CFTC Proposes Bona Fide Standard for In-House Market Makers Without Directional Positions

The CFTC proposed Thursday that in-house market makers affiliated with exchanges may continue operating, but only as bona fide liquidity providers that maintain continuous two-sided quotations and avoid taking directional positions. The consultation document highlights ambiguity in how certain enforcement elements would apply in practice.

The Commission observed growth in affiliations between regulated entities and market makers, a trend most pronounced in prediction markets because of the large number of small, short-lived contracts. It is aware of approximately eight such entities. Concerns center on conflicts of interest, including an exchange’s self-regulatory duties when its affiliate serves as a potential profit center.

The proposal recognizes the value of these market makers in supplying initial liquidity where independent firms hesitate. It stops short of a ban. Instead it seeks to distinguish bona fide activity from proprietary directional trading.

Bona Fide Market Making Requirements

Under the proposed rule, a bona fide market maker must be contractually obligated to provide continuous two-sided quotations. Its orders would be filled only after those of unaffiliated participants at every price level. The market maker could not establish directional positions except as required to meet its quoting obligation. The CFTC states this limits conversion of operational or informational advantages into proprietary profit.

Exchanges must disclose the presence of any affiliated market maker in clear, conspicuous plain language that details all conditions and limitations, including order subordination. The Commission requests comment on whether specific net-position thresholds should be added or whether alternatives would better ensure bona fide conduct.

CFTC Chair Michael Selig described the approach as striking the right balance. “By setting forth principles-based regulations for vertically integrated market structures, the CFTC is taking a significant step in our continued efforts to support responsible innovation in U.S. derivatives markets,” Selig said. He added that the proposal would “institute purpose-fit rules of the road that bolster market integrity without stifling novel market structures or imposing excessive compliance costs on registrants.”

The Open Question on Enforcement

As reported by InGame, ambiguity remains around how regulators will determine when a trade is “inconsistent with the purpose” of liquidity provision. The Commission considered but declined to impose fixed position limits, noting that even a bona fide market maker might temporarily hold one-sided exposure. This principles-based framing invites industry input during the 60-day comment period.

The proposal represents an inflection point. It moves voluntary practices into a codified framework that delivers predictable expectations for client-partners while preserving liquidity support in prediction markets. Operators and investors should assess the final language closely once comments are incorporated.

Reporting: CFTC Rule Proposal: In-House Market Makers Allowed, But They Can’t Take A Side (www.ingame.com)