The Role and Responsibilities of an Introducing Broker
An Introducing Broker (IB) is an industry term for a commodity broker or futures broker. An introducing broker is a brokerage firm that deals directly with the client, while the trade execution and back office work are the responsibility of a Futures Commission Merchant (FCM). Another term for an FCM is a clearing firm.
Each introducing broker has a relationship with an FCM. The FCM has a direct connection with the futures exchanges to execute trades. FCMs supply trading platforms on which clients have the ability to place trades online. FCMs are responsible for account management. One of the most important features of an FCM is that they deposit all customer funds in customer segregated accounts.
IBs typically operated out of smaller offices located all over the country. IBs solicit business for FCMs. Many IBs are one-person operations, while others are larger, multi-location businesses. IBs are better able to service their clients as they are local, and their primary goal is customer service. An FCM focuses on executing trades and the maintenance of trading infrastructure. Outsourcing the prospecting and servicing of clients to the IBs creates economies of scale for FCMs and the futures industry.
Most IBs do not have the financial resources to execute trades for their clients directly. Direct execution of trades requires a direct relationship with futures exchanges as well as the maintenance of daily accounting of client trades and balances, the creation and servicing of trading platforms and many other expenses that can become prohibitive.
The majority of FCMs would find it financially impossible to open offices around the country. Many brokers operate in rural areas for hedging clients, spread out all over the United States. If it were not for IBs, FCMs would need to hire brokers and maintain offices, which is an expensive and inefficient method of operating a futures business. IBs allow FCMs to do business on a local basis while using the FCM's infrastructure for trading.
IB's have a direct relationship with an FCM. The FCM will charge the IB a fee for each trade, allowing the IB to participate in the costs of services associated with the FCM's business.
An IB will add a profit margin to the amount charged by the FCM to compensate for their services. Some full-service commodity brokers might charge high fees per round turn in brokerage commissions.
The amount of commission is a function of trading volume, the more transactions the less the per trade commission rate. Rates are negotiable and larger IBs typically charge lower rates than smaller ones.
One of the main expenses of an introducing broker is advertising. Some brokers focus on their local market and depend on referral business. However, most brokers have to spend a lot of money on advertising to bring in clients and constantly replace the clients who lose their money.
Many commodity traders do not remain in the market for more than six months. Brokers who make profitable trade recommendations tend to retain customers and make more money in the long-run.
Online futures trading has become more competitive among brokers over recent years and profit margins have declined. Those who trade online are typically short-term traders that do many transactions.
These active traders tend to seek the lowest rates possible. Some online brokers make only a few cents on each trade. Volume is the most important consideration for online commodity brokers.
The chances are that when you open a commodities trading account, it will be with an introducing broker. Clearing firms employ brokers who can directly service accounts, but the majority of an FCMs business comes from introducing brokers. The term commodity broker typically refers to an introducing broker. IB is the official designation by the CFTC for brokerage firms that are not FCMs.
The IB does not directly execute and customer orders rather it forwards them to an FCM. In the wake of increased regulation of the market over recent years and the Dodd-Frank legislation, IB’s are closely regulated these days. FCM’s spend a great deal of time vetting and monitoring IB’s via their compliance and legal departments.