International In-house Counsel Journal Vol. 7, No. 28, Summer 2014, 1
Lawyering in the Online Gambling Sector Part 2 - non-legal aspects of the in-house work
MARTIN LYCKA Legal Counsel, Betfair Limited, UK
Being an in-house lawyer does not only require top class knowledge of a requisite number of different areas of law but also an in-depth understanding of the products sold by the business as well as non-legal elements that may affect its performance, in particular taxation. This is even more the case in the online gambling sector where competition is tough, regulation is very strict and taxation can seriously impact the future success of the business and its more innovative products. This article will deal with some non-legal aspects of the work of in-house lawyers in the online gambling industry, focussing on the taxation of gambling products and the necessity of cooperating effectively with in-house and external tax advisers, to be able to advise on and deliver external messages about non-legal aspects of the business. It will also deal with the regulatory, tax and other issues associated with the operation of betting exchanges, one of the most innovative products offered across the global online gambling industry. It will highlight some of the challenges an in-house lawyer may face if his objective is to get the innovative products, which some people may find complex, or even controversial, albeit for no good reason, regulated in a new jurisdiction. This article will argue that national governments and regulators are best advised to introduce a taxation regime that will permit all potentially interested operators to enter newly regulated online gambling markets with a view to generating healthy competition. This should ultimately lead to a sizeable reduction in the size of the previously existing unregulated market and enhance levels of consumer protection. I will also argue that innovative products like betting exchanges should not be omitted in practice from regulation, either by way of prohibitive taxation or prohibitive regulatory restrictions, because of the risk that consumers will find ways to bypass such regulation and continue using their favourite gambling products anyway. Taxation of online gambling products Some (in-house) lawyers would tell you that they’ve chosen to do law because maths was no friend of theirs during the secondary school days. Or that the internal tax team will be there if help is required or something goes awry. Be that as it may, tax issues usually form part of every (in-house) lawyer’s practice and at least some understanding is required. To have good background in tax is even more important in the online gambling sector where the product and tax regulation are inseparably intertwined. Unworkable tax regulation may mean that the business cannot be commercially viable in that jurisdiction. In general, the taxation of online sports betting can provide an important source of revenue for national governments if it is properly designed. When calculating the total tax burden all operating costs must be taken into account, including all associated business taxes, licence fees, administrative and compliance costs, as well as the actual tax rate. A prohibitively high betting tax, or an improperly structured one, drives online gambling
International In-house Counsel Journal ISSN 1754-0607 print/ISSN 1754-0607 online 2 Martin Lycka operators out of the market, resulting in lower revenue for the government and fewer choices for consumers. Prices in the betting markets are based on the operator’s expectation of the outcome of an event. This fact needs to be combined with the assumption that customers naturally strive to achieve the highest possible pay out rates which forces the operators to offer competitive rates. If it turns out that the operators cannot balance their books to face the two above factors they can react in two different ways: either by reducing their profit margins or by increasing in their prices. Several economic studies have shown that in a turnover tax system where the company faces a constantly high tax burden (assuming the turnover of the operator remains constant or very similar over a long period of time), the reduction of margins leads to irrecoverable losses, which may ultimately force the operator out of the market.1 In combination with a workable effective rate, the choice of an efficiently structured tax can have benefits for consumers, operators, and governments. One structure, a gross gaming revenue (“GGR”) tax, is levied directly on the operator’s revenues, which reflects its actual position on the market. Moreover, the GGR tax creates a level playing field between operators, permitting the freedom to provide consumers with greater choice and value without concern for the margin of specific offerings. The GGR tax, as opposed to a turnover tax, i.e. a tax on the total volume of bets collected by the operator, is the best option for the online sports betting sector because it has the highest potential to provide better value, entertainment, and choice for the consumer. The margins of online gambling operators genuinely oscillate between 90 and 96 percent (depending on the types of products that are offered). By consequence if a country that is in the process of regulating its online gambling market decided to apply any form of a turnover tax, the operators would struggle to make the two ends meet because the very low margins they generate would have to cover the turnover based tax as well as all other costs associated with entering a market and maintaining market positions. Even a very low turnover tax combined with the other costs would take a very high proportion of revenue away from the operators and would make them reconsider their presence in such a market as will be shown below in the example of France. Economic studies conducted in the online gambling sector have also shown that increases in price as an attempt to balance the operator’s book in a turnover system is by no means ideal either.2 This is because if the operators opt for this false strategy the turnover tax system compels them to reduce the turnover (to pay less tax), whilst increasing the price to artificially high levels which are not acceptable to customers (to at least retain the same level of bottom line). This may result not just in lower tax income for the government but also force customers to look for “cheaper” alternatives, most likely in the black, i.e. unregulated, market. In one of their studies PWC summarised the unsuitability of the application of a turnover based tax for taxation of online gambling products as follows:”a tax levied on stakes should be avoided as it discourages competition and customer demand (taxes are typically passed to the user), while encouraging use of non- regulated channels, leading finally to a smaller taxation base”.3
1 See for example, Australian Productivity Commission, Report on Gambling, 2010: http://www.pc.gov.au/projects/inquiry/gambling-2009, or Schmidt, U., Maschke, M., Das Wettmonopol in Deutschland, Status Quo und Reformansaetze, Kiel Policy Brief, No. 18, 2010. 2 See for example, Australian Productivity Commission, Report on Gambling, 2010: http://www.pc.gov.au/projects/inquiry/gambling-2009, or Schmidt, U., Maschke, M., Das Wettmonopol in Deutschland, Status Quo und Reformansaetze, Kiel Policy Brief, No. 18, 2010. 3 PWC, Report, Romanian Market Assessment and Tax Scenarios, June 2011. Non-legal aspects of the in-house work 3
Unlike the turnover taxation system, a betting duty based on the operator’s gross gaming revenue is conducive to price competition between the operators (which is always good for the ultimate beneficiary, i.e. the customers).4 Assuming a workable tax rate, taxation based on gross gaming revenue doesn’t compel operators to reduce their turnover (because the turnover figure is irrelevant for the purposes of this tax) or their profit margins (because excluding other costs the tax rate would have to be relatively very high to reduce operators’ profit to naught). In addition, the gross gaming revenue regime is much more flexible because it is capable of effectively supporting diverse business models, including online cash poker and betting exchanges. Neither of these two products could effectively work if they were to be taxed on the basis of the operator’s turnover. The principal reason for that is turnover is not equivalent to the money effectively held by the operators of these types of games, let alone the revenue/profit they make. This means that to achieve a workable taxation regime, it is not enough to introduce a gross gaming revenue tax full stop. It is equally important to make sure that the definition of “gross gaming revenue” is wide and flexible enough to cover all online gambling products available in the market. PWC opined in one of their recent studies on an EU gambling market that a broad enough definition of “gross gaming revenue” removes potential volatility between accounting periods and simplifies the audit and compliance process, especially for poker.5 In other words online gambling operators will be keen on entering a particular market only if they can be sure that they will have an option of offering the widest possible portfolio of their products. This is not to say that they must choose to do so every time or that they may be forced not to offer some of their products for regulatory or other reasons. However any change to the existing portfolio or look of products usually gives rise to additional costs, which especially in the case of smaller economic markets, may count against operators’ entry. Another important general consideration is the rate of the betting duty. It would be next to impossible to define an ideal rate which could be definitely considered by all relevant stakeholders, i.e. operators, governments and customers, who also indirectly bear the tax burden here. However it is not advisable to introduce a tax rate higher than 20 percent (assuming that the starting point is a gross gaming revenue tax). As will be shown in the examples of countries who have more or less recently regulated their gambling markets, tax rates which are higher than 20 percent tend to dissuade operators from entry and are capable of largely stifling the market. Furthermore, a significant advantage of the GGR tax is that it reduces consumer motivation to gamble illegally. When consumers are confronted with a visible tax, they may seek out lower-cost alternatives such as gambling in a tax-free black market. A GGR tax, set at a reasonable rate, is likely to be absorbed by the operator in a competitive market and thus consumers are able to effectively gamble tax-free. In contrast, under other tax systems such as a turnover tax, operators are likely to be forced to pass on the tax to consumers given the unpredictability of the tax burden. Apart from the potential revenue leakage there is also the associated social cost of stimulating a criminal environment. An analysis by the UK Customs department found that the switch to the GGR tax significantly decreased the risk of illegal betting and thus protected government revenues.
4 Schmidt, U., Maschke, M., Das Wettmonopol in Deutschland, Status Quo und Reformansaetze, Kiel Policy Brief, No. 18, 2010. 5 PWC, Report, Regulation of Online Gambling in Hungary, Evaluating the Benefits of Regulating the Online Gaming Market, August 2011. Suggest formatting of this footnote checked and a « conts. »word added if required with superscript 9 on following page 4 Martin Lycka
The effectiveness of the GGR tax, as opposed to a turnover tax, can be further illustrated in a comparison of the online sports betting markets in Denmark and France. The total revenue of online sports betting operators licensed in Denmark, which introduced a 20 per cent tax on GGR, amounted to approximately 186 million euros in 2013.6 It was only 79 million euros in France, which opted for an 8.8 per cent tax on stakes.7 Whereas the French market has stagnated and some previously licensed operators have even left it, the Danish market is growing whilst being able to retain the high number of licensed operators. Regulation of innovative online gambling products – betting exchanges Betting exchanges are still considered an innovative and in many respects a unique product proposition in the online gambling industry. The nature of the product and its somewhat controversial nature (controversial from the view point of some competitors) make sure that working for a betting exchange provider is never dull. This is because getting a betting exchange product regulated in a new jurisdiction gives rise to a certain number of challenges and requires careful explanation of some of the product and other features in an environment which sometimes tends to be antagonistic. In other words the legal and non-legal skills of the in-house legal (and regulatory affairs) team can be pushed to the limit and put to a very tough test. In essence, an online betting exchange is a system which enables customers to request bets on either side of a particular betting market. These bet requests are then matched over the Internet using the betting exchange operator’s platform. Each customer may place either a request for a ‘‘back’’ bet, i.e. a bet that something will happen - for example, that Real Madrid will beat Barcelona in the Champions League final - or a request a ‘‘lay’’ bet, i.e. betting that something will not happen. All such bets are matched anonymously – a customer cannot know with whom his bet has been matched. Customers can also choose the odds at which their bets can be matched. However such odds can only be accepted if such bets can be matched on the exchange. A betting exchange operator makes its revenues by taking a commission (usually 5%) from the winning bet. Whilst the operating model differs slightly from that of a traditional bookmaker, an exchange operator is in essence a bookmaker who has established a system to perfectly manage his risk. A betting exchange enables customers to bet on both outcomes of an event and also place back and lay bets in order to manage risk in a particular market. Due to the absence of a margin which bookmakers price into their odds to increase revenue, betting exchanges usually offer better odds than other sports betting operators. Operators such as Betfair have increased price competition in regulated gambling markets, leading to better odds within the regulated sphere thus removing the incentive for customers to seek out unregulated offers on the internet. Better competitive conditions within the regulated market mean more successful channelling of Portuguese customers away from unregulated sites, optimising tax revenue take and ensuring better customer protection. In fact, Betfair was the first operator to launch a betting exchange. Upon launch in the UK in 2000 it successfully applied for a bookmaker’s permit which was at the time the necessary licence for any sports book. This was the first time that any regulatory authority had looked at the way exchanges should be regulated. When the UK government overhauled the regulation of gambling with the UK Gambling Act 2005, it
6 Danish Gambling Authority Annual Report 2012. 7 http://www.arjel.fr/IMG/pdf/2013T4.pdf Non-legal aspects of the in-house work 5 specifically provided for betting intermediary licences which cover exchange betting. Although a separate category of licence, in practice the way exchanges are regulated in the UK is almost identical to other sports betting products. A number of European countries have regulated betting exchanges since – betting exchanges are permitted and in most cases already licensed in Italy, Spain, Denmark, Bulgaria, Hungary, Malta, Gibraltar and the German federal state of Schleswig Holstein. Romania and the Netherlands are in the process of regulating their online gambling markets and it is already clear that betting exchanges will be permitted and licensable in both countries. In addition, betting exchanges are legal under the laws of California and of Tasmania, Australia. The state of New Jersey is also considering regulating betting exchanges in the foreseeable future. Regulation of exchange betting in all the above mentioned countries is not materially different to regulating traditional on-line sports books; the technical issues as well as the operating processes are the same. For example in the Licence Conditions and Codes of Practice issued by the UK Gambling Commission,8 the only difference between the two types of regulation concerns the voiding of certain bets by the regulator which may have implications for exchanges that do not apply to traditional bookmakers. One of the challenges associated with getting new innovative products regulated in a new jurisdiction is the fact that the regulation may encounter fierce opposition by the established incumbent operators, some of whom may be desperate to engage in any skulduggery to stop the legislation process. In the past betting exchanges have been reproached as being prone to give rise to money laundering and sports integrity risks. It is explained in the next section why this is not the case. The below sections also further illustrate that an in-house lawyer working in the online gambling sector, and ultimately in any other industry sector, has to be able to advise on and explain a number of non-legal issues, most often based on advice sought from internal experts, which relate to the basic features of products and services offered by their business. Anti-money laundering process relating to betting exchanges Under the terms and conditions which betting exchange customers enter into with Betfair, being one of the betting exchange operators, bets are only accepted if the full risk of each bet can be matched with another customer or a set of customers with the opposite view of the outcome of an event. As with any other online based gaming product all customers are required to open an account whereupon the customer will have to pass a customer due diligence process verifying a least their identity, address and date of birth. The business relationship with the customer is subject to on-going monitoring and should there be any cause for additional verification then enhanced due diligence is undertaken which may include (but not exclusive) source of funds, source of wealth, detail of customer’s business activities/employment. The level of due diligence is comparable to the regulated financial sector. All funds entering the customer’s gaming/exchange account is deposited from/withdrawn to an account established within the regulated financial sector, no cash is accepted. This provides for an additional level of protection that the funds entering the gaming/exchange account originate from a legitimate source. In addition, the ‘closed loop’ principle is applied.
8See UK LCCP at : http://www.gamblingcommission.gov.uk/PDF/Licence%20conditions%20and%20codes%20of%20practice%20 -%20May%202014.pdf. Suggest formatting of this footnote checked and a « conts. »word added if required with superscript 9 on following page 6 Martin Lycka
Whilst the betting exchange will know and have verified the identity of all customers a customer can never know the identity of the customer(s) with whom his/her bet is matched on a betting exchange. As with financial exchanges, it is not possible to specify that a betting exchange bet request should be matched against a certain other customer. All bets are matched by special software provided by a betting exchange operator taking place automatically without any human intervention or influence. Putting the betting exchange technology in perspective it is worthwhile comparing it with online poker where there is direct interaction between players and where players can be easily identified by other players meaning that players can choose against whom they wish to play. The fact that such players could actually be identified by other players means that there is a risk of collusion between players (e.g. chip dumping), hence there being a greater risk of passing of funds. In contrast to online poker, the only relationship an exchange customer has is with the exchange operator. A betting exchange customer cannot choose, and does not know, with whom his bets are being matched. Betfair’s bet matching system, just like the systems of other betting exchange providers, is automatic and designed to give a customer the best available price. This will be applied across the product regardless of the licensing jurisdiction and location of customer. Whilst emphasising that the betting exchange should not be considered a specific money laundering risk, it is important to note that in the online environment every action by a customer is logged and retained. This provides for extensive monitoring on risk based principles as determined by the business. The risk criteria cover: Customer risk Financial risk Behavioural risk Geographical risk Product risk It is not possible to go into too much detail in this paper but, using the comparison of financial institutions again, this approach provides for transactions of higher risk to be more closely scrutinised. Taking into account such scrutiny, to successfully carry out the passing of funds (the transfer element of the money laundering definition) and importantly significant funds, which a committed money launderer would want to achieve, using a betting exchange the money launderer would most likely have to pass funds a number of times to achieve this purpose. Such activity would attract the attention of the monitoring process for the following reasons outlined below. In addition to the extensive monitoring explained above, a betting exchange actually provides a difficult environment for the passing of funds for the following reasons: 1) Customers intending to pass and receive funds on a betting exchange face need to choose a market/event where there is a predictable outcome so that such funds can move in the intended direction. Collusion must be synchronised so that the funds move from customer A to customer B and agreed odds are selected. Timing is also crucial for the successful passing of funds; 2) To create any certainty that funds can be passed colluders will try and do so on markets with little liquidity – markets which do not have a great deal of odds movement and there is little interest from other customers in participating in such a market. This severely limits the markets where such Non-legal aspects of the in-house work 7
passing of funds can actually take place. However on markets with little liquidity it is clear to Betfair’s monitoring systems when such passing of funds is taking place. Such activity will come to the attention of Betfair’s analysts. Betfair uses a number of monitoring tools and analysis to identify such activity; 3) Customers attempting to ensure that the above conditions are in place will attract attention due to the monitoring process. On markets with little liquidity, for example, it will be clear to monitoring systems that attempts to pass funds are taking place. In more liquid markets there is also the risk that the ‘bets’ of such customers may not be matched as intended. For the customers (passer and receiver) to minimise their risks they are likely to use odds at the lower end of the scale meaning that such odds could well be accepted by other customers on the exchange, thus preventing the passing of funds; 4) Unusually high odds (which may be being offered for the purposes of passing of funds) may appear attractive but on analysis present risks for passing of funds if the outcome of the event is not as predicted. It could be argued that it is a good way to move larger amounts from the layer to the backer but collusion must take place to exactly match the bet to move the desired amount of funds from layer to backer. Collusion leading to such exact matching would be highlighted for further investigation; and 5) Furthermore, if the colluders try to set odds outside normal market conditions and odds to match bets, monitoring would highlight such movement. There would also be a risk that other customers would see the odds in the market place, see it as an unusually attractive proposition and match very quickly themselves, reducing the amount available for matching between the passer and receiver at the colluded price which prevents the passing of the intended amount and creates a leakage to innocent customers. Sports integrity Certain national authorities have suggested that exchange betting increases the risk of fraud in sports. In reality, due to advanced technology, transparency, and audit trails, betting exchanges provide a very effective means of identifying people who try to corrupt sporting events. After all, by their nature, exchanges maintain a complete digital audit trail of every bet down to the last millisecond—unlike cash-over-the-counter forms of betting. This is proven by actual examples of individuals being identified and reported to sports governing bodies by exchange betting providers, such as Betfair, and ultimately being found guilty of sporting corruption offences using the evidence provided. There are several British Horseracing Authority case examples in the public domain.9 Nevertheless, opponents of exchanges (themselves without anywhere near the same audit trails) are at pains to discredit exchanges by association when instances of malpractice arise—even though it is the exchanges that are helping to lift the cover on otherwise undetected displays of questionable integrity.
9 See, e.g., the results of the 2007 disciplinary inquiry against Robert Winston, Luke Fletcher, Fran Ferris, and Robbie Fitzpatrick, Robert Winston/Fran Ferris/Luke Fletcher/Robbie Fitzpatrick/Ian Nichol—Results and Reasons, British Horseracing Authority (Feb. 16, 2007),
Like other online gambling products, exchanges track every transaction, including logins, all of which can be used for monitoring and investigative purposes. The exchange operators, like Betfair, use (amongst other things) computer forensics, detailed betting pattern analysis, and linked account searches to investigate suspicious activities. Consequently, betting anomalies can be reported to sporting governing bodies in real time. Indeed, regulators and sporting bodies can, by arrangement, access betting data in real time themselves, if they so wish.10 Furthermore, it cannot be plausibly argued that ‘‘laying,’’ i.e., betting against an outcome, is a reason why exchanges encourage corruption in sports. In a two-runner market, such as a tennis market or a football match, laying one player is the same as backing the other player. In a betting market with multiple runners, it is possible to effectively bet on an outcome to lose by backing all other outcomes to a certain percentage. There are online tools which help to calculate the necessary bets with non- exchange betting operators. As a result, we are increasingly seeing traditional bookmakers offering odds to bet against an outcome, albeit at generally less attractive, less efficient prices that expose them to risk. Conclusion In conclusion, lawyering in the online gambling sector goes well beyond mere interpretation of statutes and drafting of contractual documents. Like in many other industry sectors one has to be prepared to go way out of his or her comfort zone to satisfy the “customer demand”, i.e. the demand of global businesses that can face a number of complex non-legal issues that may affect the commercial viability of their products. One may even have to reconsider his decision, made ages ago, to steer clear of sophisticated mathematics … *** Dr. Martin Lycka, LL.M. has worked in the Legal Department of Betfair since September 2009 focusing on EU and competition law as well as regulatory issues. Before joining Betfair, Martin worked with Clariant SA, Aliachem, a.s., The Ministry of Foreign Affairs of the Czech Republic and Salans Europe LLP. He graduated from the Charles University in Prague and obtained a LL.M. degree at the College of Europe. Martin qualified as a UK solicitor in July 2014. He has authored more than 80 academic articles on EU and international law (including EU gaming law) and is a co-author of two books. Betfair is one of the world’s largest international online sports betting providers and pioneered the first successful Betting Exchange in 2000. The Betting Exchange, where customers come together in order to bet at odds sought by themselves or offered by other customers, has eliminated the need for a traditional bookmaker. Driven by world-leading technology the company now processes over five million transactions a day from its three million registered customers around the world. In addition to sports betting, Betfair offers a portfolio of innovative products including casino, exchange games, arcade and poker.