Commodity Futures Trading Commission Explained

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Commodity Futures Trading Commission (CFTC) Definition

The Commodity Futures Trading Commission (CFTC) is a federal agency in the United States charged with regulating and overseeing trade activities in the futures and options market. The agency was founded in 1974 following the establishment of the 1994 Commodity Futures Trade Commission Act. CFTC formulate regulations which ensure that the commodity future and option prices are fair; without the CFTC regulations, sellers would be having complete control of the commodity futures market which would result in the unfair prices of countless goods in the market. The goal of CFTC is to promote competitive and efficient future markets and protect investors against abusive, manipulative trade policies and fraud.

A Little More on What is the Commodity Futures Trading Commission

In general, CFTC is headed by five commissioners who serve five year terms. The commissioners are usually appointed by the president and approved by the Senate. In addition, no more than 3 of the commissioners can be within the same political party at any one time. The commission has its offices located in different cities including New York, Chicago, and Kansas City.

CFTC constitutes five committees whose focus is on agriculture, energy, global markets, technology, environmental markets, and cooperation between SEC and CFTC. The committees constitute individuals that represent the interest of specific traders, industries, commodities exchange, futures exchanges, the environment, and consumers. CFTC committees engage in numerous studies and countless research to provide consumers and investors with reasonable prices of commodity futures in the competitive market.

In the US, the trading of commodity futures is regulated by the Commodity Exchange Act (CEA) which was passed in 1936. Since then, the Act has been amended several times. CEA establishes a statutory framework under which the CFTC operates. The Act provides that CFTC has the authority to formulate directives and regulatory frameworks which are published in Title 17, Chapter I of the Code of Federal Regulations (CFR).

After the 2008 financial crisis which resulted from the unregulated swap market, the US Congress and President Obama enhanced the regulatory authority of CFTC. Since the passage of Dodd-Frank Act, Dodd-Frank Wall Street Reform and Consumer Protection Act, the commission is now overseeing over $400 trillion swap market.

Challenges facing the CFTC

The CFTC is moving away from its traditional role of regulating commodity products-related futures and options contracts to explore new challenges in the 21st century digital age.

One of the challenges that the commission faces is in relation to the new financial technology (FinTech) products and crypto-currencies such as Bitcoin. The CTFC believes that FinTech is driving innovation in the financial markets throughout the globe. New technologies are in a wide-ranging scopes have emerged including algorithm trading, cloud computing artificial intelligence, distributed ledgers, machine learning, and network cartography. These technologies are associated with transformational impact on CFTC-regulated markets. CFTC also plans to play a key role in the oversight of the emerging innovation.

CFTC plays a critical role in regulating the financial market. Lack of such regulator and its regulations can increase the risk of fraud among market participants who are exposed to unscrupulous individuals who in turn, can lose faith in the capital market. This phenomenon can make capital markets ineffective at allocating financial resources efficiently to most deserving means of productive economic activities to the detriment of consumers, investors, and the society at large.

References for Commodities Futures Trading Commission

Academic Research on Commodity Futures Trading Commission (CFTC)

  • Commodity Futures Trading Commission Act: Preemption As Public Policy, The, Johnson, P. F. (1976). Vand. L. Rev., 29, 1. This paper discusses the Commodity Futures Trading Commission Act which was introduced in 1974. The authors address the key elements of the Act including its historical developments and effects on the capital market. In details, the author discusses the legislative history of the Act including the 1973-1974 hearings, the conference, and the appointment delay. The effects of the Act are then discussed as well as the subsequent legislative efforts to balance the trading market.
  • The Exclusive Jurisdiction of the Commodity Futures Trading Commission, Russo, T. A., & Lyon, E. L. (1977). Hofstra L. Rev., 6, 57. This article illustrates how the Commodity Futures Trading Commission came into being. The authors assert that the Congress, in 1974, was determined to remove the commodities regulation from the department of Agriculture and place it under the auspices of the CFTC. It is, however, noted that one of the most controversial aspect of the amended Commodity Exchange Act was the CFTC jurisdiction, particularly the parameters of its “exclusive jurisdiction.” The author claims that challenging questions have arisen because of the exclusive jurisdiction as the amendment stipulated.
  • Index funds, financialization, and commodity futures markets, Irwin, S. H., & Sanders, D. R. (2011). Applied Economic Perspectives and Policy, 33(1), 1-31. According to this journal, policy makers and market participants believe that the index fund investment was the key drive of the commodity futures prices spike witnessed between 2007 and 2008. A group of empirical studies did not find any evidence that commodity index investment had any impact on the future prices level. Data and methods use for the studies, however, are subject to criticism that limit the confidence of the findings. The lack of empirical link between the index fund trading and commodity future prices casts considerable doubt on the theory that the price bubble was fueled by index funds.
  • International Regulatory Responses to Derivative Crises: The Role of the US Commodity Futures Trading Commission, Born, B. (2000). Nw. J. Int’l L. & Bus., 21, 607. This paper reviews the role of the Commodity Futures Trading Commission in response to derivatives crises witnessed in the US. The authors illustrate how the derivatives market, particularly the over the counter (OTC) market has become global in nature. The Commission has played a key role in overseeing the futures and commodity option trading by fostering international regulatory cooperation. The paper then addresses the crises in the capital market that result in widespread financial impact which in turn trembles the currency and equity markets.
  • The impact of index funds in commodity futures markets: A systems approach, Sanders, D. R., & Irwin, S. H. (2011). Journal of Alternative Investments, 14(1), 40-49. This article provides an overview of the debate regarding the role of index funds in the future commodity markets. According to the authors, many economists have argued that index funds are speculators of bubbles in futures prices. This is based on the premise that the sheer size of index investment overwhelms the normal functioning of markets. An empirical correlation has also been established between prices and commodity index fund positions. The authors used the US Commodity Future Trading Commission data to make the empirical analysis. This paper further asserts that Grangerstyle causality regressions offer no evidence that positions held by swap dealers affect market returns.
  • Hedgers, funds, and small speculators in the energy futures markets: an analysis of the CFTC’s Commitments of Traders reports, Sanders, D. R., Boris, K., & Manfredo, M. (2004). Energy Economics, 26(3), 425-445. This article discusses the role of the Commodity Future Trading Commission (CTFC) in the energy futures markets. The authors use Commitment of Traders (COT) data to examine futures contract of crude oil, heating oil, unleaded gasoline, and natural gas. The procedures of COT data collection are first examined, followed by the Granger causality tests to determine the correlation between the market price and trader positions. The findings reveal that there is a positive correlation between the positions help by noncommercial traders and returns. On the other hand, there is a negative correlation between market returns and commercial positions. In addition, it is evident that positive returns result in increased noncommercial net positions whereas the net long positions held by commercial hedges drops due to price increases.
  • The impact of index and swap funds on commodity futures markets, Irwin, S. H., & Sanders, D. R. (2010). This paper examines the effect of index and swaps fund participation in energy and agricultural commodity futures markets. Using new data and empirical analysis, the study reveals that index funds does not result in bubble of the agricultural futures prices. Based on Ganger causality methods, the authors find that there is no statistically significant relationship between index changes and swap fund positions and increased market volatility. It was found that there was an overwhelming evidence in the analysis of agricultural futures markets since data on index trader positions is measured with reasonable accuracy. Weak evidence is found in two energy markets that were examined because of the uncertainty of the degree to which data actually reflects index trader positions in the market.
  • Interday variations in volume, variance and participation of large speculators, Chang, E. C., Pinegar, J. M., & Schachter, B. (1997). Journal of Banking & Finance, 21(6), 797-810. The authors of this study have utilizes CFTC data to document the intraweek trading pattern of large speculators in 5 future markets. The markets include futures trades within the stock exchange market against the Standard and Poor’s 500 stock index, gold corn, bonds, and soybeans. The authors examine the influence of the large speculator trades on the volatility and volume patterns for contract samples. Although a familiar U-shaped and inverted U-shaped patterns have been detected, the association between volatility and volume becomes stronger when large speculator volume is separated from the volumes associated with other traders. It is also found that there is a larger coefficient on large speculator volume compared to the coefficient on other volume in such regressions.
  • Financialization and structural change in commodity futures markets, Irwin, S. H., & Sanders, D. R. (2012). Journal of agricultural and applied economics, 44(3), 371-396. This article provides an overview of the structural changes and financialization of the commodity future markets. The authors discuss the changes witnessed in the commodity future markets in the 21st century. They reveal that trading volumes and open interests have markedly increased during the era, and a historic change in trading and participants had also been witnessed. Existing literature also affirms that there harmful and irrational impacts of the witnessed structural changes in the commodity future markets have been minimal in the past decades. There is also little evidence that passive index investment results in massive bubble of the commodity futures prices.
  • The adequacy of speculation in agricultural futures markets: Too much of a good thing?, Sanders, D. R., Irwin, S. H., & Merrin, R. P. (2010). Applied Economic Perspectives and Policy, 32(1), 77-94. This article provides an overview of the ‘adequacy of speculation’ debate in agricultural futures markets. The authors have utilized the positions held by index funds in the reports of Commitment of Traders. It was found that index fund positions are relatively stable percentage of the total open interest between 2006 and 2008. There was no evidence of material shifts over sample period based on traditional speculative measures. Values remained within the historical ranges even after adjustments of the speculative indices of commodity index fund. An implication, according to the authors, is that markets traditionally dominated by short hedging can benefit from long-only index funds.
  • Index investment and the financialization of commodities, Tang, K., & Xiong, W. (2012). Financial Analysts Journal, 68(5), 54-74. This paper examines the correlation between index investment and financialization of commodities. According to Xiong and Tang, prices of non-energy commodity futures in the US are increasing becoming correlated with oil prices, a phenomenon that is concurrent with the rapidly growing index investment in commodity markets witnessed in the early 2000s. The finding reflects the financialization of the commodity markets and aid explaining the large increase in the price volatility of non-energy commodities in 2008.
  • A speculative bubble in commodity futures prices? Cross‐sectional evidence, Sanders, D. R., & Irwin, S. H. (2010). Agricultural Economics, 41(1), 25-32. According to this article, the recent accusations pressed against speculators and long-only commodity index funds include: increasing market volatility, distorting historical price relationships, and fueling of commodity prices. Many researchers, according to the article, have argued that these market participants may have inadvertently prevented efficient food aid distribution to deserving groups. This result counters the classical argument that prices become more efficient with speculators and as such improves the economic efficiency of the food marketing system. The authors also highlight that it is crucial to develop a clear understanding of long-only index funds and their potential market impacts. In addition, empirical evidence should be added in regard to cross-sectional market returns.

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