New investors to the futures world often ask, “How does opening an account work?” It is a good question. Unlike traditional brokerage accounts, the rules of margin, how trades clear, and the counterparties involved operate differently. A Futures Commission Merchant, typically called by its FCM acronym, is a key player working between all the various players in a transaction. As firms merge, it is important for clients to understand what role they play as it relates to their investments.
Account Opening and Trading Workflow
When an investor decides to open a futures account, one of the first choices is the FCM. This is where their account will be traded. Firms may be publicly traded in the case of StoneX or an ADM (Archer Daniels Midland), or privately held like RJ O’Brien (recently acquired by StoneX). Once chosen, the customer fills out FCM paperwork to ensure that they qualify to trade, understand the risk, and pass background checks for anti-money laundering as required by the CFTC (Commodities Futures Trading Commission). Alongside this, manager paperwork is completed for each CTA chosen. These operate independently in separate sub-accounts with limits set forth for each unit. Traders can be cross-margined for efficiency and each sub-account can be viewed down to the trade and cash level every night on a report sent from the FCM.
Assets for each FCM are held at a third-party bank in a segregated account. This means the funds never get sent to a brokerage firm or individual trader. This provides important protection by limiting access to cash movement without layers of approval. When a trade is submitted, margin is moved from the segregated account, through the FCM, and to the exchange where the collateral is ultimately held. Once the trade is closed, the process flows back, plus or minus profits accrued from the trade.
What the FCM Actually Does
While the process may sound simple at a high level, it is actually quite complex. Traders submit their trades to the FCM using a multitude of trading systems and platforms. Some connect directly to the FCM through an API (Application Programming Interface) for higher-frequency trading, which allows direct order submission. Others will route their executions through their platform to the order management system of the FCM, which then connects to the exchange. CQG, Ninja Trader, Cunningham Trading Systems, and Trading Technologies are a few examples of popular options that traders use. The merchant acts as the clearing service, guaranteeing both sides of trade settlement. Exchanges benefit from this arrangement with a reliable partner who complies with the extensive rules of the CFTC.
A key safeguard for the CME and other exchanges is that the FCM takes on the risk of a client failing to meet their obligation to cover margin. This makes the FCM’s risk management systems vitally important to the operation of a market. By issuing margin calls, tracking exposure, and calculating the client’s ability to cover losses, they can act in real time. While rare, this might include closing trades or freezing accounts entirely. By doing so, they protect not only their business but also other clients that depend on their ability to shield them from contagion across accounts. Failure to maintain sufficient reserves or comply with regulations can result in heavy fines to the FCM issued by the CFTC or the NFA.
Why Consolidation Is Happening
With increasing regulations, including Sarbanes-Oxley and the Dodd-Frank Act, to name a couple, legal expenses and compliance costs continue to increase. The speed of markets poses an additional threat as events like the May 2010 Flash Crash and February 2018 Volmageddon display reasons for caution. These sharp movements shift billions in positions so quickly that ever more advanced computer systems are needed to keep up. Diversifying a client base and therefore spreading positions across additional markets is helpful as well. My hope for the RJO and StoneX merger is that they adopt the RJO client interface. This portal is easy to operate, shows live positions, and can be used to easily access past reports. The StoneX system, by contrast, seems archaic and difficult to use despite many tries at improvement.
The Road Ahead
I expect fewer firms going forward. While this limits customer choice, it will make it easier for regulators to focus on a discrete number of players. These FCMs will continue the process of ever-smaller trading costs driven by evolving technology, providing savings to all market participants. The fear is that less competition might affect customer service and responsiveness. This is something we track daily through our interactions with the various departments across companies. Our goal, as always, will be to explain the pros and cons of each choice so our customers can make informed decisions.
Photo by Sean Pollock on Unsplash