The futures market has evolved to encompass a wide array of assets. Commodity futures are only a small part of it, but their trading has been going on for decades. They were originally used by producers to lock in the price of agricultural goods. As time passed, the number of commodities increased, and the need to develop guidelines for commodity futures became essential. To this end, the Commodity Futures Trading Commission (CFTC) was established. By setting up an independent federal agency, the commodity space could be managed more efficiently. In terms of the diversity of assets offered, commodities continue to be the leading asset class.
What is the Commodity Futures Trading Commission (CFTC)?
The Commodity Futures Trading Commission (CFTC) is an independent body responsible for regulating the futures and options market in the United States. Any firm or person looking to participate in the commodity futures market needs to register with them. The agency looks to promote futures trading in the US and improve competitiveness and efficiency. They do so by ensuring a level playing field for all investors. The CFTC also monitors the commodities trading market for unfair practices like fraud, market manipulation, and other illegal activities. With the evolution of technology, the supervisory activity of the CFTC has become more complicated. Today trades happen at a much faster pace, opening up opportunities for potential exploits.
The scope of the CFTC has also expanded over the years. Now it covers different aspects of the commodities derivatives market. The CFTC also oversees other participants in the futures market like brokers, commodity trading advisors, and commodity pool operators. This makes their task all the more challenging. The agency also needs to monitor the activities of stakeholders outside the marketplace. For example, a commodity trading advisor who oversees a managed futures account may adopt a strategy that may not be in their client’s best interests. The CFTC also has the authority to look into the activities of asset managers and intervene if their practices are not in line with the best interests of their clients.
How is it organized?
The CFTC consists of 5 commissioners appointed by the President of the United States. One among these serves as the Chairman of the Committee. These positions are held for a tenure of 5 years, and they do not become vacant at the same time. There are also 13 divisions and offices within the CFTC. You’ll find the full list below in no particular order.
Clearing and Risk (DCR): DCR stands for Division of Clearing and Risk. This division is responsible for supervising the participants involved in the clearing process. Some of the clearing agents include swap dealers and futures commission merchants.
Enforcement (DOE): As the name suggests, the Department of Enforcement is responsible for investigating any alleged violation and proceeding with punitive measures as well.
Market Oversight (DMO): This division ensures that the markets are fair, transparent, and competitive by overseeing all the trading platforms. It also reviews any new applications and assesses whether the potential participant adheres to regulatory requirements and system standards.
Market Participants Division (MPD): This division looks into the activities of intermediaries in the derivatives market, namely commodity trading advisors, futures commission merchants, and commodity pool operators. Through its Office of Customer Education, the MPD develops educational material to support customers and prevent them from violating any rules or being victims of fraud.
Division of Data (DOD): This division is responsible for managing the data of CFTC via support analytics and other strategic initiatives.
Legal Division (LD): This division supports all of the agency’s legal functions. This includes providing legal advice and representing the CFTC in various litigations.
Division of Administration (DA): The DA manages internal functions like finance, security, and operations.
Office of the Chief Economist (OCE): This office is primarily for the conduction of research. It provides economic advice on the implementation of any new regulation. It is also responsible for training staff.
Office of International Affairs (OIA): This is the face of the CFTC in international forums. It looks into international regulatory frameworks.
Office of Public Affairs (OPA): This body is essentially the public face of CFTC on the domestic front. It provides information to the public to build trust and to communicate with different stakeholders.
LabCFTC: As trading platforms become more sophisticated, LabCFTC promotes innovation and ensures that the public knows any new innovation.
Office of Legislative and Intergovernmental Affairs (OLIA): This office acts as a bridge between the CFTC, Congress, and federal agencies. The OLIA helps in developing legislation on behalf of the CFTC.
Office of Minority and Women Inclusion (OMWI): The OMWI promotes equal opportunity and diversity at the workplace. This department also handles any issues related to civil rights.
The CFTC also has three regional offices in Chicago, Kansas City, and New York.
The History of the CFTC
When futures contracts were first developed in places like Chicago, Kansas City, and New York during the late 1800s, the commodity futures market was still fragmented. It was only during the 1970s that the scope of futures contracts increased. Futures contracts on foreign currencies, Treasury instruments, and stocks became popular during this time.
The CFTC came into existence after the Commodity Futures Trading Commission Act of 1974. This act replaced the Commodity Exchange Act of 1936. The original 1936 act had already undergone several changes before the CFTC Act passed. The primary objective of the Commodity Futures Trading Commission Act was to establish an independent agency that could oversee the commodity futures market. This gave the agency more authority to regulate the commodity futures market.
The CFTC has come a long way since the Grain Futures Act of 1922 was penned to oversee agricultural products. The number of commodities increased considerably, but there is also a wide range of other assets that the CFTC has to monitor. The agency has also been taking an active role in regulating futures related to cryptocurrencies like Bitcoin.
What does the CFTC do?
The way the CFTC is structured should give a broad indication of its major functions. With time, the scope of what the CFTC does has expanded. You’ll find a comprehensive list of what the CFTC does below:
Overseeing the commodity futures market activities: The CFTC ensures that unfair practices are not employed, and the market is transparent and fair.
Creating regulations: The legislative wing assists Congress in framing regulations governing the market it regulates. The chief economist carries out the assessment of such legislations.
Prosecuting participants who do not adhere to the rules: In addition to overseeing, the CFTC also engages in prosecuting participates in fraud, market manipulation, and other illegal activities
Protecting customers’ interest: The CFTC achieves this by keeping an eye on advisors and asset managers responsible for acting in the best interests of their clients. The commodity futures market can be a risky space to venture into, and there are times when intermediaries do not act in the best interest of their customers. The CFTC can look into the activities of these intermediaries so that customers are not deceived. The CFTC only allows credible market participants so that investors do not have to worry about losing their money.
Engaging with external bodies: As friction among markets worldwide eases, it becomes essential to understand how other markets operate. The CFTC engages with local bodies like the FRB and is also involved in consultations with other international bodies.
Educating the customers: There have been numerous instances in which clients have become victims of fraud and other inappropriate activities. In most cases, these people were not aware of the products that they had invested in. The CFTC updates and provides educational content so that investors do not lose wealth because of unscrupulous agents.
Pioneering digital initiatives: The transition from a physical platform to an online platform has made it easy for market participants. One can expect that in some time, all commodity futures contracts would be settled online. The CFTC has constantly been trying to develop strategic changes that make the trading of futures smoother. A robust digital platform also ensures better governance and improved risk management capabilities.
Providing ancillary services: These could include data analytics and other consultation papers that can provide insights into the commodity futures market. The CFTC has also been proactive in bringing digital assets like Bitcoin under its jurisdiction and categorizing it as a commodity.
What does the CFTC regulate?
The Commodities Exchange Act is still the regulatory framework governing commodity futures in the United States. The list of participants the CFTC regulates includes the following:
Trading Organizations: These include Designated Contract Markets (DCM) and Swap Execution Facilities (SEF). DCMs are essentially exchanges that list commodity futures and options and allow traders to participate. SEFs cater to the swap market. The CFTC reviews each DCM and SEF regularly to establish compliance with all the rules and regulations.
Clearing Organizations: The Derivatives Clearing Organization (DCO) must comply with the core principles of the CEA, which states that the DCO should be adequate in terms of operational and financial resources. The DCO should have robust risk management systems and have efficient rules to deal with default.
Data Repositories: The facility to store data is given to SDRs or Swap Data Repositories. The data includes storage of trades both cleared as well as uncleared.
Intermediaries: The CFTC regulates a wide array of intermediaries. These intermediaries act as agents for other people when dealing with futures, swaps, and options. The intermediaries coming under the purview of CFTC are:
Commodity Pool Operator (CPO): Commodity pools are funds that trade in commodities. The CPO acts as an agent that helps raise funds.
Commodity Trading Advisor (CTA): Funds or individuals hire them to provide advice on commodity futures, options, or swaps.
Futures Commission Merchant (FCM): FCMs accept the order to purchase or sell any commodity for future delivery.
Introducing Broker (IB): An Introducing Broker places an order on behalf of a client
Major Swap Participant (MSP): MSP is not a swap dealer but an agent who holds a significant position in any major swap category.
Swap Dealer (SD): Acts as a dealer or market maker for swaps. SDs could also directly enter swaps as the normal course of their business.
In addition to the nature of market participants in the commodity futures space, the CFTC can also determine which commodities you can trade via futures. There was a time when the commodity futures market only consisted of a few assets. Nowadays, US exchanges even offer foreign products. The CFTC has also been responsible for regulating futures on cryptocurrencies. Over time, the CFTC has expanded. The number of products that it managed has also increased at a very rapid rate.
How does the CFTC affect Futures Trading?
The CFTC affects the futures trading business in multiple ways. As a regulator, it ensures that the market is a level playing field for all the participants. It ensures enough liquidity and keeps on upgrading the list of products offered based on what the economy needs. The CFTC has led the digitalization of trades. Today trading mainly happens through online channels, and their contributions are undeniable. The open outcry channels that once used to dominate the market have become outdated. Trading pits are so rare they’re almost non-existent.
The CFTC also plays a critical role in expanding the commodities futures market by drawing the interest of foreign investors. It’s not a surprise that the commodity futures market in the US is the most active. The underlying assets for the futures they offer can be very diverse. The volume has also increased, and the execution time and efficiency of trading platforms have improved considerably.
The CFTC also keeps a check on fraudulent activities. They do so via risk management systems that keep tabs on the activities of traders. It also ensures that anyone looking to obtain a license should have adequate technology in place. By collaborating with international regulators, the CFTC has also helped reduce the friction existing between markets. There has been an influx of foreign investors in the US market due to this, making the market more liquid.
How does the CFTC enforce its rules?
The CFTC acts as an independent agency responsible for regulating the commodity futures market in the United States. While the onus of framing legislation lies with Congress, the CFTC plays an active role in providing advisory support. Laws concerning commodity futures rarely pass without involving the CFTC in the discussion.
The CFTC can also cancel the registration of participants who fail to comply with the regulations specified in the acts that govern commodity futures trading. It also has the discretion not to approve the application of a market participant if it deems them to be unfit. Furthermore, the CFTC can initiate legal proceedings against those who break the rules and engage in unfair practices like market manipulation, fraud, terrorist financing, etc. The agency imposes hefty fines on bad actors who use illegal means to profit from futures trading.
The CFTC has assumed a major role in the development of the commodity futures market. It is a key factor in ensuring that commodity trading will continue to thrive in the future. As an independent regulator, the CFTC has shown how effective a dedicated regulator can be at meeting the requirements of specific markets. Soon, all eyes will be on how the CFTC handles the digital asset space and whether it can manage to further develop this market.
There is a lot of development in the fintech space as well. That’s why the CFTC has a dedicated office to look into this sector. It would be interesting to see how the agency incorporates advanced computing techniques like big data and artificial intelligence in the commodity futures market. Such innovations can assist the regulator in maintaining oversight of the trading activities and detecting any fraudulent activities immediately. It will also improve their analytics capabilities.
The CFTC also faces pressure from other global markets looking to grab a greater share of the international futures market that US exchanges dominate. Whether it can manage to maintain the status quo of US hegemony in the futures market remains to be seen. For further reference, you can check out their official site here.
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