Futures exchange
A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts defined by the exchange. Futures contracts are derivatives contracts to buy or sell specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. Futures exchanges provide physical or electronic trading venues, details of standardized contracts, market and price data, clearing houses, exchange self-regulations, margin mechanisms, settlement procedures, delivery times, delivery procedures and other services to foster trading in futures contracts. Futures exchanges can be integrated under the same brand name or organization with other types of exchanges, such as stock markets, options markets, and bond markets. Futures exchanges can be organized as non-profit member-owned organizations or as for-profit organizations. Non-profit, member-owned futures exchanges benefit their members, who earn commissions and revenue acting as brokers or market makers; they are privately owned. For-profit futures exchanges earn most of their revenue from trading and clearing fees, and are often public corporations.
Role in futures contracts standardization
Futures exchanges establish standardized contracts for trading on their trading venues, and they usually specify the following: assets to be delivered in the contract, delivery arrangements, delivery months, pricing formula for daily and final settlement, contract size, and price position and limits. For assets to be delivered, futures exchanges usually specify one or more grades of a commodity acceptable for delivery and for any price adjustments applied to delivery. For example, the standard deliverable grade for CME Group's corn futures contract is "No. 2 Yellow", but holders of short positions in the contract can deliver "No. 3 Yellow" corn for 1.5 cents less than the contract delivery price per bushel. The locations where assets are delivered are also specified by the futures exchanges, and they may also specify alternative delivery locations and any price adjustments available when delivering to alternative locations. Delivery locations accommodate the particular delivery, storage, and marketing needs of the deliverable asset. For example, ICE frozen concentrate orange juice contracts specify delivery locations as exchange-licensed warehouses in Florida, New Jersey, or Delaware, while in the case of CME live cattle contracts, delivery is to exchange-approved livestock yards and slaughter plants in the Midwest. The futures exchange also determines the amount of deliverable assets for each contract, which determines a contract's size. Contract sizes that are too large will dissuade trading and hedging of small positions, while contract sizes that are too small will increase transaction costs since there are costs associated with each contract. In some cases, futures exchanges have created "mini" contracts to attract smaller traders. For example, the CME Group's Mini Nasdaq 100 contract is on 20 times the Nasdaq 100 index.Clearing and margin mechanisms
Futures exchanges provide access to clearing houses that stand in the middle of every trade. Suppose trader A purchases of gold futures contracts from trader B. The reality is that Trader A has bought a futures contract to buy of gold from the clearing house at a future time, and trader B has a contract to sell to the clearing house at that same time. Since the clearing house has taken on the obligation of both sides of that trade, trader A does not have to worry about trader B becoming unable or unwilling to settle the contract – they do not have to worry about trader B's credit risk. Trader A only has to worry about the ability of the clearing house to fulfill their contracts.Even though clearing houses are exposed to every trade on the exchange, they have more tools to manage credit risk. Clearing houses can issue margin calls to require traders to deposit Initial Margin moneys when they open a position, and to deposit Variation Margin moneys when existing positions experience daily losses. A margin in general is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty, in this case the central counterparty clearing houses. Traders on both sides of a trade have to deposit Initial Margin, and this amount is kept by the clearing house and not remitted to other traders. Clearing houses calculate day-to-day profit and loss amounts by 'marking-to-market' all positions by setting their new cost to the previous day's settlement value, and computing the difference between their current day settlement value and new cost. When traders accumulate losses on their position such that the balance of their existing posted margin and their new debits from losses is below a threshold called a maintenance margin at the end of a day, they have to send Variation Margin to the exchange, which passes that money to traders making profits on the opposite side of that position. When traders accumulate profits on their positions such that their margin balance is above the maintenance margin, they are entitled to withdraw the excess balance.
The margin system ensures that on any given day, if all parties in a trade closed their positions after variation margin payments after settlement, nobody would need to make any further payments, as the losing side of the position would have already sent the whole amount they owe to the profiting side of the position. The clearing house does not retain any variation margin. When traders cannot pay the variation margin they owe or are otherwise in default, the clearing house closes their positions and tries to cover their remaining obligations to other traders using their posted initial margin and any reserves available to the clearing house. Several popular methods are used to compute initial margins. They include the CME-owned SPAN, STANS, and TIMS.
Traders do not interact directly with the exchange – they interact with clearing house members, usually futures brokers, who pass contracts and margin payments on to the exchange. Clearing house members are directly responsible for initial margin and variation margin requirements at the exchange even if their clients default on their obligations, so they may require more initial margin from their clients than is required by the exchange to protect themselves. Since clearing house members usually have many clients, they can net out margin payments from their client's offsetting positions. For example, if a clearing house member has some of their clients holding a total of 900 long position in a contract, and some other clients holding a total of 500 short position in a contract, the clearing house member is only responsible for the initial and variation margin of a net 400 contracts.
Nature of contracts
Exchange-traded contracts are standardized by the exchanges where they trade. The contract details what asset is to be bought or sold, and how, when, where and in what quantity it is to be delivered. The terms also specify the currency in which the contract will trade, minimum tick value, and the last trading day and expiry or delivery month. Standardized commodity futures contracts may also contain provisions for adjusting the contracted price based on deviations from the "standard" commodity, for example, a contract might specify delivery of heavier USDA Number 1 oats at par value but permit delivery of Number 2 oats for a certain seller's penalty per bushel.Before the market opens on the first day of trading a new futures contract, there is a specification, but no actual contracts exist. Futures contracts are not issued like other securities, but are "created" whenever open interest increases; that is, when one party first buys a contract from another party. Contracts are also "destroyed" in the opposite manner whenever open interest decreases because traders resell to reduce their long positions or rebuy to reduce their short positions.
Speculators on futures price fluctuations who do not intend to make or take ultimate delivery must take care to "zero their positions" prior to the contract's expiry. After expiry, each contract will be settled, either by physical delivery or by a cash settlement. The contracts ultimately are not between the original buyer and the original seller, but between the holders at expiry and the exchange. Because a contract may pass through many hands after it is created by its initial purchase and sale, or even be liquidated, settling parties do not know with whom they have ultimately traded.
Regulators
Each exchange is normally regulated by a national governmental regulatory agency:| Country or territory | Agency |
| Australia | Australian Securities and Investments Commission |
| Chinese mainland | China Securities Regulatory Commission |
| Hong Kong | Securities and Futures Commission |
| India | Securities and Exchange Board of India |
| South Korea | Financial Supervisory Service |
| Japan | Financial Services Agency |
| Pakistan | Securities and Exchange Commission of Pakistan |
| Singapore | Monetary Authority of Singapore |
| UK | Financial Conduct Authority |
| US | Commodity Futures Trading Commission |
| Malaysia | Securities Commission Malaysia |
| Spain | Comisión Nacional del Mercado de Valores |
| Brazil | Comissão de Valores Mobiliários |
| South Africa | Financial Sector Conduct Authority |
| Mauritius | Financial Services Commission |
| Indonesia | Commodity Futures Trading Regulatory Agency |