The Story Behind the Financial
Integrity of the U.S. Futures Markets
Trading volume in futures contracts and options on futures
on U.S. markets has risen to more than 500 million contracts
annually. And the dollar value of futures contracts traded
currently exceeds severalfold the dollar value of common
stocks traded on all U.S. stock exchanges.
A requisite for this growth has been the financial integrity
of futures markets. While trading in futures contracts obviously
involves risks related to price changes, market participants
have historically had little reason to be concerned about
the security of their funds. Customer losses due to the
insolvency of a futures brokerage firm have been virtually
non-existent. Indeed, such losses have totaled less over
50 years than the Securities Investor Protection Corporation
has paid, on the average, to reimburse customers of the
securities industry for member firm insolvency losses each
year. For anyone considering participation in the nation's
futures markets, the reasons behind this continuing and
impressive record of financial soundness are worth knowing
about.
Daily Cash Settlement
As futures prices move upward and downward, the market value
of customers' open positions increases and decreases. Resulting
gains and losses from futures trading are credited or charged
to each customer's account each day following the close
of trading. Subject to existing margin requirements, all
gains deposited to a customer's account through this procedure
become immediately available to the customer.
Margin Requirements
Buyers and sellers of futures contracts are required to
at all times maintain sufficient funds on deposit in their
brokerage accounts to cover losses that might be incurred
as a result of price changes. Margin deposits provide protection
for all market participants. In volatile markets, the exchanges
increase margin requirements accordingly. The availability
of such funds is what makes daily cash settlements possible
under all market conditions.
The Exchange Clearing Houses
Once each purchase of a futures contract is precisely matched
to the corresponding sale (a process which occurs each day),
the clearing organization of the exchange where the contracts
are traded becomes the "buyer to every seller and the
seller to every buyer." The purpose: provide a mechanism
that assures the payment of all gains and collection of
all losses on a daily basis.
Capital Requirements
Every firm that conducts business with the public as a Futures
Commission Merchant must have and maintain sufficient capital
to meet its financial obligations to its customers. These
requirements are subject to continuous audit and stringent
enforcement. Regulatory agencies have the authority to determine
compliance on a daily basis and in volatile markets clearing
organization can demand that a firm provide additional capital
on one hour's notice!
Segregated Accounts
Firms and principals of firms in the futures industry are
required to maintain their customers' funds and margin deposits
in bank accounts which are totally separate from their own.
Rules further stipulate that such funds can be used only
for the purposes the customers intended and can at no time
be commingled with the firm's funds or the funds of the
firm's principals. Compliance is strictly enforced and regulators
possess power to take such immediate action as is considered
necessary to protect the security of customers' money.
Transfer of Market Positions
Should a firm be determined to be in a financial situation
that could potentially jeopardize the safety of its customers'
funds, it can be directed to immediately cease operations
and transfer all open customer positions in the market to
a firm which is financially sound. This is to ensure that
adequately margined positions with a troubled firm will
not be liquidated at a time when the customer may not wish
for them to be liquidated.
Regulation
Regulation of the U.S. futures industry is primarily self-regulation,
with the role of the federal Commodity Futures Trading Commission
being principally an oversight role (to determine that self-regulation
is continuous and effective). Of the total expenditures
on futures regulation, more than three-fifths of the cost
is presently being paid by the exchanges where futures contracts
are traded and by National Futures Association (NFA), the
industrywide self-regulatory organization authorized by
Congress and established in 1982. The purpose of self-regulation
is to assure that those who conduct futures trading business
with the public do so in a professional, ethical and honest
manner.
NFA's responsibilities include screening, testing and registering
persons applying to conduct business in the futures industry.
NFA and the exchanges have responsibility for auditing and
enforcing compliance with industry rules. These rules encompass
financial requirements, segregation of customers' funds,
accounting procedures, sales activities and, in the case
of the exchanges, floor trading practices.
Although there is no guarantee against customer losses due
to the insolvency of a futures brokerage firm, the above
mechanisms are designed to ensure the financial integrity
of this nation's futures markets, and have in fact minimized
the risk of customer losses.
National Futures Association
200 W. Madison Street, Suite 1600
Chicago, Illinois 60606-3447
1.800.621.3570.
www.nfa.futures.org