Forming a Commodity Trading Firm
In these recent years, there are many commodity trading firms. However, some beginners still do not understand how to form a commodity trading firm. Actually, commodity trading consists of physical trading in the wholesale markets and derivative trading in commodity exchanges. A physical trading can take the form of either spot trades or forward contracts, while standard derivative trading most commonly refers to things like commodity futures and options. Then, the majority of commodity trading is through standard derivatives. Thus physical trading will use commodity exchanges for hedging. In the United States, the trading of commodity derivatives is regulated under the Commodity Exchange Act of 1936. Moreover, the appropriate authority is the Commodity Futures Trading Commission (CFTC) and the self-regulatory organization is the National Futures Association (NFA).
The physical trading includes three steps. First, decide on the nature of the firm’s business. For example, a commodity broker and a commodity dealer are both involved in commodity trading but with different business practices that require unique skills and expertise respectively. A broker will focus on the networking ability of soliciting potential clients of commodity buyers and sellers, including dealers, and brokering deals for them. Then, a dealer emphasizes things like the transporting capability of moving commodity goods around between buyers and sellers with or without a broker’s assistance.
Second, get registered and licensed. The physical commodity trading is enforced by the Model State Commodity Code as adopted by individual states. Therefore, unlike exchange trading, registration and licensing of the off-exchange transactions will be handled by states. You may check with the appropriate department of your state and file required registration.
Third, choose the types of commodities that the firm will specialize in. Trading physical commodities will require extensive product knowledge as the business involves conducting many physical activities such as inspection, transportation and storage. Then, In exchange-commodity trading where price movement dominates, financial institutions and various investors can easily participate in a range of commodity trades such as in agricultural commodities, petroleum products and both precious and industrial metals.
Moreover, the exchange trading includes three steps too. First, you have to decide on the nature of the firm’s business. Four kinds of commodity exchange-trading companies will be under direct CFTC and NFA regulations: Futures Commission Merchant (FCM), Introducing Broker (IB), Commodity Pool Operator (CPO) and Commodity Trading Advisor (CTA). Then, a FCM is a full service commodity brokerage and an IB is a commodity broker specializing in client solicitation but without futures floor operations that must be delegated to a futures commission merchant. On the other hand, a CPO pools investor’s funds and invests them in commodity futures and other derivatives and a CTA receives compensation by giving its clients commodity trading advice.
Second, you should prepare for registration and arrange for proficiency examination. It is because individuals and organizations that intend to do business as a futures professional must register under the Commodity Exchange Act with the CFTC and apply for membership with the NFA, which handles all registrations.
Third, apply for trading privileges with a commodity exchange if a firm wishes to become a member of an exchange. All forms of commodity trading firms are also eligible for becoming a commodity exchange member. The commodity pool operators and commodity trading advisors may choose to have their own floor operations.
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