Editorial: Short Changed

5 November 2002

Targeting just the layers is a lose-lose for the betting exchanges, the BHB and the Levy Board, but a big win for the bookies.

With the announcement of the terms of the 42nd Levy Scheme to apply from April 1, 2003, it would appear that the bookies have "won" the philosophical debate, viz. the offerer/requestor must now pay the 10 percent levy on his/her profit from bets--the same as bookmakers do. If the user "takes" a price, he is deemed to be input taxed (in the same way if a punter or another bookie bets with a bookie). It is a sound argument. It also addresses the fact that making offers or bids compresses the wagering market margin--something that is not in the interest of making "profit."

While it is a sound argument, it is not in my opinion the best argument because it fails to address the fact that bookies can minimize the "bookmakers'" gross wagering margin (and therefore GPT and levy) and transfer the profit to a "punter" associate company (or even offshore to minimize income tax too).

Targeting "layers" is flawed, not the least because of how an exchange's trading engine operates.

An example: A "taker" accepts an "offer," but in the processing queue someone gets there first so that his take becomes an unmatched offer taken before he can cancel, and he is liable for 10 percent if it wins. It's not viable to break out and ask the user if it's OK to change state from taker to offerer. Case in point: Betfair is matching over 10,000 transactions per minute.

There's an argument that 90 percent of a win is better than 100 percent of nothing, however, such an argument misses the point about pricing risk into odds on offer. The simplest example of this is a single "toss of the coin" (an even-money, or $2, event), whereby if only the layer is levied 10 percent of his win, then he must offer odds of $1.90 or 9/10 so that both parties have an equal chance of winning 90 cents.

While targeting layers ("offerers" or "requestors" may be a clearer definition) is clearly logical because they are the parties responsible for any compression in prices (and thereby distorting the wagering market) and on one argument are the bookmakers (who by definition "offer" prices), it will not be of much value to the BHB if they don't make a profit (which they won't because of market failure issues).

Double Whammy or Double Dip?

Under the BHB's comprehensive license, betting exchanges will be required to pay 10 percent of layers' profits assessed by individual account (this mirrors the levy scheme), and under the BHB's media license, betting exchanges will also have to pay 10 percent of the exchange's commissions derived through British racing.

It's not a double dip because exchanges will be able to offset the total amount paid to the Levy Board and will be required to pay the BHB the remaining amount, which, given the "mirror" layer conditions, means that betting exchanges effectively just have to remit 10 percent of commissions received. But it's certainly a double whammy.

Given that the winning layer does not get to deduct commission as cost before assessment for the levy, there is an element of double dip, though it is consistent with how bookies are levied, but it is very difficult to comment on such fine detail from press releases and Web site information at this early stage.

If you Make Your Own Bed

That said, the exchanges coming out with "we don't want to pay" and "our users shouldn't have to pay because we are smarter than the average bear" rather than "here's what we can pay and why it's fair" really haven't (understatement coming) helped their cause. If you make your own bed you have to lie in it.

The Goose that 'Laid' the Golden Egg

Exchanges, in dreaming up or agreeing with an HMCE proposition for the "layer's shoes" (there are a couple of versions of how it came into being), sowed the seeds for their own demise. I've discussed this issue in some detail in previous editorials. The exchanges, in finding that their GPT/BL liabilities were lower than the same percentages of commissions received, have made a rod for their own back by not putting the issue on the table.

What the 42nd Levy decision has done is clarify the ambiguity of the "layer's shoes" approach for the levy (and the GPT). As well it makes clearer the original intent of the drafters of the rules for the GPT. The mistake of the exchanges may have been using the layer vs. backer approach, which is more favorable, mathematically, to the exchange.

A Fair Rights Fee

The BHB should set a license for authorized wagering on their product. It should be applied equitably and fairly to all wagering operators and their users. A turnover fee and a "super" profits fee (e.g. the greater of 1 percent of turnover or 10 percent of gross wagering margin) is the best option for the rights holder--the BHB--and is the fairest for all the participants.

That said, a turnover levy would alienate the new class of punter that the exchanges have given rise to--the trader, who may dip in (back) and out (lay) many times and may not even have open positions (outstanding bets) when the event is resulted.

Not Right and Not Fair, but Legal

The bottom line: There is nothing illegal about this solution. In fact, the bookies could mount a strong argument about it's a real leveling of the playing field. It just isn't the right solution.

Pain and Suffering

What will really hurt is that exchanges will have in escrow the 10 percent profit from each winning laying (offer/request) bet (and I assume allow for a credit for each losing laying bet), thereby maintaining a running liability for each user during the course of a year and paid to the HBLB at the end of the year.

To put this in perspective, if a layer wins the commission, 2 percent to 5 percent is deducted from the winnings. But now an additional 10 percent must be escrowed for the levy liability, although if he loses, he would get funds (10 percent of the loss) released from the escrow if in credit, or if not, then carried forward to be offset against future winnings' liabilities.

This means for Betfair's highest turnover customers, the deductions will increase by five times on an event-by-event basis.

What's that going do to liquidity?

What Is a Layer?

The other bit to be made clear is that it is the offerer who is liable in any matched bet. If you don't want to be stung, you only take bets at the price offered.

That means unmatched takes cannot be put in the system as requests--depriving the exchange of liquidity. If they were to be put in automatically then by rights, the price should be adjusted to account for the potential liability. This isn't easy as the long run risk is much less than the individual event risk--to return to the "toss of the coin"--over many events, and assuming that the parties could withstand a run of outs, the odds offered should be much closer, if not equal to, even money, or $2. Given we are talking about uncertain but assessable probabilities (a horse race) there is significant risk that must be priced into the odds offered.

How Will Users Be Charged?

I just can't see how a betting exchange could pay the levy out based on the current commission "net winnings" structure.

Given betting exchanges have to pay both 10 percent of commission revenue as well as collect the 10 percent levy from laying users' gross profits, the only logical thing is to charge the two separately, despite how damaging it will be to exchange depth and liquidity.

It is possible that the exchanges could do the math and estimate their (long-run) liability and pay for it out of commissions, however, given that non-aggregation has now been ruled out, this means that rather than losing punters, in effect reducing the exchange's liability, they would be, in fact, cross-subsiding the winning punters. That's a bit like being kicked while your down!

The high-water mark has been set: If you want to play the "wagering game," you play on our turf, by our rules. That doesn't provide for innovation.

In my opinion, the bookies have set Betfair (and other exchanges) up to deal almost exclusively with real "licensed" bookmakers, making the exchange simply another account wagering distribution channel. But where is attraction for punters in that?

One possibility is that Betfair might get a gig as a clearing house for bookmaker-to-bookmaker risk management (more though for smaller bookmakers than the chains), which may attract punters to the "exchange," but then it's only last-minute flurry betting.

Sting in the Tail

There is little doubt that this step by the Levy Board and BHB will turn the focus to the gross profit tax. If the view is that this is no more than a clarification of the "layer's shoes" (a better fit, so to speak), then the exchanges and their users are in for an awful surprise because the GPT will have to be calculated on the same basis.

It would ludicrous if betting exchanges could deem both users to be layers for two statutory charges as a means of minimizing one. That would mean an additional 15 percent must be escrowed, although if he loses, the layer would get funds (15 percent, or 25 percent including the levy, of the loss) released from the escrow if in credit (or carried forward if not for offsetting against future winning's liability). Of course, over many events, even a successful exchange layer would be lucky to make 4 percent on his turnover, so this impost will be much, much lower over the long run.

Unlike the HBLB's more generous annual assessment of the GWM of the layers, the GPT is a monthly liability without the ability to offset losing months against winning months.

Tim Ryan is a graduate of Agricultural Science, though he is probably best described as an innovator. He has worked in consumer online information and transaction systems since their inception and was the Australian pioneer of television data broadcast and is still the Consultant General Manager of the Seven Network’s teletext and datacast services – the principal provider of real time wagering information in Australia. Tim was an innovator of integrated wagering information and transaction systems. He has also consulted to a number of wagering system developers on the internationalisation of their systems. Tim became a NSW licensed bookmaker early in 2000 for regulatory reasons associated with the development of wagering systems. Despite not being a ‘working’ bookmaker Tim was appointed to the Australian Registered Bookmakers Advisory Council, Australia’s peak body representing all its 800 bookmakers. In this capacity he was instrumental in lobbying the independent Senators and the Government to ensure the exclusion of wagering from the Interactive Gambling Act.