The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed swaps rather than futures, a concern that has garnered little attention, CME Group Chairman and CEO Terry Duffy stated. 'There's an ambiguity from a tax perspective for all US participants now,' Duffy said in an interview. The comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts in the US.

A federal court decision is pending, which could significantly influence how the US approaches perpetual futures. One consequence, according to Duffy, is how the Internal Revenue Service (IRS) will tax these contracts.

The dispute centers on whether perpetual futures should be treated as futures or swaps. Duffy argues that perps should be classified as swaps due to the periodic funding payments exchanged between long and short positions.

Unlike traditional futures, perpetual contracts never expire, with traders periodically exchanging funding payments to keep the derivative's price close to the underlying asset. Duffy believes this mechanism satisfies the statutory definition of a swap under US law. The main problem with the current designation is that if perpetual contracts are considered futures, many institutional traders could receive a blended tax treatment under Section 1256 of the US tax code. However, if they are deemed swaps, they will be taxed under ordinary taxation.

Given that perpetual futures are newer innovations, the IRS has not provided guidance on their tax treatment. If regulators or courts ultimately conclude that perpetual contracts are swaps, market participants who have been treating them as futures for tax purposes could face uncertainty about how to report those positions to the IRS.

Legal experts say the issue is complex, with the definition of swaps being extremely broad. The challenge lies in determining whether perpetual futures function more like swaps or futures, which will depend on the court's interpretation.

This could lead to a long and drawn-out process, with potential litigation and the need for separate guidance from the IRS.