Commodity and Futures Trading
SIC 6221
NAICS 523130
Commodity trading firms buy and sell commodity contracts on either a spot or future basis for themselves or on behalf of others. They are members, or are associated with members, of recognized commodity exchanges. This discussion also includes a review of commodity exchanges.
In 1972, 18 million futures and options contracts were traded worldwide. At the start of 2005, this volume had reached 1.5 billion contracts, according to figures compiled by the Futures Industry Association (FIA), the industry's trade association. Fueling the phenomenal growth of the futures industry in the early 2000s was the surge in interest rate and equity index trading activity. Financial trading as a whole grew 75.3 percent in 2001, with equity index trading up 117.9 percent and interest rate trading up 44 percent. Non-financial trading, however, dropped 4.5 percent, due to lagging agricultural commodity and non-precious metal trading.
Although still used interchangeably, the once commonly used term "commodity trading" was replaced by "futures trading" when contracts were developed on foreign currencies and government securities, not just on tangible or storable products. The terminology "futures trading" became more widely used after 1981 when the Chicago Mercantile Exchange (CME) introduced trading in Eurodollar futures, the first such market that called for settlement in cash rather than by delivery of the underlying physical commodity. CME is the largest futures exchange in the United States.
Futures and options on futures are classified by category. Categories include interest rate, equity indices, agricultural commodities, energy products, foreign currency/index, precious metals, non-precious metals, and other. Commodities and futures are known as "derivative instruments," because they are dependent upon underlying cash markets for their identities. They serve two economic functions: transferring risk—or hedging—and price discovery. The U.S. Commodity Futures Trading Commission (CFTC) defines hedging as "taking a position in the futures market opposite to a position held in the cash market to minimize the risk of financial loss from an adverse price change." Price discovery is simply the market's free negotiation of prices based on supply and demand.
In 2005 the Korean Stock Exchange (KSE) was the largest global futures and options exchange, in terms of volume. Eurex was in second place, followed by CME, Chicago Board of Trade (CBOT), and London International Financial Futures Exchange (LIFFE). Many of the largest exchanges began considering demutualization (converting to for-profit status) in the early 2000s, as a means of increasing efficiency and cutting costs.
Futures exchanges, industry members, and federal regulators share responsibility and work together to protect the interests of all futures market participants.
The Commodity Futures Trading Commission (CFTC), which is based in Washington, D.C. and has offices in Chicago, Kansas City, Los Angeles, Minneapolis, and New York City, is the U.S. federal agency responsible for the regulation of the U.S. futures markets. Created in 1974 by an act of Congress, the CFTC has a threefold mission: to ensure fair practice and honest dealing in futures trading; to permit accurate price discovery; and to provide for efficient hedging through competitive, manipulation-free markets. The president of the United States, with the advice and consent of the U.S. Senate, appoints commissioners to fill vacancies on the five-person commission; each commissioner serves a staggered, five-year term.
The CFTC had a budget of US$89.9 million in 2004 and approximately 500 employees to oversee 13 commodity exchanges in the United States.
In 1998 the CFTC approved rules designed to facilitate the merger of the Coffee, Sugar & Cocoa Exchange with the U.S. Cotton Exchange into a new entity controlled by a holding company, to be called the Board of Trade of the City of New York. The merger was scheduled to be complete by mid-2004.
The National Futures Association (NFA) is the industry-wide, self-regulatory organization for the futures industry. Authorized by an act of Congress in 1982, NFA became the answer to a proposed futures transaction tax. Rather than institute the tax, Congress decided that an industry-funded, self-regulatory organization would serve as an effective, efficient, and equitable way to share the regulatory costs between the futures industry and public participants.
NFA has four main areas of responsibility: registration, compliance, arbitration, and education. NFA has accepted the responsibility for screening and registering firms and individuals who conduct business in the futures industry, including futures commission merchants (FCMs), commodity pool operators (CPOs), commodity trading advisors (CTAs), introducing brokers (IBs) (individuals previously known as agents of FCMs), associated persons (APs) (individuals associated with a firm, such as firm principals and sales personnel), and floor brokers and floor traders. NFA developed an arbitration program for the resolution of customer disputes between NFA members. NFA also monitors the financial and sales practices of its members. In 1998 NFA employed 257 full-time and 10 part-time employees and had a total budget of US$29.78 million. NFA is completely self-financed; its funds are derived from membership dues and fees as well as from assessments paid by NFA members and futures market users.
Another key organization in the futures industry, the FIA, based in Washington, D.C., is the industry's trade association, with representatives from all segments of the marketplace, including the largest brokerage firms, and domestic and international futures exchanges, banks, law and accounting firms, insurance companies, pension and mutual funds, and other market users.
Other countries use regulatory bodies to monitor the industry as well. In Australia the principal regulatory agency is the Australian Securities Commission, based in Sydney. Brazil's leading regulatory body is Comissao de Valores Mobiliarios (Brazilian Security Exchange Commission), while Canada maintains the Office of the Superintendent of Financial Institutions. In Europe, which is heavily involved in commodity trading, the primary regulatory agencies are as follows: for France, the Commission des Operations de Bourse and the Conseil du Marché à Terme; for Germany, the Bundesaufsichtsamt für das Kreditwesen; for Spain, the Comision Nacional del Mercado de Valores; and in the United Kingdom, the Department of Trade and Industry (DTI) and the Securities and Investments Board. Leading Pacific Rim regulatory agencies include the Securities and Futures Commission of Hong Kong; the Ministry of Finance and the Ministry of International Trade and Industry (MITI) in Japan; the Commodities Trading Commission in Malaysia; and the Monetary Authority of Singapore.
In July 1997, the CFTC established the Office of International Affairs to help the commission respond quickly to market crises that have global implications. On 31 October 1997, regulators from 16 countries issued an agreement on certain basic principles of regulation in futures and options markets, covering contract design, market surveillance, and information sharing. CFTC chair Brooksey Born testified on 31 March 1998 before the U.S. Senate Appropriations Committee Subcommittee on Agriculture, Rural Development and Related Agencies, that those principles would help protect U.S. markets from events occurring in foreign markets and would assist in leveling the international regulatory playing field for markets and commodities professions.
Prices are not set by futures exchanges. Rather, futures exchanges are free markets where the forces that influence prices (including, but not limited to, supply and demand figures, currency exchange rates, inflation rates, and weather) are brought together in an open auction atmosphere. As the marketplace assimilates the new information that becomes available throughout the trading day, the fair market value or price as agreed upon by buyers and sellers is discovered.
The open-outcry auction market, which was first used in the nineteenth century, continued to be used in the early 2000s because it was considered by many to be the most-efficient method of assimilating new market information as quickly as possible and translating that information into a fair market price. Offers are made to buy or sell by open, competitive outcry so that any exchange member in the pit or ring can accept that offer. Agreed-upon prices are recorded and disseminated virtually instantaneously via state-of-the-art telecommunications equipment to market participants and interested observers worldwide. Although electronic platforms had supplanted open-outcry at most leading European exchanges by the early 2000s, open-outcry remained the main trading method at U.S. exchanges.
Floor brokers and floor traders in the pit or ring communicate in two ways: open outcry and standardized hand signals to confirm their verbal communications. The position of a trader's or broker's hand informs another trader or broker whether he is buying or selling: when the palm of a trader's or broker's hand faces himself, he is indicating that he "wants," or intends to buy; when the palm of a trader's or broker's hand is positioned outward, he is indicating that he "does not want," or intends to...
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