The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately classified as swaps rather than futures, warns CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants. The comments come as CME continues to challenge the Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts in the US, with the outcome potentially influencing the US approach to these rapidly growing financial instruments. A key issue is whether perpetual futures should be legally treated as futures or swaps, with Duffy arguing that they should be considered swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire and involve recurring funding payments to keep the derivative's price close to the underlying asset's price. Duffy believes this mechanism satisfies the statutory definition of a swap under US law. The mismatch in designation could lead to institutional traders receiving a blended tax treatment under Section 1256 of the US tax code if perpetual contracts are considered futures. However, if classified as swaps, they would be subject to ordinary taxation.
Given the novelty of perpetual futures, the IRS has not provided specific guidance on their tax treatment. Legal experts consider the issue complex, with the definition of swaps being extremely broad and encompassing a wide range of financial instruments. The outcome will depend on the court's interpretation, and the process is likely to be lengthy and involve considerable litigation.
Until regulators, tax authorities, or the courts provide clarity, large institutions may face uncertainty in reporting trades involving perpetual futures, potentially leading to tax implications and regulatory issues.