obligation on the part of both buyer and seller.
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This statement will be followed by a white paper at a later date
(see Attachment).
Futures Markets and Contracts as Regulated Risk Management Tools
Futures markets have operated successfully in the United States
since the middle of the 19th century. They provide a facility for the
trading of standardized contracts to buy and sell a specified
underlying asset at a fixed price at a future date. Commonly traded
assets are stocks, bonds, currencies, metals, energy, and commodities.
The market is used extensively by various parties to transfer risk and
adjust their wealth exposures to levels that are suitable for their
risk tolerances. Futures markets provide an absolute credit guarantee
that is enabled by the existence of a clearinghouse that stands between
each party to a futures contract and guarantees payment to the party
that profits that it will pay if the party that loses defaults.
Clearinghouses have existed since around the 1920s, and no party has
ever suffered a credit loss from failure of a clearinghouse. In my
opinion futures markets have performed exceptionally well during
periods of market stress. In particular, during the crash of October
19, 1987, on which U.S. stocks lost nearly a fourth of their value a
single day, U.S. futures markets led the rally that stopped the
carnage.
Futures markets exist alongside other markets for similar
instruments, some of which trade in standardized regulated markets and
some of which trade exclusively in the largely unregulated over-the-
counter market. Options, for example, which can often be used with or
in place of futures, exist in both exchange-traded markets and over-
the-counter markets. Swaps and forwards, which are even more closely
related to futures, trade only in over-the-counter markets. These
instruments are part of the larger family of instruments called
derivatives. As noted, they are often substitutable and their existence
and use is nearly always for similar purposes.
Futures markets are regulated by the United States Commodity
Futures Trading Commission (CFTC). In its history, the Commission has
approved over 700 futures contracts. The CFTC has tended to take the
view that futures contracts should be allowed to be offered and succeed
or fail on their merits. Futures exchanges are highly competitive and
aggressively compete by offering similar products. A sign of a healthy
market is a low success rate and indeed U.S. futures markets are
healthy. My research has shown that only about one in four new
contracts is successful.
A Market for Futures Contracts on Movie Revenues
Cantor Fitzgerald has proposed a new type of futures contract, one
in which traders would enter into agreements to pay a fixed sum of
money for the right to receive a variable sum of money that would be
determined by the financial performance of a movie. These ``movie
futures'' are, in my view, long overdue and should be permitted. There
is a long history of discussion about this type of instrument and
indeed, the film industry itself has a track record of attempting to
create similar instruments. Regardless of what views have been conveyed
by the entertainment industry on the matter of this new proposed
exchange, it is apparent that this industry is interested in means of
shedding some of its risk.
Based on my research, I believe the first such effort was the
issuance of a $400 million, 7 year bond by the Walt Disney Company in
1992. This bond specified that the interest would be determined by the
revenues from a package of 13 movies to be released in Europe. Hence,
Disney was laying off some of the risk of the performance of these
movies to the investors who bought the bond. In 1997, Pullman LLC
offered what came to be known as the famous ``Bowie Bonds,'' a $55
million issue purchased by Prudential in which the interest payments
were determined by David Bowie album sales. Similar bonds have since
been offered based on royalties generated by James Brown, the Isley
Brothers, the songwriting teams of Ashford and Simpson as well as
Holland, Dozier, and Holland, and by revenues from movies of Dreamworks
SKG. Many of these instruments are created through a process known as
securitization, whereby investors can obtain equity returns as well as
interest payments. Thus, the entertainment industry has clearly
indicated a desire to eliminate some of its risk.
There appears to be considerable demand on the part of investors
for opportunities to trade derivative instruments based on film
revenues. This interest is fueled by two factors. One is that
professional investors are constantly looking for new opportunities in
asset classes that have little to no correlation to the more
conventional asset classes, such as stocks, bonds, and real estate.
This lack of correlation improves the efficiency of investment
portfolios, leading to higher expected returns for a given level of
risk. Movie revenues are indeed the very type of asset class that
appeals to such investors. As my research shows, movie revenues have
virtually no correlation with the stock market.
The second factor is the sheer interest in movies. One of the
important characteristics for the success of a futures contract is that
there must be a significant interest in the asset or value on which the
contract is based. Movies are not only appealing for their
entertainment value, but the financial performance of a movie is a
much-watched statistic to many Americans. Each week, a news story
discusses how new releases did over the weekend. There are several
successful websites that track the performance of movies and the
revenue generated by stars. While the performance of a movie is
probably not as widely followed as sports scores and the stock market,
it does, nonetheless, garner considerable attention, which passes the
litmus test of a successful futures market--there must interest.
Discussions of the creation of exchanges for standardized trading
of financial instruments based on entertainment revenues have a long
history but little success to date. There has been far more talk than
action, and none appear to have been structured within the regulated
environment of futures markets. The Cantor proposal, set up within the
U.S. regulatory structure, is the first one I believe that has a
reasonable chance of success. And if it is not successful, movie
revenue futures will go the way of the 75% of other futures contracts
that were launched and failed. That is the American way.
I understand that the film industry objects to the Cantor proposal.
I believe it has expressed the view that it is not likely to use these
contracts to hedge. I respectfully disagree, based on my observations
that the entertainment industry has for many years sought means of
laying off this kind of risk. It may well take some time, but I believe
the industry will warm up to this product. In particular, the
independent film makers who do not have access to the tremendous
resources of the major studios could make substantial use of this
contract. Providing these small companies with such opportunities would
help them be more competitive with the larger studios. This could also
have the effect of stimulating more independent film production, which
can only be good for the American public. If the industry ultimately
does fail to use it, however, it is unlikely that this new exchange
will be successful. The losers will be only Cantor Fitzgerald. In my
view, Cantor should be allowed to try and if it cannot make a success,
it should fail. That is how we do it in this country and indeed that is
what makes America great.
The industry has also opined that no one is likely to buy these
contracts, inasmuch as it sees no party that would be harmed by
outstanding performance of a movie. It seems to me, however, that
parties that negotiate DVD and television rights, the rights to
manufacture and market other products with tie-ins to movies and
characters, and international distribution rights would be buyers.
Better performing movies are far more expensive to these parties, and
they could greatly benefit from the use of these futures to keep their
costs more predictable, which is the main benefit of hedging.
The industry has also argued that the data on which payoffs are
made is subject to manipulation. I find this a rather strange response
for two reasons. It is as if a company objects to the trading of
derivatives on its stock because the company could manipulate the
financial information it releases. Moreover, if the industry would
manipulate its own data, it sounds like an admission that the industry
would use the contract. But in any case, financial regulations permit
trading of derivatives on the company's stock, whether the company
objects or not. If the data are subject to manipulation, it is almost
surely no more than the manipulation that is possible by corporations
operating within Generally Accepted Accounting Principles. This leads
to my last reason for wanting to see this contract.
I suspect the industry does not want financial analysts and
professional investors studying the finances and accounting for movies.
I believe, however, that the financial industry can serve a valuable
public purpose in bringing more transparency to the film industry.
Perhaps the data are already being manipulated. Manipulation will be
harder if financial analysts and professional investors are watching
over the industry, as they will if these futures contracts are allowed
to trade. Thus, this new market can help improve the quality of the
information that originates from this industry.
Conclusions
I urge the United States Congress to grant the petition of Cantor
Fitzgerald to create this new futures market. Your concern should be
what is good for the public and in that regard, I see no real risk to
the public. Cantor Fitzgerald is not large enough to present a systemic
threat, and this project is not large enough that its failure would
destroy the firm. Therefore, if this exchange fails, the only losers
are the owners of Cantor Fitzgerald.
There is yet another reason why this Congress should approve this
proposal. I suspect that if we do not allow this kind of market in the
regulated U.S. futures environment, it will create itself either within
the unregulated over-the-counter market, as it has done on a small
scale already, or it will be created and succeed overseas. With almost
all of the successful movies being produced in this country, it would
be quite a shame if movie futures markets exist only in foreign
countries.
Attachment
michael s. pagano, ph.d., c.f.a., professor of finance, villanova
school of business, villanova university
The Potential Effects on the Movie Industry of Futures Trading on Film
Revenues \1\
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\1\ To better inform those parties interested in understanding the
role of futures trading on first-run movies, Cantor Exchange, Inc.
commissioned the author to write this report describing the new
potential market for enabling investors to manage risk and trade these
new contracts. This article presents my analyses and opinions only and
does not necessarily represent the opinions of the sponsor of this
project. The author retained full editorial control over the content
and conclusions of this report.
---------------------------------------------------------------------------
I. Executive Summary
This report addresses the key questions that have recently been
raised about the introduction of a contract such as the proposed
Domestic Box Office Receipt (DBOR) futures instrument and the
associated Cantor Exchange. The report has three key components that
address this important issue from several perspectives.
First, using classic financial principles that describe what
effective futures contracts and financial markets should contain, I
find that the DBOR contract and Cantor Exchange meet these criteria and
thus this contract market represents a legitimate and effective vehicle
to conduct futures trading in the area of first-run movies. In
addition, the role of speculators within a futures market is clarified
using the U.S. Commodity Futures Trading Commission's (CFTC) own
description of these market participants. Contrary to some of the
recent media coverage, speculators are not ``gamblers'' or ``evil'' and
thus these investors provide a useful economic role in ensuring
liquidity and greater price transparency within a futures market.
Second, this report also demonstrates how the introduction of a
DBOR market can benefit not only the direct participants in such a
futures market but also help other players in the movie industry such
as consumers and the movie studios. The main benefits of introducing a
DBOR futures market are:
(1) Better risk management for investors and other participants in
the movie business,
(2) Increased new investment in the movie industry from current
film investors,
(3) Additional investment from new investors that are now attracted
to the film industry, and
(4) Greater transparency which yields useful price signals for the
entire economy.
The report also examines two potential costs of such a market
related to the possibility of market manipulation and/or insider
trading. However, the financial incentives of the Cantor Exchange and
the clear mandate of the CFTC to ensure that futures markets are fair
to all participants indicate that both of these organizations have the
proper motivation to actively employ the necessary surveillance and
enforcement systems in order to mitigate the possibility of market
manipulation and/or insider trading.
Lastly, this report also reviews the academic literature on this
subject and I find that there is both sound financial theory and solid
empirical evidence that support the notion that the benefits of
introducing a futures market can greatly outweigh the potential costs
noted above. Empirical evidence over the past two decades not only in
the U.S. but also more recent evidence from numerous countries around
the world confirm the positive effects of introducing a futures market
in terms of increasing price transparency, providing better risk
management, reducing price volatility, and increasing the liquidity of
financial markets.
II. Introduction/Background
This report examines the potential benefits and costs associated
with introducing a set of futures contracts based on the revenues of a
first-run movie's initial 4 week box office revenues. To begin, it is
helpful to review the classic principles that underlie all effective
financial markets and futures contracts. In addition, this section
explains the fundamental role that traders who are not hedging an
underlying exposure (typically referred to as speculators) can play
within a properly functioning financial market.
Key attributes of a financial market:
There is a well-established set of academic literature on the role
of financial markets within an economy. In particular, seminal work by
Hayek (1945), Debreu (1959), and Arrow (1964) show that an effective
financial market can serve two economically important functions: (1)
the market can help investors allocate and share risk via trading and
hedging activities, and (2) the market can communicate, via public
disclosure of price and volume data, important information about the
value of financial securities to all members of society (not just the
counterparties to the transaction). This latter function is extremely
useful because all participants in the economy (not just the specific
financial market) can use these price and volume data as signals of the
relative supply and demand for the relevant securities which, in turn,
allows all members of society to make more informed economic decisions.
Given the proposed market structure of the Cantor Exchange, it
meets the above criteria of an effective financial market because it
will: (1) allow investors to hedge their exposure to the financial
performance of specific movies, and (2) provide 24/7 trading
opportunities and real-time reporting of transactions via a web-based
data dissemination service. Thus, investors in this exchange will be
able to trade, hedge, and observe the price and volume activity in a
transparent manner.
Key attributes of a futures contract:
For a futures contract to be a viable, effective tool for risk
management and trading, it should have the following qualities:
An objectively verifiable ``commodity'' that is to be traded
(i.e., the contract's value can be independently and
objectively determined by market participants).
Standardized terms (documentation that states exactly what
is the amount of the contract, expiration months, last trading
day, settlement procedures, etc.).
Clearing mechanism (a clearinghouse reduces counterparty
credit risk and improves price transparency so that all market
participants can observe the prices and quantities of the
contract that have been traded on a daily basis).
Margin system (this enables all futures positions to be
marked to market on a daily basis and thus reduces the overall
counterparty credit risk within the clearinghouse and between
the rest of the market participants).
Low transaction costs (this encourages greater trading
activity and thus higher levels of liquidity that benefit all
market participants).
Open, easy access to the futures market (by permitting
direct access to the market for all investors, the market's
liquidity can be maximized).
The DBOR futures contract, as proposed by the Cantor Exchange,
Inc., meets all of the above criteria for a futures contract.
The role of speculators in a futures market:
Although the popular press and other parties might portray
speculators in the futures markets as ``gamblers'' or ``evil,'' the
economic and financial reality is that speculators play an important
role within a futures market (see Appendix 1 for some brief excerpts
from recent media coverage of this issue). In particular, speculators
provide much-needed liquidity to the market by, for example, taking the
other side of a transaction in which a person wants to hedge. For
example, a consumer of corn such as a cereal producer might want to
hedge against increases in the price of corn and thus might want to buy
corn in the futures market. If there is no one who owns corn (such as a
farmer) who is willing to sell corn in the futures market, then the
speculator can step in and play an key role by selling the corn on
speculation that the price will fall. The speculator's trade enables
the cereal producer to hedge its position and thus help this firm
manage its risks more efficiently.
In fact, the CFTC itself recognizes this important role that
speculators play, as shown by the following excerpt from their web site
(www.cftc.gov):
The Role of the Speculator
A speculator is one who does not produce or use a commodity,
but risks his or her own capital trading futures in that
commodity in hopes of making a profit on price changes. While
speculation is not considered one of the economic purposes of
futures markets, speculators do help make futures markets
function better by providing liquidity, or the ability to buy
and sell futures contracts quickly without materially affecting
the price. Long and short hedgers may not be sufficient to
create a liquid futures market by themselves. The participation
of speculators willing to take the other side of hedgers'
trades adds liquidity and makes it easier for hedgers to hedge.
In sum, using the fundamental criteria noted above that define what
effective futures contracts and financial markets should possess, I
find that the DBOR contract and Cantor Exchange meet all of these
criteria and, accordingly, create a valid means of providing both
hedgers and speculators with an effective way to conduct futures
trading in the area of first-run movies. The above discussion also
dispels the belief that speculators are inherently bad for a financial
market and the economy in general.
III. The Main Benefits and Costs of Film-Related Futures Contracts
Film-related futures contracts have four main benefits and two
potential important costs, as noted below.
Benefit 1. Better Risk Management for Investors and other
Participants in the Movie Industry
When discussing the role of a futures contract such as the Domestic
Box Office Receipt (DBOR) contract, it is most important to keep in
mind the hedging, or risk management, feature of these contracts. The
use of DBOR futures allows existing parties with material investments
in the success of a movie to hedge their risks (e.g., not only the
financial investors in the film but all of the movie theater operators
around the world can be at risk of having a large number of empty seats
in their theaters if a film is unsuccessful). Thus, there is a genuine
need for these investors to hedge some of the risk associated with
their investments in time, money, and other resources associated with a
specific movie.
Retail consumers of movies could also benefit by participating in
the market for DBOR contracts. For example, if their trades in this
market are profitable, then this can offset the cost of purchasing
movie tickets, DVDs, and other movie-related goods and services. This
type of interest on the part of retail consumers could also spur
greater consumption of movies, DVDs, etc., as these individuals might
be more interested in going to additional upcoming movies that they
would not have otherwise been aware of.
Benefit 2. Stimulates New Investment from Current Investors in the
Movie Industry
By enabling both large film investors/financiers and theater
operators to hedge in the DBOR market, another benefit is created,
namely, this hedging capability can stimulate additional investment
from these existing participants in the movie business. Thus, by using
DBOR futures to hedge, say, half of a film investor's investment in one
movie, this investor could then invest in a second, additional movie
and hedge half of his/her investment in this second film. In this way,
the investor can invest in two movies for the same amount of net risk
exposure as he/she would have normally done for one movie when there
was no DBOR market. Consequently, more investment capital can be
provided by current film investors/financiers to the movie studios that
produce these films. So, both investors and the movie studios can
benefit through the increased amount of capital available for
investment in the movie industry. Consumers who purchase movies can
also benefit from this additional investment if the movie studios
produce films of greater quality, quantity, and variety.
Benefit 3. Attracts Additional Investment from New Investors to the
Movie Industry
Another side benefit of an active DBOR futures market is that a
``positive externality'' can exist between this futures market and
potential new film investors and theater operators.\2\ For example, the
hedging and trading activities of existing investors and theater
operators can have a positive effect on individuals and firms that are
not currently involved in the film business. The economics of positive
externalities, sometimes referred to as ``network effects,'' indicates
that the creation of an active DBOR market can encourage new investors
and other firms to become interested in investing in the movie business
(either by investing directly in first-run movies, building new
theaters/DVD stores, or trading in the DBOR market).
---------------------------------------------------------------------------
\2\ A ``positive externality'' is a benefit that some individuals
or firms receive without paying the full cost for this benefit due to
the economic activities of other unrelated parties. For example, if two
people own cell phones, then a third person can benefit by calling
these individuals even though he/she might not own a cell phone. In
turn, the benefit to this third person for purchasing a cell phone
might be greater than the phone's cost because he/she can now call
several other people in a more convenient way.
---------------------------------------------------------------------------
In the past, these investors and firms might have been interested
in the movie business but deemed it too risky to invest in. However,
these potential participants may now invest in the movie industry
because the DBOR contract provides these players with a cost-effective
way to mitigate some of their movie-specific risk. This will have the
positive effect of stimulating greater investment in not only first-run
movies but also the entire movie business infrastructure (theaters,
stores, rental kiosks, etc.). In turn, this can help stimulate
employment in various areas such as the film studios, theater
operators, DVD rental stores, and even the construction industry to
some extent.
Benefit 4. Greater Transparency yields Useful Price Signals for the
Entire Economy
By developing an active DBOR market, not only do the market
participants benefit from the greater ``price discovery'' created by
trading this futures contract but also non-participants can benefit
because they can use the transaction price and trading volume data as
useful ``price signals'' about the anticipated supply, demand, and
growth prospects for various films.\3\ This information, for example,
can be useful to a movie studio which does not even participate in the
DBOR market because the price and volume data from this market can help
the studio decide to invest more in, say, 3D movies because the DBOR
futures market might be showing strong price gains for contracts
related to current 3D films. By monitoring prices and volume in the
movie futures market, the relatively scarce economic resources of any
one film studio can then be allocated in a more efficient manner. This,
in turn, benefits the entire economy because better price and volume
signals from the futures market can lead to more effective investment
decisions by studios, theater operators, retail DVD stores, and
consumers. Given the relatively flat/stagnant trend in movie box office
receipts and ticket sales over the past decade, the ability to make
better investment decisions should help stimulate growth and innovation
in the U.S. movie industry (see the table in Appendix 2 for more
details).
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\3\ By ``price discovery,'' I mean the process by which traders
submit orders to buy and sell in order to identify the ``true''
equilibrium price for the security (i.e., where supply equals demand
for a film's expected revenues). Interestingly, it could be that the
film studios are concerned that they will lose their monopoly position
on this price discovery process because information about various
movies will be published by the futures exchange which all market
participants can then observe and analyze. This is the type of
information that is currently held privately by the film studios and
thus some of these firms might be concerned with losing their
informational edge to non-Hollywood participants in the futures market.
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Potential Cost 1. The Possibility of Market Manipulation
The biggest ``cost'' (as opposed to benefit) of the proposed DBOR
futures contract is the possibility that the market could be
manipulated by one or more traders for their personal gain by
artificially pushing prices up or down and then profiting from a sudden
reversal in prices. In any market (not just futures contracts) where
there is low liquidity, this risk is present. The key to minimizing
this risk and lowering the potential ``cost'' associated with DBOR
futures trading is through diligent monitoring and active enforcement
of the rules established by the CFTC and the Cantor Exchange itself.
Otherwise, investors will not want to trade on an exchange where it is
perceived that prices are easily manipulated and thus the market is
``rigged'' against these investors.
Since the Cantor Exchange has a strong and direct incentive to
maximize the DBOR market's trading volume and the CFTC's role is to
ensure that all futures markets are fair to all investors, both of
these parties are motivated to ensure that the participants in the DBOR
market are acting in a responsible and fair manner. Thus, the Cantor
Exchange has set up monitoring/surveillance systems which can thwart
the efforts of potential price manipulators and ban them from the
trading system. In addition, the CFTC has its own sophisticated
surveillance and enforcement systems and staff which will be monitoring
the trading activity in the DBOR market and can impose severe penalties
for those parties that attempt to distort market prices.
Potential Cost 2. The Possibility of Insider Trading
Another potential cost associated with not only the proposed DBOR
futures market but any financial market is the problem related to
insiders trading on material, non-public information. For example, some
have voiced concern that employees of film studios, studio sub-
contractors, or other individuals would exploit their inside
information about the prospects for a film via the DBOR futures market.
However, this problem is no different than the problem faced by the
employees of a large consumer of corn (e.g., a cereal maker) or the
corn farmer himself, for that matter, who potentially has inside
information on the supply and demand for corn which could be exploited
in the corn futures market. Thus, the CFTC has decades of experience
dealing with this issue and has demonstrated that it can effectively
monitor this issue to ensure a fair and level ``playing field'' for all
futures market participants. In addition, the Cantor Exchange itself
has strong financial incentives to ensure the DBOR market is one of
high integrity.
In sum, the four primary benefits noted above are quite powerful
while the two potential costs can be properly mitigated by effective
surveillance and enforcement systems operated by both the Cantor
Exchange and the CFTC. Overall, the main benefits described above
appear to clearly outweigh the potential costs associated with
introducing the DBOR futures contract. Next, I turn to the academic
literature to see what effect prior introductions of derivatives
markets have had on existing financial markets. This review of both
finance theory and empirical evidence can help inform us about how the
introduction of the DBOR market might affect the movie industry in the
future.
IV. Review of the Relevant Literature on the Impact of Introducing a
Derivatives Contract into an Existing Financial Market
Theoretical Models of Derivatives Introduction
Given the above discussion of the key features of well-designed
financial markets and futures contracts, as well as an assessment of
the key benefits and costs of introducing the DBOR contract, it is
instructive to review the relevant theoretical and empirical academic
literature. In this way, one can see how prior introductions of
derivatives contracts have affected the efficiency of an underlying
``cash'' market (also referred to as a ``spot'' market). By doing so,
one can gain greater confidence regarding how the introduction of the
DBOR contract could affect the existing market for first-run movies.
Although, strictly speaking, there is no cash, or spot, market for
the secondary trading of movie tickets, there is clearly a large market
for the primary sale of movie tickets by theater operators.\4\ That is,
there is no active market for consumers to trade movie tickets amongst
themselves in a secondary market but, as the table in the Appendix 2
shows, there is a $10 billion annual market for the primary sale of
movie tickets by theater operators. Thus, one can view this market as a
primary ``spot'' market for movie tickets.
---------------------------------------------------------------------------
\4\ A primary market is one where a security is sold for the first
time such as the initial public offering (IPO) of common equity in a
new company. A secondary market is one which trades securities that
have been previously issued. In addition, a ``cash'' or ``spot'' market
is one in which an investor can purchase or sell a security today (as
opposed to sometime in the future, as in a futures market).
---------------------------------------------------------------------------
Initial theoretical work on the impact of derivatives contracts on
underlying cash/spot financial markets builds upon the seminal work by
Kyle (1985). In Kyle's model, asymmetric information is present in the
financial market, which meant that some traders have better information
(i.e., they are ``informed'' traders) while others have less
information (they are described as being either ``uninformed'' traders
or serving as a single ``market maker'' in the financial asset).
The above issue of asymmetric information is an important attribute
of a real-world financial market because it is clear that some traders
are more sophisticated and better-informed about the future value of a
security (e.g., mutual fund or hedge fund managers) than other traders
(e.g., small retail investors and market makers). Since informed
traders, by definition, know more than the uninformed traders, the
less-informed traders will typically lose, on average, when they trade
with their better-informed counterparts. Since an uninformed trader
such as a market maker knows this, this person will try to infer the
presence of informed traders by carefully observing the flow of orders
submitted to the financial market.
Based on the Kyle model, the bottom line is that asymmetric
information can lead traders to behave strategically and can ultimately
affect the pricing of financial assets, as well as the trading volume
and price volatility associated with these assets. In general,
investors will typically pay less for an asset if it is traded in a
market with high levels of asymmetric information and uninformed
investors are also less likely to participate or trade in such a
market. The practical implication of the model is that well-designed
financial markets such as the Cantor Exchange's proposed DBOR market
can reduce the problems associated with asymmetric information by
promoting greater price transparency and increasing the public
disclosure of information related to the financial asset. In turn, this
can lead to greater liquidity, lower price volatility, and greater
trading volume in both the futures and cash markets.
Building upon Kyle (1985), research articles such as Grossman
(1988), Detemple and Selden (1991), Subrahmanyam (1991), Jarrow (1994),
Huang and Wang (1997), and Cao (1999), among others, examined how
asymmetric information and traders' strategies are affected when a
derivatives market is introduced for a corresponding spot market. In
addition, without relying on an asymmetric information model, Silber
(1985) shows that a futures market can potentially enhance the
efficiency of a spot market by enabling market makers in the cash asset
to hedge more effectively.
By focusing on the hedging capabilities of a derivatives market,
Grossman (1988) demonstrated that the introduction of a derivatives
contract can help people aggregate all information related to
investors' hedging strategies which can then reduce the level of
asymmetric information in the overall market. In turn, this reduction
in asymmetric information can reduce the price volatility of both the
derivative contract and underlying cash asset.
Detemple and Selden (1991) examine how the introduction of a call
option market can increase the underlying price of the cash asset due
to the simultaneous pricing of both the call option and this cash
security. Cao (1999) examines the incentives to collect information on
the underlying cash asset and finds that investors have greater
motivation to gather this information and thus cash prices are higher
and volatility is lower when a derivatives market exists. In general,
all of these models suggest that the introduction of a derivatives
market can be positive in terms of raising the value of the cash
security and reducing price volatility. In addition, a side benefit of
these two positive effects is that it encourages more investors to
participate in these markets, thus making them more liquid and
efficient. Thus, a ``virtuous'' cycle between the derivatives and cash
markets can be created due to the above effects.
In contrast to the above models, Subrahmanyam (1991), Jarrow
(1994), and Huang and Wang (1997) cast a more ambiguous light on the
effects of a derivatives market. For example, Subrahmanyam (1991)
compares the introduction of a stock index futures market to the cash
market for the securities that comprise this stock index. The author's
focus is on where discretionary traders choose to trade. In the model,
there are some traders who have discretion over where and when to trade
and thus these individuals face a choice of whether to trade in the
cash or derivatives markets.
The model suggests there is a trade-off between trading in the
index futures market where there is potentially less asymmetric
information (because a stock index will diversify away some of this
information-related risk) and the cash market where there might be
greater liquidity (because larger, informed traders might prefer to
trade in this market). Thus, the model shows that the effect on the
underlying cash asset's price is ambiguous and is dependent on the
discretionary traders' choices based on the above trade-off. For
example, if the discretionary traders all send their orders to the
derivatives market, the liquidity in the cash market might dry up and
cause the cash price to fall and become more volatile. Conversely, if
these traders choose to route their orders to the cash market, then
cash prices will be higher and volatility lower. In this context, it is
ultimately an empirical question as to which effect dominates.
Huang and Wang (1997), using a different theoretical framework,
come up with a similar conclusion in that the incentives to collect
information are greater when a derivatives market is present but this
positive effect is counter-balanced by the fact that increased levels
of trading activity can result in noisier price signals in the cash
market. Thus, once again, the question of which effect is predominant
becomes an empirical one.
Jarrow (1994) approaches the problem from a different perspective
by examining an investor's incentives to manipulate prices when an
options market is introduced for an underlying cash asset. The model
demonstrates that investors might try to manipulate prices to take
advantage of arbitrage opportunities between the cash and options
markets. However, Jarrow (1994) also proves how this type of
manipulation can be easily avoided by applying a properly specified
variant of the conventional binomial option pricing model. Thus, by
using the appropriate option pricing model, the author shows that the
incentives to manipulate prices can be effectively eliminated.
Summing up the theoretical literature, one can see that all of the
models explain how the introduction of a derivatives market such as the
DBOR futures contract can improve the welfare for society by providing
more accurate price signals about the supply and demand for the
underlying cash asset, as well as by reducing price volatility and
increasing market liquidity. However, as noted above, some theoretical
models indicate that there may be a trade-off between these benefits
and other factors such as the decisions of discretionary traders and
the level of trading activity in the underlying cash market.
Accordingly, I now turn to a review of the relevant empirical
literature to see which effects are dominant in real-world financial
markets.
Empirical Tests related to Derivatives Introductions
Early empirical research related to the effects of derivatives
contracts on cash financial markets typically focused on how the
introduction of a futures contract on a stock index such as the S&P 500
affected the price volatility of the underlying cash market for the 500
stocks that were actively traded in secondary markets such as the New
York Stock Exchange (NYSE) and NASDAQ. In general, this initial
research showed that futures markets can increase trading activity but
the effect on price volatility is somewhat muted except on the
expiration day of the futures contract (and even then, the increase in
volatility is short-lived, e.g., within one trading day). For example,
Stoll and Whaley (1987, 1988), Edwards (1988), and Harris (1989) all
study the S&P 500 futures contract and its impact on the cash market
for the stocks that comprise this index.
Edwards (1988) finds that stock price volatility has been lower
since the introduction of stock index futures contracts while Harris
(1989) observed no economically significant change in volatility. In
contrast, Stoll and Whaley (1987) document that trading volume and
price volatility can increase at the time of the futures contract's
expiration but this effect is temporary and is actually less than the
impact of a typical ``block trade'' in the underlying cash market.\5\
In a follow-up article, Stoll and Whaley (1988) summarize the important
role that a financial market (in this context, a market for stock index
futures) can play in terms of communicating relevant information to all
members of society: ``Financial markets serve as the economy's
messenger. . . . Index futures expand the number of routes through
which messages can travel.''
---------------------------------------------------------------------------
\5\ A ``block trade'' is typically defined as a trade of 10,000
shares or more in a single stock.
---------------------------------------------------------------------------
Overall, the early empirical evidence based on U.S. markets
supports the notion that price volatility and trading volume in the
underlying cash market can be affected but not in an economically
significant way during normal market conditions. Thus, this initial
strand of the literature suggested that, on average, the effect of
introducing a futures market on stock prices was neutral in that it
created neither unusually greater nor lower volatility.
After the first wave of empirical studies during the mid to late
1980s, more sophisticated empirical tests were performed during the
1990s and the most recent decade. For example, Detemple and Jorion
(1990) find significant positive support for Grossman's (1988)
prediction that the introduction of options can increase underlying
stock prices and reduce volatility. In contrast, tests of
Subrahmanyam's model in Jegadeesh and Subrahmanyam (1993) show an
economically insignificant increase in the average proportional bid-ask
spread for a set of stocks that included the securities that comprise
the S&P 500. The authors also report an insignificant increase in level
of asymmetric information within the cash market. In general, these
relatively insignificant results indicate that the S&P 500 futures
market does not harm the cash market for S&P stocks and thus provides
neutral, or mixed, evidence in support of the positive effects espoused
by many of the theoretical models noted above.
Easley, O'Hara, and Srinivas (1998) examine the market of stock
options in the U.S. to determine the informativeness of this
derivatives market vis-a-vis the underlying cash market for these
stocks. Consistent with the theories that show a positive role for
derivatives markets such as Grossman (1988), Detemple and Selden
(1991), and Cao (1999), Easley et al. (1998) report that option trading
volume can be a leading predictor of cash stock prices. The authors
conclude that this result could be due to the possibility that informed
traders prefer to trade in the options market and thus these option
traders' actions help reveal useful information that can enhance stock
prices in the cash market for all investors.
Most notably, Hasbrouck (2003) studied the market for the S&P 500
stock index by analyzing which of the following cash and derivatives
markets contributed the most information to setting prices for the cash
value of this index (i.e., floor-traded index futures contracts,
exchange-traded funds (ETFs), electronically traded, small-denomination
futures contracts (E-minis), and sector ETFs that sub-divide the index
into sub-industry portfolios). The author finds that the S&P 500 index
(as well as the Nasdaq-100 index) receives its most informative price
signals from the E-mini futures market.
The above empirical finding is another important example of the
positive benefits associated with the introduction of a futures market
that were predicted by the theoretical models of Grossman (1988),
Detemple and Selden (1991), and Cao (1999). It is also particularly
striking that the smaller E-mini futures market leads the way in terms
of setting prices in the market because these contracts were
specifically designed to attract smaller, retail investors who cannot
generally afford the larger, more expensive floor-traded futures
contract. Thus, the results are also consistent with Subrahmanyam's
model because the evidence suggests the positive effects of trading
with a futures contract outweigh the potentially greater liquidity in
the cash market (and so even retail investors prefer the futures market
over the cash market in this case). In turn, this suggests the positive
effects of introducing a futures market dominate the potential negative
factors of such a market.
The results of Hasbrouck (2003) have also spawned somewhat of a
global search to see if Hasbrouck's findings can be replicated in
other, non-U.S. markets where futures contracts have been introduced.
For example, Illueca and Lafuente (2008) applies Hasbrouck's approach
to a foreign market which introduced a retail-oriented stock futures
contract. Specifically, the authors examined the effect of introducing
the Ibex 35 mini-futures contract in the Spanish stock market. By
allowing retail investors to participate more actively in the futures
market for this Spanish stock index, Illueca and Lafuente find prices
in this new futures market are highly informative and underlying stock
price volatility does not increase.
Most importantly, the above results are not isolated to the U.S.
and Spain. For example, additional results reported in recent research
studies such as Bhaumik and Bose (2009), Drimbetas, Sariannidis, and
Porfiris (2007), and Ozun and Erbaykal (2009), among others, show that
derivatives trading can be beneficial to cash markets in many non-U.S.
markets such as India, Greece, and Turkey. Thus, these additional
results not only replicate Hasbrouck's earlier U.S. findings but also
provide empirical evidence on a global scale in support of the positive
theories of derivatives markets noted in the prior sub-section of this
report.
In sum, both finance theory and empirical tests of real-world
derivatives markets demonstrate that the benefits of introducing a
derivatives security such as the DBOR futures contract can have a
positive impact on an economy by fostering greater information
disclosure, lower volatility, and greater liquidity. All of these
factors, in turn, can benefit society in general by allowing people to
make more efficient financial and economic decisions.
V. Conclusion
This report has shown how the introduction of a contract such as
the proposed DBOR futures instrument and the associated Cantor Exchange
might affect the market for first-run movies. Using the classic,
fundamental criteria that describe what effective futures contracts and
financial markets should possess, I find that the DBOR contract and
Cantor Exchange meet these criteria and thus represent a valid vehicle
to conduct futures trading in the area of first-run movies. In
addition, the role of speculators within a futures market is clarified
using the CFTC's own description of these market participants. Contrary
to the belief of some, speculators are not ``gamblers'' and thus these
investors provide a useful economic role in ensuring liquidity and
greater price transparency in a futures market.
This report also demonstrated how the introduction of a DBOR
futures market can benefit not only the participants in such a market
but also help other players in the movie industry such as consumers and
the movie studios. The main benefits of introducing a DBOR futures
market are:
(1) Better risk management for investors and other participants in
the movie business,
(2) Increased new investment in the movie industry from current
film investors,
(3) Additional investment from new investors that are now attracted
to the film industry, and
(4) Greater transparency which yields useful price signals for the
entire economy.
Two potential costs of such a market related to the possibility of
market manipulation and/or insider trading are also examined. However,
the financial incentives of the Cantor Exchange and the clear mandate
of the CFTC to ensure that futures markets are fair to all participants
indicate that both of these organizations have the proper motivation to
actively employ the relevant surveillance and enforcement systems in
order to mitigate the possibility of market manipulation and/or insider
trading.
This report also reviewed the academic literature on this subject
and I find that there is both strong financial theory and robust
empirical evidence that support the notion that the benefits of
introducing a futures market can outweigh the potential costs noted
above. Empirical evidence over the past 2 decades not only in the U.S.
but also more recent evidence from several countries around the world
confirm the positive effects of introducing a futures market in terms
of increasing price transparency, providing better risk management,
reducing price volatility, and increasing the liquidity of financial
markets.
References:
Arrow, K. 1964. The role of securities in the optimal allocation of
risk-bearing. Review of Economic Studies 31, 91-96.
Bhaumik, S., and Bose, S. 2009. Impact of Derivatives Trading on
Emerging Stock Markets: Some Evidence from India. Comparative Economic
Studies 51(1), 118-137.
Cao, H.H. 1999. The effect of derivative assets on information
acquisition and price behavior in a rational expectations equilibrium.
The Review of Financial Studies 12, (1); 131-163.
Debreu, G. 1959. Theory of Value. New Haven, CT: Yale University
Press.
Detemple, J., and Jorion, P. 1990. Option listing and stock
returns: An empirical analysis. Journal of Banking & Finance 14(4),
781-801.
Detemple, J. and Selden, L. 1991. A General Equilibrium Analysis of
Option and Stock Market Interactions. International Economic Review
32(2), 279-303.
Drimbetas, E., Sariannidis, N., and N. Porfiris. 2007. The effect
of derivatives trading on volatility of the underlying asset: evidence
from the Greek stock market. Applied Financial Economics 17(2), 139-
157.
Easley, D., O'Hara, M., and Srinivas, P.S. 1998. Option volume and
stock prices: Evidence on where informed traders trade. The Journal of
Finance 53 (2), 431-465.
Edwards, F.R. 1988. Does futures trading increase stock market
volatility? Financial Analysts Journal 44 (January-February), 63-69.
Grossman, S.J. 1988. An analysis of the implications for stock and
futures: price volatility of program trading and dynamic hedging
strategies. Journal of Business 61, 275-298.
Harris, L. 1989. S&P 500 cash stock price volatilities. Journal of
Finance 44, 1155-75.
Hasbrouck, J. 2003. Intraday price formation in U.S. equity index
markets. The Journal of Finance 58(6), 2375-2399.
Hayek, F.A. (1945) The use of knowledge in society. American
Economic Review 35, 519-530.
Huang, J. and Wang, J., 1997, Market structure, security prices,
and informational efficiency, Macroeconomic Dynamics 1, 169-205.
Illueca, M., and Lafuente, J.A. 2008. Introducing the mini-futures
contract on Ibex 35: implications for price discovery and volatility
transmission. Spanish Economic Review 10(3), 197-219.
Jarrow, R.A. 1994. Derivative securities markets, market
manipulation, and option pricing theory. Journal of Financial and
Quantitative Analysis, 29(2), 241-261.
Jegadeesh, N., and Subrahmanyam, A. 1991. Liquidity effects of the
introduction of the S&P 500 index futures contract on the underlying
stocks. Journal of Business 66, 171-182.
Kyle, A.J. 1985. Continuous auctions and insider trading.
Econometrica 53: 1315-1335.
Ozun, A. and Erbaykal, E. 2009. Detecting risk transmission from
futures to spot markets without data stationarity: Evidence from
Turkey's markets. The Journal of Risk Finance 10(4), 365-376.
Silber, W.L. 1985. The economic role of financial futures. In A.E.
Peck (ed.), Futures Markets: Their Economic Role, 83-114. Washington,
D.C.: American Enterprise for Public Policy Research.
Stoll, H.R., and Whaley, R.E. 1987. Expiration day effects of index
options and futures. Financial Analysts Journal 43 (March): 16-28.
Stoll, H.R., and Whaley, R.E. 1988. Volatility and futures: Message
versus messenger. Journal of Portfolio Management 14(2), 20-22.
Subrahmanyam, A. 1991. A theory of trading in stock index futures.
Review of Financial Studies 4(1), 17-51.
appendix 1. excerpts from selected business media articles
Excerpt from Christian Science Monitor article on 3/29/10 (Gloria
Goodale and Dan B. Wood, ``Trading `movie futures' like pork
bellies? MPAA fights the idea.'')
Speculation isn't inherently bad
While the industry registers its protests, media and financial
observers suggest that the issue is more complicated.
``The MPAA's concerns are a bit overblown--these claims against
`evil' speculators [are] age-old and ring a bit hollow because [they]
ignore potentially very useful price signals,'' says Michael S. Pagano,
professor of finance at the Villanova University School of Business in
Pennsylvania.
``Speculators are not, by definition, bad for society,'' he says.
``In fact, they can be quite good by providing liquidity and price
signals that would not exist if these players were not present in the
market.''
Excerpt from Christian Science Monitor article on 4/9/10 (Dan B. Wood,
``Big screen battle: Hollywood vs. box office speculators'')
Legalized gambling?
The Chicago-based firm, Veriana, carries on its website this
rebuttal, written by the Futures Industry Association (FIA):
``The MPAA has asserted that futures trading is a form of
`legalized gambling' that has no commercial interest or value
to the public. Nothing could be further than the truth. Futures
markets have proven to be vitally important mechanisms for risk
management, as evidenced by the phenomenal growth in the use of
futures contracts by a wide range of commercial and industrial
enterprises, both here and abroad.''
FIA also counters MPAA claims that these new contracts could lead
to ``rampant speculation and financial irresponsibility. . . . It is
clear that the MPAA is not familiar with the futures markets or the
regulatory framework within which they operate.''
Industry observers similarly line up on both sides of the issue.
``I agree wholeheartedly with the MPAA and the movie industry who hold
that this is pretty much a thin veil for basic gambling,'' says Chris
Lanier, president of Motion Picture Intelligencer, a box office
prediction firm. ``If you want to lose all your money that badly, why
not just go to Las Vegas?'' And Douglas Gomery, a retired professor of
the economics of cinema at Maryland University, has called the idea
``gambling, pure and simple.''
But Michael S. Pagano, professor of finance at the Villanova
University School of Business, says there can be some legitimate
reasons to have such an exchange.
New investors, more capital
``In particular, the trading of these contracts gives useful
information to all market participants about the demand, profitability,
and growth potential of various types of movies, including the film
studios,'' Pagano says. ``The exchanges can aid in the movie industry
because film investors will now have a way to hedge their investments
which, in the end, can attract new investors and generate more capital
from existing investors.''
He surmises other reasons for the vehement industry resistance.
``It could be that the film studios are concerned that they will
lose their monopoly position on information about various movies
because the futures exchange will publish information which all market
participants can then observe and analyze,'' says Pagano. ``This is the
type of information that is currently held privately by the film
studios and thus they could be fearful of losing their informational
edge to non-Hollywood players.''
As debate continues to heat up prior to the CFTC's decision, Pagano
says one concern of the film studios that is correct pertains to market
manipulation.
``It is crucial that the exchange operator . . . create a set of
trading rules and monitoring systems to ensure the market is a level
playing field for all participants,'' he says. ``Because if it is
perceived to be a rigged market, then retail investors and possibly
other market participants can be taken advantage of and this could also
be disruptive to the film studios' operations.''
appendix 2. historical data on movie ticket sales and revenue (1995-
2010)
Annual Ticket Sales
Note 2: in order to provide a fair comparison between movies
released in different years, all rankings are based on ticket
sales, which are calculated using average ticket prices
announced by the MPAA in their annual state of the industry
report.
Data source is the movie industry data website: www.the-
numbers.com/market
______
Submitted Letter by Charles R. Plott, Professor of Economics and The
Edward S. Harkness Professor of Economics and Political Science,
Division of the Humanities and Social Sciences, California Institute of
Technology
April 29, 2010
Hon. Collin C. Peterson,
Chairman;
Hon. Frank D. Lucas,
Ranking Minority Member,
Committee on Agriculture,
House of Representatives,
Washington, D.C.
Re: April 22, 2010 Committee Hearing on Application of Cantor Futures
Exchange, L.P.
Dear Chairman Peterson and Ranking Member Lucas:
I am a Professor of Economics at the California Institute of
Technology. I have published extensively (over one hundred and fifty
scientific papers) in the areas of market organization, risk, finance
and information. I am a member of the National Academy of Science,
American Academy of Science, and I am the recipient of numerous awards.
The Commodity Exchange Act recognizes that futures contracts serve
the national public interest because the contracts are used for hedging
and price discovery. From their earliest days, futures contracts have
been used by farmers to help finance their purchase of seed and to
facilitate their sale of crops. Futures contracts allowed farmers to
lock-in all or a portion of their grain price to assure their bank that
they can repay their loans and lock-in a profit regardless of the price
of grain at the time of its sale. Over the decades, use of futures
contracts have provided similar benefits for other physical commodity
players, banks and others exposed to interest rate and currency
fluctuations, investors concerned about stock prices and others
interested in hedging exposures.
The benefit of any futures market is derived from risk sharing and
the associated pricing of risk. The basic principle applies to films
for the same reasons that it applies to any other futures market. Just
as producers of grains base hedging on the resulting size of a crop,
the investors and producers of films can base hedging off the size of
the box office of a film. Through a focus on this key event the market
is designed to accommodate the uncertainty that accompanies production
efforts. It allows the sharing of risk and rewards and removes the full
burden of risk from the producer while facilitating the removal of risk
from commerce and contracts related to the production of films. The key
to the success is the identification of the risky event, which allows
the building of risk sharing contracts conditional on the event. In the
case of the movie industry, there seems to be little doubt that a major
source of risk is the box office earnings of a film.
To date, the benefits of hedging and price discovery have not been
available to the entertainment industry. The Cantor Futures Exchange's
offering of Domestic Box Office Receipt futures will allow studios and
others exposed to movie performance risk to hedge a portion of that
risk. Just as agricultural futures have helped farmers, DBOR futures
will allow studios to obtain financing on favorable terms and develop
new sources of capital. DBOR futures also will allow professional and
retail customers to take a position on the success of individual movies
thereby providing an important source of price discovery and liquidity
for the movie industry.
Consistent with the fundamental purposes of any futures market, the
Cantor Futures Exchange, by facilitating hedging and risk shifting,
will provide a new means of connecting the suppliers of capital and the
demanders of capital. This provides studios and financial investors in
film with more funding and less risky opportunities for producing
films. The economic function of the Cantor Futures Exchange is to
channel capital into productive use from the hands of those who own
capital into the hands of those that can productively use the capital.
The Exchange does this by crafting instruments that allow hedging and
the removal of individual risk. In addition, the Exchange will create
instruments that aggregate information, making success or failure more
predictable and in doing so will remove risk from the system and
encourage greater investments. The DBOR contract is an important part
of this effort.
Existing Barriers to Efficient Capital Flows
Today there is an obvious absence of a broad-based capital flow
into the entertainment field. Many barriers exist. Currently, the only
ways through which an investor can participate in the profit potential
of individual films are (i) invest in a studio, which is actually a
portfolio of films and other assets or (ii) participate as a partner/
owner of a film with a studio. Alternative (i) does not permit the
investor to specialize investment strategies to the particular films
about which the investor might have some information or opinions. The
investor's funds are applied to the priorities as seen by the studio.
Alternative (ii) involves many risks. First, the risks are large and
concentrated. Each film is an expensive undertaking about which the
uncertainty is great. The film requires a large investment while at the
same time there is poor information about likely success. Such risks
loom large for the studios, much less the individual investor, who
faces even greater uncertainty due to an inherent moral hazard.
Ownership is in terms of shares of profits but the individual investor
might have little control over or information about costs. Contract
monitoring and enforcement are expensive and requires specialized
expertise, skills, and experiences.
Improving Economic Efficiency: The Cantor Futures Exchange
Through a combination of new organizational relationships,
specially crafted financial instruments and the establishment of an
efficient system for exchange, the Cantor Futures Exchange serves to
remove the major barriers to economical capital flows to the
entertainment industry.
One barrier has been the absence of easily verifiable measures on
which returns to capital can be based. Profits would be the natural
measure except costs are difficult to measure, verify and attribute to
interrelated business activities. The Cantor Futures Exchange solves
that problem through a focus on domestic box office receipts.
Box office receipts are a verifiable, quantitative measure
of success.
By developing a measure of success of a movie and by crafting
special financial instruments based on that measure, the success can be
decomposed into smaller measures and distributed among more
participants. Instruments that are based on a proportion of box office
receipts can be sold in smaller lots and thus provide access to broader
participation. As a result, the risk can become more diffused and
spread across a larger number of entities.
The Cantor Futures Exchange DBOR futures contracts
facilitate both diffusion and a broader sharing of risk,
thereby increasing the economic attractiveness of movie
investments.
Bringing together the suppliers of capital and demanders of capital
is no simple task. Economic issues exist between the studios and the
investing public and economic issues also exist among members of the
investing public. After the capital has been transferred to the
studios, following the initial investments, various members of the
investing public using DBOR futures contracts will now have an
opportunity to lay off some of that risk in an efficient marketplace.
The Cantor Futures Exchange will increase market efficiency
by supporting the portfolio adjustment needs of asset holders
such as:
(i) pricing and price discovery;
(ii) clearance and settlement--trades made by trusted
parties (institutional and individual customers); and
(iii) new physical environments to conveniently bring
investors and speculators together.
A major function of markets is the reduction of risk through the
aggregation of information and beliefs. Markets are known to have the
capacity to aggregate and merge the different opinions and information
that is dispersed across the experiences of many people. Prices in a
properly functioning market can more efficiently reach balanced levels
through the improved flow of information. The futures market will
provide indices that help investors become aware of events that are
known to others and thus help investors avoid the unexpected. This
improved flow of information will be of use to both the studios and the
investing public.
The Cantor Futures Exchange DBOR futures market will improve
market efficiency by improving the information and thereby
reducing uncertainty.
The introduction of DBOR futures serves several functions. First,
such contracts allow appropriate hedging by the individual investors,
thereby allowing them to achieve the efficiency advantage of a
portfolio. Second, DBOR futures carry information about both future
events and the likely movement of spot prices. Both are central to
uncertainty reduction.
Market risks are not the only risks that investors face. Today's
investors have become very sensitive to corporate misbehavior. The
perceived risk dampens appetites for new investments and inhibits the
flow of capital to the producers of assets.
The Cantor Futures Exchange DBOR futures contracts
inherently protect the participating public's interests.
(i) Information about box office receipts is reported
independently of those who have raised the revenue (the
studios). Thus, the system does not depend upon the
good faith of the studios who would otherwise have a
potential conflict of interest;
(ii) Contracts are structured such that potential
conflicts of interest between the studio and
participants are removed; and
(iii) The exchange prohibits participation by certain
insiders holding material non-public information.
Cantor has a clear interest in supporting a successful market.
Misbehavior by studios will be detrimental to Cantor's interest. To
protect that interest, Cantor has employed the skills and procedures
developed through decades of successful operations in asset markets.
The proposed market is structured to be efficient. Cantor has the
capacity to support hundreds of different contracts trading at the top
velocities experienced by markets throughout the world. Price movements
are efficient and natural. The mechanism proposed for the initial sale
of futures, the one price auction, is known to be the most efficient of
the call auction forms.
The market architectures of the Cantor Futures Exchanges are
the most efficient known. The Exchange will operate in a manner
that is fair to all participants and efficient.
In summary, the Cantor Futures Exchange's offering of DBOR futures
is based on the traditional goals of any futures exchange: hedging and
price basing. The Exchange will allow a broad range of investors and
others with interests in movie performance to manage their risk. By
permitting these hedging opportunities, DBOR futures will facilitate
the efficient flow of capital from investors interested in a movie's
success to studios interested in raising low cost capital and reducing
their exposure to a movie's performance. At the same time, speculators
and others with an opinion on a film's box office receipts will be able
to purchase or sell DBOR futures, allowing the market to be an
efficient location for price discovery. In these important respects,
DBOR futures will serve a valuable economic purpose for the
entertainment industry.
Sincerely,
The Edward S. Harkness Professor of Economics and
Political Science.
______
Submitted Letter by Ann Rutledge, M.B.A., Adjunct Associate Professor,
Department of Finance, Hong Kong University of Science and Technology
New York, April 30, 2010
Hon. Collin C. Peterson, Hon. Frank. D. Lucas,
Chairman, Ranking Minority Member,
Committee on Agriculture, Committee on Agriculture,
House of Representatives, House of Representatives
Washington, D.C.; Washington, D.C.
Re: April 22, 2010 Committee Hearing on the Cantor Futures Exchange,
L.P.
Dear Chairman Peterson and Ranking Member Lucas:
My name is Ann Rutledge, and this is an unsolicited letter of
support for the Cantor Fitzgerald Cantor Futures Exchange. I am an
adjunct assistant professor in the Hong Kong University of Science and
Technology department of finance.
With Sylvain Raynes, I co-authored two books on the structured
finance market, The Analysis of Structured Securities: Precise Risk
Measurement and Capital Allocation (2003) and Elements of Structured
Finance (2010), both published by Oxford University Press. I am also
the co-founder of R&R Consulting, an early critic of structured finance
ratings and highly regarded credit risk measurement service provider.
In the last 15 years, my professional focused has been structured
finance and asset securitization, but in the early 1990s I headed J.P.
Morgan's Asian prime brokerage business and consulted to the Hong Kong
Futures Exchange (now part of HKEX, on clearinghouse reform, new
listings, including the successful Hang Seng Option, plus some failed
contracts) and managing external relations with Chinese reformers
studying the role of exchanges in improving the circulation of
information and goods through the Chinese economy.
Most of the arguments I have read for and against DBOR are standard
arguments about the risks and benefits of futures exchanges or new
contract markets, generally. They do not specifically address the risks
and benefits of film futures. Certainly such arguments are still
relevant to the case of DBOR because all futures markets have certain
attributes in common, namely--
They allow the commercial producer or processor to manage
the risk of its business flows by hedging (taking the opposite
side of their natural position);
They have the backing of a clearinghouse to manage price
volatility and counterparty risk;
They have a central administration to design the contract
market and make the rules and regulations for membership,
trading, reporting, disciplinary action and other key
functions, which they enforce.
It may be difficult for the layman to understand how these points
relate to film production, which, at first blush, seems to have nothing
in common with agriculture or finance. Film studios, like any other
commercial institution, must sell what they produce at a profit.
Although they have managed to convince the public that film economics
cannot be rationalized, studios nevertheless manage to run profitable
businesses.
In the lingo of futures, a film studio that makes films is a
natural ``long.'' The existence of a futures market in films gives
studios an ability to sell contracts on unmade films at an internal
target to hedge their price risk. A distributor of these films, or
rights to them, is a natural ``short.'' Distributors can lock into
profits by taking the other side of the trade, i.e., selling contracts
on the unmade films. If the long and short interest is in balance,
liquid interest will develop around the futures contract, which will
encourage further buying and selling by smaller, speculative
institutions that give the contract market liquidity. This enables the
commercials to rebalance their positions flexibly as they require. The
availability of a symmetrical risk management tool is expected to have
a salutary effect on the film industry generally as it shifts the focus
of film studios and distributors from extracting surpluses from each
other to monetizing the films they make and distributing them at fair
value.
From the foregoing explanation, it should be easy to understand why
commercial producers are almost always the slowest to accept a futures
market. They have a powerful information edge over the rest of the
market, and they believe they lose far more by opening up their price
advantage to competitive bidding than they gain from access to a risk
transfer mechanism. This is how banks originally viewed financial
futures, and film studios are no different. It is as natural for them
to resist the establishment of film futures in the 2000s as it was for
banks in the 1970s to reject financial futures, even though they later
adopted financial futures wholesale. The adverse response of the
studios is not simply a maneuver to hide the industry's accounting
games, as Dr. Chance suggests in his testimony, though that may be part
of the motivation as well.
The second and third bullets above are further reasons to consider
the timeliness and advisability of creating a film futures market. As
Dr. Chance mentions, the studios have dabbled in the nascent OTC
securitization market for film since 1996, when the credit rating
agencies began rating royalty receivable backed transactions. (Sylvain
Raynes developed the method for Moody's.) In this decade, some studios
used the film slate deal format to lay off the risk of failed films on
to unsuspecting investors at a price that did not reflect intrinsic
value.
As we are learning from the Subprime Crisis, the OTC market format
lacks key controls of a formal exchange. Credit rating agencies fulfill
some of the roles of the administrator in the OTC market, but they do
not ensure continuous price (rating) feeds or clearinghouse protection
from the impact of counterparty defaults. Given that the studios are
already using financial engineering to redistribute the risks of the
films they make, bringing this activity into an organized exchange
offers investors better protection and may to some extent curb the
production of bad movies that get made because they can be fraudulently
off-loaded.
Many people doubt that the studios could actually engage in adverse
selection because they do not believe film revenue cannot be estimated
reliably. R&R disagrees. We have devoted considerable internal
resources to developing a predictive algorithm for the revenues of
independent film in the $7-$20 MM category at script stage (i.e.,
before the first box office weekend), and the revenue estimates from it
achieve an R2 of over 90% when compared to a database of
over 500 films. While these results do not provide an open-and-shut
case for revenue certainty, they do provide evidence that revenue
benchmarking is possible in the indie category, and that trading in an
exchange venue could be quite robust because the variance could be
small enough to attract a tradable bid-asked spread.
Finally, Dr. Chance is right to observe that the DBOR market may
fail on its own, even if Congress approves it. Then, no one will be the
worse off, because very little trade will have taken place and the risk
exposures will be de minimus. On the other hand, if DBOR is a good idea
but the industry needs time to come around to it, we may be worse off
if Congress votes it down. It is not common knowledge that the Chicago
Mercantile Exchange's wildly successful Eurodollar market, built in the
1970s, stumbled for a decade until banking system and capital reforms
in the 1980s gave U.S. banks a motivation to join. Yet the Eurodollar
market laid the foundation for swaps and other engineered products that
put the U.S. financial system in the driver's seat of change and
progress. It is easy to overstate the unintended negative consequences
of change, but the unintended negative consequences of delaying
inevitable change may be much more costly.
Sincerely,
______
Submitted Questions
Questions Submitted by Hon. Leonard L. Boswell, a Representative in
Congress from Iowa
Dan M. Berkovitz, General Counsel, Commodity Futures Trading Commission
Question 1. You acknowledge that the Commission has recognized that
media contracts may require special review to ensure that the contracts
are consistent. Why is that?
Answer. Staff reviewed the contracts to determine whether the
contracts satisfied (are consistent with) core principles applicable to
contracts--primarily Core Principle 3 (Contracts Not Readily Subject To
Manipulation) and Core Principle 5 (Position Limitations Or
Accountability). Staff gave heightened review to the motion picture
revenue contracts under these core principles due to the unique and
novel nature of the contracts. Staff determined that the terms and
conditions of the motion picture revenue contracts from both Exchanges
appeared to meet the standards for cash-settled contracts.
Question 2. What is the price discovery function or aspect to these
markets?
Answer. The futures contract provides a market-determined estimate
of the motion picture revenues over the defined revenue periods.
Assuming that the proposed contracts develop a reasonable amount of
trading volume, the futures contracts could provide a price discovery
mechanism where there currently is no such mechanism.
Question 3. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. Congress excluded motion picture box office receipts
related contracts from the definition of commodity in the Dodd-Frank
Wall Street Reform and Consumer Protection Act enacted on July 21,
2010. The Commission, of course, will enforce that law.
Response from Robert S. Swagger, Chairman and CEO, Media Derivatives,
Inc.
Question 1. You cite an existing opaque over-the-counter market for
trading of motion picture products. Could you elaborate on this? Who
engages in it? How large is it?
Answer. The Trend Exchange, Inc., also known as Media Derivatives,
Inc. (``MDEX''), appreciates the opportunity to respond to the two
questions raised by Chairman Boswell.
As we testified at the hearing, MDEX is not seeking to establish a
market for the trading of motion picture products in an opaque over-
the-counter (``OTC'') market. Based upon conversations with
entertainment industry participants, we understand that a fragmented
private financing market already exists. In this market, participants
attempt to manage risk using various techniques, including the
equivalent of collateralized loan obligations (``CLO'') and OTC
options. Given the opacity of the OTC market, we are not aware of the
size of this market.
We understand that approximately $20 billion of production capital
is expended annually on the creation of motion pictures in the United
States. Approximately $15 billion of this amount is raised from studios
using their balance sheets, often through partnerships with large
private equity investors or syndicates of equity investors. The
remainder is raised through a combination of single picture financing
and so-called ``slate financing'' that does not involve major studios,
but includes private investors and financial institutions. A
significant portion of this financing is raised outside of the United
States and is inclusive of tax benefit driven structures.
The process of raising slate financing is similar to that of a CLO,
which some characterize as a form of OTC derivative. CLOs are
originated by investment banks and investors in tiered investment
structures comprising of senior debt, mezzanine debt and equity debt.
There is a very limited secondary market for these interests that are
traded from time to time between this small group of participants. All
of this financing--which is significant by any measure--occurs solely
outside of the public view and subject to no Congressional or agency
oversight. MDEX simply seeks to bring the demonstrable benefits of
futures contracts--such as pricing transparency, liquidity and
centralized clearing in a regulated environment--to the highly
uncertain and variable outcome of movie box office revenues.
Moreover, as of this writing, a form of unregulated offshore
trading in movie box office futures occurs in foreign markets. Most
notably, on Intrade, a market based in Ireland, you can place trades on
the opening weekend box office results of major U.S. motion pictures.
The Intrade market is open to the public, including U.S. citizens which
trade in the market, is unregulated and relies upon leverage. We
believe that an unintended consequence of the box office ban will be to
push U.S. movie production and financing market participants to
offshore potentially retail, leveraged markets that are subject to no
oversight by the CFTC or Congress.
Rather than push market participants offshore, MDEX seeks to list
and clear contracts in a fully regulated and transparent fashion,
subject to comprehensive CFTC oversight and sound risk management
principles.
Question 2. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. We strongly oppose the language in the Senate bill that
would ban futures contracts based upon movie box office receipts (the
``box office ban''). The box office ban is both unnecessary and
unprecedented since the creation of the Commodity Futures Trading
Commission (``CFTC'') in 1974. On a sole occasion in 1958--prior to the
creation of the CFTC--Congress banned the listing of futures contracts
on onions.
Rather, we believe that the CFTC is the proper forum for resolving
the review and analysis of the product, and Congress should reject any
attempt to subvert the regulatory process. The CFTC has the expertise
and resources necessary to conduct market surveillance with respect to
the commodity upon which MDEX seeks to list futures contracts, and the
CFTC has demonstrated its expertise during periods of extreme market
stress, such as during 2007-2009.
As you may know, the movie box office ban in the Lincoln-Dodd
compromise amendment to S. 3217 was added to the bill with no notice,
knowledge or discussion with our exchange or many others in the futures
community. While MDEX has sought strictly to adhere to the requirements
of the Commodity Exchange Act (``CEA''), our transparent and open
efforts have unfortunately been met with an attempted subversion of a
well-established, Congressional mandated regulatory process.
We understand that the box office ban is based partly upon the
misplaced notion that such futures contracts may damage the
entertainment industry and amount to ``illegal gambling.'' This notion
is without demonstrable support. As we testified, over the past several
decades, numerous industries have made the same claim with respect to
futures contracts only to find that such products ultimately provide a
critical risk management tool, which include the U.S. Government and
the listing of Treasury futures; the housing industry and the listing
of housing futures; the insurance industry and the listing of weather
futures; the aluminum industry and the listing of aluminum futures; and
the agricultural industry and the listing of various agricultural
futures.
In fact, derivatives are widely used today in virtually all
industries to manage risk. According to Professor Rene Stulz, 29 of the
30 companies that comprise the Dow Jones Industrial Average--i.e.,
America's ``blue chip'' companies--use derivatives.\1\ Further, in
2009, ISDA conducted a survey on the use of derivatives by Fortune
Global 500 companies and found that 94 percent of these companies use
derivatives to manage business and macroeconomic risks.\2\ We believe
that the notion that regulated futures contract tarnishes an industry
and is tantamount to ``legalized gambling'' is patently outdated and
uninformed.
---------------------------------------------------------------------------
\1\ Rene M. Stulz, In Defense of Derivatives, Wall Street Journal,
April 6, 2009, at A15.
\2\ ISDA Research Notes, No. 2 (2009), at 1.
---------------------------------------------------------------------------
Further, we oppose the box office ban because we believe that the
development of movie box office futures and related risk management
products is consistent with a major thrust of Congressional legislative
history which seeks to promote, among other things, innovation with
respect to risk management tools such as futures contracts. To the
extent that Congress permits the movie box office ban to remain in the
Senate bill, it would severely discourage the development and
investment in innovative risk management tools while telegraphing that
an industry may on a piecemeal basis attempt to subvert the CFTC's
regulatory process.
Finally, we believe that a box office ban would continue to push
U.S. investors to foreign leveraged markets that are not subject to any
oversight by the CFTC or Congress. As we testified, unregulated foreign
markets trade products based upon movie box office revenues and related
measures. This market is open to the public, unregulated and employs
leverage.
Rather than push market participants offshore, MDEX seeks to list
and clear contracts in a fully regulated and transparent fashion,
subject to comprehensive CFTC oversight and sound risk management
principles.
We thank you for the opportunity to respond to these questions.
Response from A. Robert Pisano, President and Interim CEO, Motion
Picture Association of America, Inc.
Question 1. You have indicated that your members would not use
these exchanges to hedge and that one of the characteristics of
legitimate commodity futures contracts is that they are designed to
serve the interests of the industries that use the underlying
commodities by providing a means for price discovery and hedging. If
investors in your studios or other entities in the film industry were
to indicate that they would use the product to hedge their financial
risk, would that change the association's position even if your studios
themselves would not participate?
Answer. We do not believe that the proposed contracts can be used
as hedging vehicles. If someone tries to do so, we believe that they
will not find the contracts to be useful hedges. In any event, the MPAA
would remain opposed to the contracts for the reasons stated in my
testimony.
Question 2. How do you respond to concerns that if these exchanges
are not approved and regulated in the United States, they will simply
be used offshore and without the regulatory mechanisms we currently
have in place?
Answer. The Commodity Exchange Act has permitted trading in over-
the-counter swaps among sophisticated ``eligible contract
participants'' for the past ten years. No over-the-counter swap market
in anything like the MDEX or Cantor contracts has developed. There is
no reason to believe one would now. Underscoring our views is the fact
that these contracts are gaming contracts that are prohibited by the
Wire Act from being bought and sold over-the-counter. That is why the
Hollywood Stock Exchange allows only make believe betting on such
contracts now--no money changes hands. We are not aware of any
proposals before foreign futures regulators to trade futures in motion
picture box office receipts. We would oppose any such proposals as
vigorously as we oppose the current proposals in the U.S. We believe
that prohibiting such contracts in the U.S. will send a clear and
strong message around the world that such contracts should not be
permitted.
Question 3. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. We fully support that language and the ban. Motion picture
box office receipts are not a commodity. There is no cash market for
them; they are not bought and sold. Nor do they provide a valuation of
any cash commodity. Industry contracts that are tied to box office
receipts are governed by actual receipts, not Rentrak numbers or studio
estimates. The contracts do not provide a price discovery function and
they are not useful for hedging. Accordingly, it is not appropriate
that they be within the definition of commodity.
Response from Scott Harbinson, International Representative,
International Alliance of Theatrical and Stage Employees; on
behalf of Directors Guild of America
Question 1. You have pointed out the effect that negative box
office predictions could have on residuals, which have a direct
financial impact on your members. However, Facebook and Twitter have
already revolutionized the way people communicate about movies, notably
by spreading bad reviews more quickly further damaging a movie that
might have made some minimum amount on opening weekend or opening
night. Have you seen an impact from this information exchange on box
office revenues, and therefore, your members' residuals?
Answer. Social media is simply a broader extension of film reviews
by newspapers, blogs and entertainment shows. Twitter and Facebook are
relatively new outlets and we are not in a position to measure their
ultimate impact, if any, on residuals payments to our members,
especially given the lag time between the theatrical release of a movie
and when residuals are generated from downstream revenues.
Additionally, demonstrating such cause and effect specifically
attributed to such social media is difficult given all of the other
variables involved in determining box office receipts.
Comparing the impact of new social media participation to the
potential impact that movie futures contracts could have on the film
industry is not an apt comparison. Participation in social media today
(i.e., ``tweeting'' opinions about a particular film) is not motivated
by an underlying financial interest to disseminate negative information
to make money by ``shorting'' that particular movie's future contract.
We are aware of a recent study conducted by two researchers at HP
Labs that analyzed millions of ``tweets'' on movies over a three month
period. That study included two preliminary findings:
1. The volume of tweets (no matter if positive or negative)
correlated to the box office success for the opening weekend,
and
2. The ratio of positive to negative tweets, combined with the
volume of tweets, correlated to box office success in the
following weekend (i.e., if more positive than negative the
better the results).
Thus, we would be most concerned about potential manipulation of
social media outlets and the adverse impact that could have on box
office receipts if movie futures contracts are approved.
Question 2. You have indicated that if the CFTC does not have the
authority to reject these applications, then Congress should act. Would
you support acting even if that means that these exchanges still occur,
but on foreign, unregulated markets?
Answer. Yes, we would support Congress acting to prevent such
commodities exchanges from being created. Currently such trading with
``play money'' (Hollywood Stock Exchange) or on foreign owned websites
(Intrade, which is based in Ireland) does not have the same potential
to harm the industry on the scale a U.S. Government-sanctioned trading
platform would create. Because of the scope, number of films released,
financial investments and other defining features of the American film
industry, these newly proposed exchanges could have far greater
detrimental impact on a film's success. While there other nations
allowing on-line gambling, that does not seem a justifiable reason for
it to be approved in the United States.
Question 3. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. We believe such a blanket exemption is necessary. We also
believe it is narrowly crafted to make clear the Congressional intent
that while derivatives futures trading in box office receipts or
related data would be prohibited, the language would not hinder the
creation of other types of legitimate derivatives in the future.
Response from Schuyler M. Moore, Adjunct Professor, UCLA School of Law;
Adjunct Professor, UCLA Anderson School of Management; Partner,
Stroock & Stroock & Lavan LLP
Question 1. You have indicated that the exchanges will enhance
transparency. However, with one exchange beginning sales 6 months from
a movie's release and the other proposing to begin sales just 4 weeks
from a movie's release, that doesn't seem like a lot of time to shed
light on the market. Is that sufficient to add more transparency to
this industry or would longer timeframes have added value?
Answer. The value of transparency is having the value of a film
investment be directly based on the film's box office results, since
that alone eliminates all the lunacy of normal Hollywood accounting.
Thus, it really doesn't matter how much earlier than release the
exchange starts; what matters (for transparency) is that the investors
will get paid based on box office results.
Question 2. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. This language was added at the request of the MPAA for the
reasons I mentioned at the hearing: (a) fear of anything new and (b)
fear that the public won't go to a film that is tracking badly on the
exchange. I think these fears are misguided (for the reasons I stated
at the hearing), and I am hoping for the sake of the industry--
including the studios--that this language gets deleted from the bill.
The odd part of the MPAA knee-jerk objection is that the box office
exchange concept will bring badly needed capital to the studios.
I sincerely thank Chairman Boswell for taking the time to study
this issue.
Schuyler M. Moore.
Response from Richard Jaycobs, President, Cantor Futures Exchange, L.P.
Question 1. You mention that settlement of the contract is based on
the box office receipts as reported by the distributor of the film and
captured by Rentrak. Aren't there incentives for the distributors of a
film to report inaccurate figures or to inflate figures?
Answer. It is generally true that studios have an incentive to
report inaccurate or inflated box office figures. However, Cantor
Exchange will compare the studio released numbers to Rentrak's
electronically tabulated numbers on a weekly basis in order to identify
any situation where the studio numbers appear to be inaccurate. In the
event the Exchange detects a material difference between a
distributor's reported number and the electronic tabulation, the
exchange Compliance Department will conduct an investigation together
with the National Futures Association and, if necessary, the CFTC to
determine if any manipulation had, in fact, occurred. In addition, if
the studio released numbers were found to be inaccurate or inflated,
Cantor would modify its contract specification to settle its DBOR
contract to Rentrak's electronically captured number.
Question 2. In your testimony, you mention seeking input of a wide
range of individuals and entities throughout the motion picture
industry while you were structuring your business model. What kind of
feedback did you receive? What were the most common concerns voiced by
the industry insiders? Did you receive any indication before the MPAA
letter that those in the film industry were opposed to the markets?
Answer. Cantor openly and widely discussed its box office contract
over a period of almost 2 years to a broad range of motion picture
industry participants. During this process, Cantor learned of potential
concerns, but there was no indication before the MPAA letter that it
would oppose the contract market or attempt to make it illegal through
legislation.
There were three concerns identified by the industry during the
process of developing the market: (1) would the market have sufficient
size and depth to be useful as a hedging tool; (2) would studios be
viewed negatively or suffer legal consequences if investors lost money
to studios who chose to `short movies'; and (3) would studios suffer
legal consequences because of their unique position as distributors of
film?
Our response to these concerns was generally (1) while there can be
no assurance of liquidity in launching a new market, based on Cantor
Fitzgerald's long record of enhancing market efficiency, the company
would make every attempt to facilitate an effective hedging platform;
(2) that the motion picture industry had a long history of benefiting
from the sale of interests in film titles to outside investors; and (3)
that the exchange rules would be crafted to provide sufficient safe
harbors for industry participation.
Question 3. Please provide your views on proposed Senate language
that would ban movie futures contracts by amending the Commodity
Exchange Act to read that no exchange be allowed to offer contracts
based on ``motion picture box office receipts (or any index, measure,
value, or data related to such receipts).''
Answer. Cantor opposes a legislative ban on futures contracts based
on motion picture box office receipts for the following reasons:
--Under the current law, the CFTC has sufficient legal authority to
determine whether a public market in box office contracts
serves the public interest;
--The proposed ban would set a unique precedent of Congressional
intervention in determining the appropriateness of a market
before the regulatory process has been allowed to conclude;
--The proposed ban is a rush to judgment at the request of a certain
group of market participants. Despite a two year process with
the CFTC and over 200 filed documents, proponents of movie box
office futures were not provided an opportunity to present
support for their position with the Senate;
--The proposed ban will support the entrenched interests and
competitive monopoly position of the major studios because
smaller entities in the motion picture industry will continue
to depend on major studios for financing and distribution.
Questions Submitted by Hon. Blaine Luetkemeyer, a Representative in
Congress from Missouri
Question 1. Please explain the process for evaluating an
application or request to create a new derivatives market (or series of
contracts). Describe the questions and then the answers that Media
Derivatives and Cantor Exchange provided that led the CFTC staff to
recommend approval of the application. Include a timeline on the entire
process as well (application received, length of q/a process, letter of
approval, etc.).
Answer. An interdivisional team was assembled to review the MDEX
and Cantor applications for compliance with 8 designation criteria and
18 core principles. To that end, each exchange submitted substantial
documentation including, among other things, rulebooks, compliance
manuals, governance documents and regulatory charts and also provided
trading and system demonstrations at their respective headquarters. The
staff evaluated all the information and made a recommendation to the
Commission to approve the application for designation which was
accepted by the Commission.
MDEX submitted draft documentation as early as October 2008 and
formally submitted its application in September of 2009. MDEX was
designated on April 16, 2010.
Cantor submitted draft documentation as early as June 2008 and
formally submitted its application in November 2008. Cantor was
designated on April 20, 2010.
Question 2. What are the most important factors that led the review
team to make its decision? For example, was the CFTC focused on
evaluating whether the new contract(s) being proposed would have a
legitimate business purpose (for say, risk management)? What other
questions or answers were also viewed as central to the application?
Answer. The contract approval determination primarily addresses
whether the proposed contract would be readily susceptible to
manipulation. Staff was satisfied that both MDEX and Cantor had
developed product rules, systems and safeguards in order to reasonably
assure that the contracts were not readily susceptible to manipulation.
Question 3. In 2008, the CFTC issued a request for comments about
whether and how it should regulate prediction markets. Please summarize
the questions asked, the comments received, and any new processes or
plans that resulted within the CFTC for how to regulate prediction
markets and/or process these sorts of applications.
Answer. The Commission previously requested comment on the
appropriate regulatory treatment of financial agreements offered by
markets commonly referred to as event, prediction, or information
markets (event contracts) in 2008. The Dodd-Frank Wall Street Reform
and Consumer Protection Act provides the Commission with authority to
prohibit listing of certain agreements, contracts, or transactions
based on commodities contrary to the public interest (e.g., contracts
on terrorism, assassination, war or gaming). The Commission will
consider the new legislation prior to enacting regulations regarding
event contracts.
Question 4. In reviewing the applications by Media Derivatives and
Cantor Exchange, how did or does the CFTC view these proposed
businesses as distinct from the Iowa Electronic Market (and the
previous ``no action'' letter that they received)? Is the difference
more than just who has access to trade these contracts or the dollar
amount of the contracts?
Answer. The University of Iowa requested no-action relief for its
Iowa Electronic Markets (IEM). The IEM is an electronic trading market
organized as an academic research and experimental program conducted at
the University. The Division of Trading and Markets of the Commission
extended no-action relief (that included limits on participation and
dollar amounts) for the operation of the Political Market and the
Economic Indicator Market on February 5, 1992 and June 18, 1993. Had
the IEM not requested and been extended no-action relief, they likely
would have had to apply to the Commission for designation as a contract
market (just as MDEX and Cantor did) if they proposed to offer these
contracts to the retail public.