Dividing Hedging and Gambling
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DIVIDING HEDGING AND GAMBLING: LEGAL contexts, they may receive different legal treatment.5 IMPLICATIONS OF DERIVATIVE INSTRUMENTS Furthermore, our perception might change if we vary the context within which the transactions take place. By Chao-hung Christopher Chen For example, it might be perfectly normal and an accepted part of commercial practice for two banks to enter into an interest rate swap. However, if the same swap occurs between two individuals who enter into The past three decades have seen the emergence in the this transaction from purely speculative intentions, we market of many different types of “derivative might start to doubt whether this transaction makes instruments”, ranging from futures, forwards, options, any sense and whether it looks more like a gamble. and swaps 1 to some other hybrid instruments 2 or Overall, we can put hedging and traditional synthetic transactions 3 . Along with insurance, gambling contracts on the same spectrum. To some derivative instruments help market participants not extent, they are all contracts that allow people to make only to hedge various types of risks but also to engage profits or avoid loss from predicting future in market speculation. A derivative transaction could uncertainties. On this spectrum, certain contracts (such serve the purpose of avoiding large losses (i.e. hedging) as wagering) have long been labelled as “gambling”. as well as earning a windfall (i.e. speculation). As such, Certain transactions (like insurance) could serve some one question arises: Is there any difference between legitimate purposes and are protected from the gambling and derivative trading? prohibitions in gambling laws with established legal If A and B make a bet (of 100 pounds) on the doctrines. Derivatives arise in the same context. Like movement (either up or down) of the FTSE 100 index, insurance, they could help market participants to hedge it is what we generally call a wager. In contrast, if one against various types of risk. On the other hand, they wishes to make speculative profits by placing an order also open the door for punters to gain speculative in the LIFFE for FTSE 100 index futures, it is profits. Indeed, derivative transactions provide us with regarded as an investment. In addition, if A places a bet many more options than traditional betting, gaming or of £10 per point (of the FTSE index) with a betting wagering, etc. This paper does not intend to cover the company, it might become a so-called “spread betting”4. relationship between financial regulations and gambling The above examples share one main scenario - making regulations. Nor is this paper interested in discussing profits by predicting future movements of the FTSE what should be regulated and how to regulate the 100 index. However, when we put them in different financial and gambling market. Instead, this paper plans to answer one basic question that many people might have in mind: what is the difference between risky derivative transactions and gambling contracts? The author thanks the reviewer for his valuable comment, We could answer this question from several and Mrs. Miriam Goldby and Mr. Arif Jamal for their helpful perspectives. This paper will focus on the legal aspect. feedback. We should be aware that the meaning of the terms 1 Many chapters could be written simply to describe what “derivatives” and “gambling” can be difficult to pin derivatives are and how they work. We can use oil prices as down because they are surrounded by ambiguous an illustration. An oil forward is a contract to buy (or sell) a jargon. This paper intends to pierce this fog and certain amount of oil to be delivered in the future with the discuss whether derivatives should be understood price fixed when the contract is made (usually, however, differently from what we generally perceive as these contracts are settled in cash without the oil actually “gambling”. In the following sections, we will first being exchanged). An oil future is the standardised version of forwards and is traded on an organised exchange. An oil explain the need to make a distinction between option is a right to buy or sell oil in the future (and the derivatives and gambling in the pre-Gambling Act 2005 option holder has to pay some premiums to the issuer of the era. We will then examine certain relevant arguments option). An oil swap involves a series of exchange of and legal doctrines, and the new dimension after the periodical cash flows based on the oil price and a new gambling regulatory schemes. predetermined fixed-rate. 2 A typical example of hybrid instrument is the Catastrophe bond (CAT). It is like a normal bond except that the repayment of money is conditional upon the non-occurrence 5 A wager was rendered unenforceable by the old section 18 of a catastrophic event (e.g. a hurricane). Higher interest is of the Gaming Act 1845 and is now legal and enforceable usually paid as compensation. after the Gambling Act 2005. Nevertheless, a wager might 3 A synthetic transaction can take many forms and can be still be unenforceable or illegal in other countries. See for extremely complicated. To give a simple example, a synthetic example, NY CLS Gen Oblig 5-401. The futures market is option is not a real option issued by another person, but now protected by the Financial Services and Markets Act could be a collection of other derivative instruments (e.g. 2000. Spread betting is now also put under the surveillance options or forwards) that mathematically creates a of the Financial Services Authority. See section 10 of the “synthetic” option on the surface. Gambling Act 2005. However, spreading betting may still 4 See City Index Ltd v Leslie [1992] QB 98. constitute illegal wagering or gambling in other countries. 1 The Need for Division – Before the Gambling Act Approach I: Definition of Gambling 2005 The first step is to define the meaning of the term At the beginning, we should be aware of the evils of “gambling”. If certain conduct does not come within gambling. Gambling attracts much opposition for the definition of gambling, it is not gambling as a various reasons. Gambling, being described as an matter of law and thus avoids negative legal opportunistic and non-productive behaviour, has consequences of gambling. This task looks simple, but received much moral condemnation. Apart from it is indeed a difficult one. As we will explain below, it general moral theory, one primary concern with would be labourious to define “gambling” in clear and gambling is its association with crime.6 Public order is unequivocal words. Since we could hardly make a clear another consideration for the government. 7 A definition of gambling, it would be equally difficult to significant part of gambling regulations or prohibition distinguish lawful transactions from gambling by way is to control gambling premises.8 In addition, excessive of a simple definition. gambling also attracts much attention. Some people do Before the Gambling Act 2005, there was no become addicted to gambling, and the addiction can single definition of “gambling”. Instead, gambling law have a negative impact on their family or surrounding used various terms, such as betting, wagering, gaming, people (e.g. astronomical debt). The vulnerability of etc., to describe certain behaviours. The most 13 youngsters and children also raises serious concerns. 9 fundamental type is what we call “wagering” . People The above concerns provide a basis to treat can also gamble by playing a game (e.g. a poker 14 gambling differently from other transactions. Over the game). Betting is a term that could contain a wide past two hundred years, there have been several pieces variety of gambling behaviours, ranging from fixed- of legislation being introduced to address various odds betting (with a bookmaker), pool-betting (e.g. a problems in connection with gambling.10 The same is horse race totalisator), to spread betting (of financial 15 also true in many other countries. Indeed, gambling has indices). Lottery is another common type of gambling. 16 largely been seen as a typical example of an “illegal” Yet even a lottery may contain several types of games. contract. Yet, this perception is not accurate. Legal These concepts could overlap with one consequences of gambling could range from mere civil another, which makes it more difficult to find a unenforceability11 to criminal sanctions.12 Nevertheless, definition. As Lord Wilberforce observed, “[i]t is as long as gambling still invites negative legal impossible to frame accurate definitions which can consequences, we have to distinguish certain cover every such variety; attempts to do so may indeed transactions that we deem legitimate from gambling, be counter-productive, since each added precision even though they might contain a certain degree of merely provides an incentive to devise a variant which speculation. Then the question is: how to achieve the eludes it. So the legislation contains a number of goal? expressions which are not, or not precisely, defined: bet, 17 wager, lottery, gaming, are examples of this.” A standard dictionary definition says that 6 gambling means “to play games of chance for money, Whether gambling really leads to more crimes is an issue esp. for unduly high stakes; to stake money (esp. to an that requires further empirical studies. See also Royal 18 Commission on Betting, Lotteries and Gaming, Report of the extravagant amount) on some fortuitous event.” A Royal Commission on Betting, Lotteries and Gaming 1949-1951 game of chance is to play with future uncertainties, (London: HMSO, 1951), p.52. which, in commercial term, might be called “risk”. 7 Gambling Act 2005, section 1(a). Thus, if we reduce the discussion to neutral terms, 8 For example, the Gambling Act 2005, section 37 and Part 8; what we generally perceive as gambling is where a the Betting, Gaming, and Lotteries Act 1963, section 1.