Controlling the Future A look into governing the Futures Market

1. Controlling the FutureA look into governing the Futures Market Russ Deboodt BA 543 May 18, 2011

2. Topics • Governing Futures before 1974 • 3 levels of control • Commodity Futures Trading Commission • National Futures Association, U.S. Commodity Exchanges, Clearing Organizations • Floor Level Controls (the pit) • Conclusion

3. Pre 1974 • 1848: Chicago Board of Trade (CBOT) is founded as a cash market for grain • 1859: The birth of the “Futures Trading” for corn, wheat, and oats at CBOT • 1865: Formal trading rules are created at CBOT governing margin and delivery procedures • 1868: Cutting “Corners” • 1880’s: Congress steps in • 1883: First clearing organization is created at CBOT • 1921: The Future Trading Act • 1922: The Grain Futures Act • 1923: Each clearing member is required to report the position of every large trader on a daily business • 1936: The Commodity Exchange Act • 1938: The Commodity Exchange Commission promulgates the first Federal speculative position limits for futures contracts in grains • 1963: The Great Salad Oil Swindle • 1974: The Commodity Futures Trading Commission Act

4. Commodity Futures Trading Commission “The CFTC's mission is to protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound markets.”

5. Commodity and Futures Trading Commission Independent Agency Consists of five Commissioners appointed by the President No more than 3 may be from the same political party Serve Staggered 5 years terms Co-locates near exchanges to increase oversight

6. Divisions within CFTC • Division of Enforcement • Investigates and prosecutes alleged violations • Division of Market Oversight • Foster markets that accurately reflect the forces of supply and demand • Oversees trade execution facilities • Performs market surveillance

8. Divisions within CFTC • Office of the General Counsel • Represents Commission in litigation and bankruptcy hearings • Advises Commission on application and interpretation of the CEA and administrative statutes • Division of Clearing and Intermediary Oversight • Oversees compliance of the self regulatory agencies which include: • National Futures Association • U.S. Commodity Exchanges • Derivatives clearing organizations

9. National Futures Association Created under the CFTC Designed to protect the public Regulates every firm or individual who conducts futures trading business with public customers (Futures Commission Merchant) Membership in NFA is mandatory Serve as a "one-stop" background check from government and self-regulatory sources about the disciplinary history and other background of 150,000 individuals and 10,000 firms that either are now or have been involved in the futures industry.

10. U.S. Commodity Exchanges • Designated contract markets (DCMs) • Allow access to all types of investors • May list futures and options contracts for all commodities • CBOT, CME, COMEX, KCBT • Derivatives transaction execution facilities (DTEFs) • Limit access and have lower level of regulation

11. U.S. Commodity Exchanges • Exempt Boards of Trade • Restricts transactions to eligible contract participants and commodities • CME Alternative Marketplace, Inc. and Swapstream Operating Services Ltd (cleared by CME) • Exempt Commercial Markets • Limit trading to principal-to-principal transactions between eligible commercial entities in exempt commodities • WorldPulp.com, EOXLive • Responsible for visually observing trades and have the primary responsibility for ensuring market participants are adhering to rules and regulations • Backroom audits and matching trades

12. Clearing Organizations • Futures • Both buyer and seller are obligated to perform • Clearing organization acts as both the seller and buyer • Individual Exchanges • CME Group • Combination of the CME, CBOT, and NYMEX • Provides services to other exchanges for a fee • Options • Option buyer has the right but not the obligation to perform • The option writer (seller) is obligated if buyer exercises the right • Options Clearing Organization • National Corporation • Provides clearing services to 14 exchanges vs. “A derivatives clearing organization (DCO) is a clearinghouse, clearing association, clearing corporation, or similar entity that enables each party to an agreement, contract, or transaction to substitute, through novation or otherwise, the credit of the DCO for the credit of the parties; arranges or provides, on a multilateral basis, for the settlement or netting of obligations; or otherwise provides clearing services or arrangements that mutualize or transfer credit risk among participants.”

13. Regulating the Pit • Self regulating • Members themselves oversee floor operations and conduct in each pit • Pit members do not want a poor reputation • A look into the pit

14. Conclusion • 3 tier governing system • CFTC and the NFA • Set broad overarching regulations and perform audits on individual members who trade with the public • U.S. Commodity Exchanges • Primary enforcers of futures and options regulations • Backroom audits • Clearing houses • Self regulating pits

15. Questions?