The Commodity Futures Trading Commission (CFTC) is a federal agency of the US that was set up to ensure the open and efficient operation of the futures market. It was established in 1974 under the Commodity Futures Trading Commission Act to protect both investors and the market as a whole from fraud, manipulation, abusive practices and other systemic risks present in the commodity futures market.
It was set up at a time when most futures trading took place in the agricultural sector, although its regulatory authority has now expanded to a wide range of asset classes in the derivatives market—which includes futures contracts, swaps, and options.
Given how central the US is to the global futures and derivatives market—after all, it was here that futures contracts were traded for the first time—the Commodity Futures Trading Commission is an important regulator with a global reach. As such, if you plan on dabbling in futures, options, swaps, or other kinds of derivatives, it is worth having a basic understanding of who the CFTC is and what they do.
In this article, we will give you a quick history of the CFTC and set out some of the powers it has.
Background to the Commodity Futures Trading Commission
The CFTC was set up in 1974 and originally had responsibility for overseeing and regulating the commodity futures and options markets within the US. Under the terms of the Commodity Futures Trading Commission Act of 1974, the primary focus of the CFTC was initially to become a federal regulator of the global derivatives market. The CFTC now has a wide remit and regulates essentially all types of derivatives, as well as the trading of the underlying assets in certain cases.
The remit of the CFTC has expanded over time, and now also covers non-US futures exchanges that permit access to trading by US persons, as well as swap transactions that have a direct connection with commercial activities in the US.
Futures contracts had been traded in the US since the mid-1800s, with federal regulations in place since the 1920s under the Grain Futures Act of 1922. This was enhanced by the Commodity Exchange Act of 1936.
As futures trading expanded beyond agricultural products – particularly from the 1970s onward – there was a need to create new regulations to capture this new market. This included futures on foreign currencies, US and foreign government securities, and stock indices, among others.
As a result, Congress created the CFTC in 1974 as an independent federal regulatory agency under the Commodity Futures Trading Commission Act of 1974, which replaced the US Department of Agriculture Commodity Exchange Authority.
The CFTC’s mandate was further expanded and refined by the Commodity Futures Modernization Act of 2000, as well as the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
What Does the Commodity Futures Trading Commission Do?
The CFTC has the power under the Commodity Futures Trading Commission Act of 1974 to regulate the US derivatives market. But what exactly is the derivatives market?
A derivative is essentially a financial contract between two or more parties that derives its value from the value of an underlying asset or group of assets. The derivative contract is set between two or more parties that can trade on ‘over-the-counter’ (i.e., a broker-dealer network) or a centralised exchange.
Derivatives contracts can be used to trade a wide variety of assets, with the most common being stocks, bonds, commodities, currencies, interest rates and market indexes.
Derivatives have a long history, with the first commodity derivatives having been traded at the Chicago Board of Trade in 1849. The first financial derivatives trading did not occur until 1972 when the Chicago Mercantile Exchange started trading futures contracts on foreign currencies.
Since then, the derivatives market has expanded considerably. According to recent figures, it was estimated to be worth around $12.4tn at the end of 2021.
Following the financial crisis of 2007-2008, wide-ranging reforms were brought in via the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which delegated rule-making and regulatory oversight to the CFTC.
Traders are interested in derivatives for a number of reasons, including:
- Hedging or mitigating risk, particularly counterparty risk
- Obtaining exposure to an underlying asset where it can’t be traded by itself
- Providing leverage
- Locking in prices
Who and What Does the Commodities Future Trading Commission Regulate?
The CFTC regulates the activities of trading organisations and swap execution facilities. Trading organisations are the organisations that host futures trading markets, while swap execution facilities are essentially platforms that facilitate the buying and selling of swaps.
The CFTC also oversees the Options Clearing Corporation, which operates under the jurisdiction of the CFTC, as well as swap data repositories.
The CFTC also has a major role in overseeing the activities of all intermediaries, which are entities that act as agents in the buying/selling of futures, swaps and options. This includes commodity pool operators, commodity trading advisors, futures commission merchants, swap dealers and introducing brokers.
Commodity Futures Trading Commission Divisions
The CFTC is a large institution that has a complex institutional structure. It consists of the offices of the Chairman and Commissioners of the CFTC, as well as the 13 operating divisions and offices that make up the organisation.
The five main divisions of the CFTC are:
- Division of Clearing and Risk: Enables the CFTC to meet its responsibility to ensure the financial integrity of transactions that fall under the Commodity Exchange Act and help to mitigate risk in the derivatives market. It also oversees all derivative clearing operations.
- Market Participants Division: Set up following the merger of the Division of Swap Dealer and Intermediary Oversight and the Office of Customer Education and Outreach, it has a responsibility to oversee organisations regulated by the CFTC that conduct dealing, trading, investment and advisory operations in the derivatives market. It also educates the public about the derivatives market.
- Division of Market Oversight: Oversees the stability and overall structure of the derivatives market and the exchanges where derivatives trading is undertaken. It also has the responsibility for developing and implementing regulations that promote the functioning and operation of the derivatives markets and responding to any new challenges.
- Division of Data: Performs analytic functions and collects data on the derivatives market. This information is used to inform the operations of the other divisions.
- Division of Enforcement: Has a responsibility to detect, investigate and prosecute any violation of the Commodity Exchange Act of the CFTC regulations.
Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC): What’s the Difference?
Although the two organisations have very different remits, the CFTC and the SEC are often confused.
While the CFTC oversees the operation and functioning of the derivatives market – which includes options and futures on agricultural products, metals and forex – the SEC regulates the US stock market. The SEC was set up back in 1934 in response to the 1929 stock market crash, while the CFTC was established in 1974.
To fulfil this role, the SEC ensures that the financial workings of US companies are made transparent, which allows investors to get accurate and consistent information about companies listed on stock exchanges.
Transparency about this kind of information is essential to the functioning of US stock exchanges, as it allows individual and institutional investors to make sound determinations about investing in companies. This understandably has a close relationship to the US economy as a whole.
The SEC also has responsibility for punishing insider traders, the intentional manipulation of the markets, and selling stocks or bonds without proper registration to do so.
Commodity Futures Trading Commission: Present and Future Challenges
As the derivatives market has expanded, regulation of the futures and options market has become much more complex. As a result, the CFTC has seen a gradual evolution in its role as a regulator of more traditional commodity futures products toward newer financial assets. We have seen this in relation to digital currencies such as Bitcoin, with a first Bitcoin futures contract launched in December 2017.
While fintech such as Bitcoin and other digital currencies has brought innovation to the futures market, however, it has also brought challenges. In particular, responding to new technologies such as cloud computing, high-speed algorithmic trading, artificial intelligence and the blockchain is difficult when the process of creating new regulations can be quite slow. This presents an obvious difficulty for an institution such as the CFTC, which has an important role in responding to these technologies to properly regulate the financial markets.
If there are any failures in regulation in response to these new technologies, however, this can undermine the integrity of the markets as a whole, causing investors to lose faith. As such, being responsive to these emerging technologies, while also protecting the integrity of the financial markets, will be an important challenge that the CFTC will continue to face.
To do so, the CFTC will require sufficient funding in the federal budget. However, some have argued that the CFTC does not receive proper funding compared to other federal regulatory agencies. The CFTC requested a staggering $365m from Congress in 2022, which was a 20% increase from the previous fiscal year. One of the justifications for this increase was the desire to expand the CFTC’s role in policing cryptocurrency trading.
The Commodity Futures Trading Commission was established to protect the American public from fraud, manipulation, and other abusive practices related to the sale of commodities and financial futures and options. It also has a responsibility for fostering the operation and functioning of the market, particularly in ensuring it is competitive and financially sound.
Some of the functions it fulfils include investigating and prosecuting various types of commodities fraud—such as foreign currency schemes, energy manipulation, and hedge fund fraud. Given how important the US is to the global derivatives market, the CFTC fulfils an important role both domestically and internationally and works with various domestic and international partners to bring criminal and other investigative actions.
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