Futures For You
INSIDE THE FUTURES WORLD
Want to learn how the futures markets really work? Dan O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com), responds to your questions about today's futures markets.
To submit a question, post your question to our website at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
THE SAFETY OF YOUR TRADING FUNDS
Following the recent bankruptcy filing of heavyweight futures broker Refco, many traders have expressed concern about the safety of their trading funds and about the financial stability of the entire industry. While a certain degree of anxiety is to be expected, these fears have been vastly overblown. The truth is, the futures industry's consistent record of financial soundness has been nothing less than remarkable. It's a story worth telling.
For starters, it's important to point out that the financial integrity of the US futures industry is of paramount importance to the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). Both agencies enforce strict regulations designed to safeguard customer trading funds. Futures brokers, too, recognize the importance of financial stability and customer protections. Everyone in the industry understands keenly that without adequate financial protections, you simply won't have the confidence to trade our markets. Let's get specific about how the system works.
Daily Cash Settlement: As futures prices move up and down each day, the market value of customers' open positions increases and decreases. Each day, resulting gains and losses from futures trading are credited or charged to every customer's account, following the close of trading. This mark-to-market system doesn't allow losses to accumulate, and stands in direct contrast to many other financial markets, in which market participants regularly assume credit exposure to each other.
Margin Requirements: Each futures exchange sets minimum margin requirements for all products traded through its facilities, and adjustments are periodically made to account for various factors, including volatility and current or anticipated market conditions. Buyers and sellers of futures contracts are required to maintain the prescribed margin -- or good-faith collateral -- in their brokerage accounts to cover any losses that might arise as a result of their trading. The availability of such funds is what makes daily cash settlements possible under all market conditions.
Exchange Clearing Houses: In every matched transaction executed through the facilities of a regulated futures exchange, the clearing organization of the exchange is substituted as the buyer to every seller and the seller to every buyer. In other words, the exchange's clearing organization becomes, in effect, the counterparty to each of your trades. The purpose is to provide a mechanism that ensures the payment of all gains and collection of all losses on a daily basis. As a trader, you needn't worry about the creditworthiness of the party on the other side of your trades.
Segregated Accounts: Every futures brokerage company is required to hold customer trading funds in a "customer segregated funds account," totally separate from their own corporate bank accounts. This is one of the industry's cornerstone protections. 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.
Capital Requirements: Finally, every firm conducting business with the public as a Futures Commission Merchant (FCM) must meet demanding financial requirements and is audited continuously. In fact, every licensed FCM that maintains customer-segregated funds must file financial reports every morning with industry regulators; in volatile markets, any exchange's clearing organization can demand that a firm provide additional capital with just one hour's notice! If there's another industry that's subject to greater scrutiny, more aggressive auditing, and tighter controls, we're not aware of it.
That said, there's no reason to be concerned about the safety of your trading funds or the futures industry in
general, even if the 800-pound gorilla in the industry has filed for bankruptcy. Thanks to all the protections described above, customer funds held in Refco's regulated futures trading unit are perfectly safe, and more generally, customer losses due to the insolvency of a futures brokerage firm have been virtually nonexistent over time. In fact, such losses have totaled less over 50 years than the average amount paid out yearly by the Securities Investor Protection Corp. (SIPC) to reimburse customers of the securities industry for member firm insolvency losses! The futures industry's system works.
Originally published in the January 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2005, Technical Analysis, Inc.
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