Futures markets are exchanges where standardized contracts trade in an open and transparent environment. One of the most important roles, when it comes to the business transacted on these exchanges, is that of the FCM.
An FCM is a Futures Commission Merchant. An FCM is an individual or organization that solicits and/or accepts orders to buy or sell futures contracts, options on futures contracts, retail foreign exchange contracts or swaps and accepts money or other assets from customers to support such orders. An FCM also has the responsibility of collecting margin from customers.
Commodity Futures Trading Commission
The Commodity Futures Trading Commission (CFTC) regulates FCM's. Any person or company that executes futures contracts on behalf of another must register with the National Futures Association. There are certain exemptions from registration. For example, if a firm or individual handles transactions only for themselves or their firm itself or their firms affiliates, top officers, directors or if they are a non-U.S. resident or firm with only non-U.S. customers and the individual or firm submits all trades for clearing to a regulated FCM that firm or individual would not have to register.
There are many rules and regulations that apply to FCM's, these rules became more stringent after the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Customers who trade futures through an Introducing Broker (IB) have their trades executed and cleared through an FCM. The largest FCMs are generally banks and financial institutions with many diverse business lines. However, some FCM's only operate within the confines of the futures business. One of the most important rules governing FCMs is that the CFTC prohibits them from mixing their own funds with funds belonging to their customers. FCMs must segregate all customer funds. This rule protects the firm's clients from losses. The case of a firm, MF Global illustrates why this rule is so important.
MF Global was an FCM that traded for its own account. When trades went against the firm, they lost a lot of money. After an investigation, the CFTC found that MF Global had mixed the firm's own money with money collected from customers. In October 2011, the firm transferred almost $900 million from customer accounts to its broker-dealer to cover losses on the firm's proprietary trades. Therefore, when MF Global went bankrupt in 2011 the customers of the firm lost their own money. Had MF Global followed the rules and segregated their customer's funds the firm might still have gone bankrupt because of the bad trades but their customers would not have suffered losses, the rules would have protected them. While many of the customers of MF Global eventually got their money back, it took almost two years to sort through the mess. As you can see, there are important reasons for rules and regulations in the volatile futures industry. Regulators design these rules primarily to protect customers.
FCMs must submit to audits and demonstrate sufficient levels of capital to run their businesses. Additionally, employees of FCM's must demonstrate proficiency in the business of futures trading and submit to background checks. Trading and investing in futures markets has attracted increasing numbers of participants over recent years. Futures markets tend to be more volatile than other asset markets and they operate with a high degree of leverage. Only a small amount of margin (a performance bond) is necessary to initiate a futures position. Without regulated Futures Commissions Merchants controlling the flow of business to exchanges, the potential for abuses would be enormous. Futures brokers are usually employees of or affiliated with an FCM. This streamlines the operation of activity that transpires on the exchanges. It creates an environment where effective regulation and oversight is possible. Futures Commission Merchants play a pivotal role in the volatile world of futures trading.