The Role of Clearing Firms in

Futures Markets
July 2022
 The Role of Clearing Firms in the Futures Markets

INTRODUCTION
In futures markets, as in most financial markets, there are several types of
intermediaries that provide customers with access to the markets and a range of
services related to their trading activity. In futures markets, however, there is one
type of intermediary that is especially important. This is the clearing firm, which
functions as the intermediary between the customers and the exchanges and
clearinghouses.

Clearing firms, which are known as futures commission merchants in the US and
general clearing members in Europe, perform several critical functions in the trading
and clearing lifecycle for the futures markets.

• First, they offer customers a central point of access to futures exchanges and
clearinghouses around the world.

• Second, they maintain an array of checks and controls aimed at protecting both
markets and customers.

• Third, they are responsible for collecting margin from their clients and
guaranteeing their clients' obligations to the markets.

• Finally, they contribute significant financial resources to the default funds

maintained by clearinghouses. These default funds serve to absorb losses from
defaults and protect the stability of the futures markets.

During periods of economic stress and market turmoil, futures markets take on
additional importance because of their resiliency. As shown during the financial
crisis of 2008, the futures markets continued to function even amid tremendous
stress in the financial system. This resiliency underscores the importance of futures
markets—and the clearing firms within those markets—to the stability of the entire
financial system.

Default Fund

Margin
Margin Clearing Exchange/Clearinghouse Margin Clearing Seller
Buyer Margin
Firm Firm Guarantee
Guarantee

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INTERMEDIARIES IN THE FUTURES MARKETS

There are two main types of intermediaries: executing brokers and clearing firms.
Executing brokers provide access to markets and support trading by their clients.
This role includes executing trades for clients, providing market data, trading
tools, portfolio analytics and automated trading software. Clearing firms process
trades after execution, hold client assets, guarantee their clients' obligations, and
contribute sizeable resources to the clearinghouses. Many intermediaries provide
both execution and clearing services, but clients have the option to unbundle
these services and use multiple firms to meet their needs.

CLEARING FIRMS AND RISK MANAGEMENT

One of the greatest risks to the clearing system is the potential for a default. Futures
are highly leveraged, and a sudden market move can cause large losses.

Clearing firms play a central role in ensuring the resiliency of the clearing system and
preventing losses from triggering a domino effect that can threaten the stability of
the markets. They do this in several ways.

First, failures of clearing members are quite rare, and customer losses resulting
from such failures are rarer still. This is due to the credit and risk due diligence of
customers performed by clearing members. This diligence reduces the overall risk
exposure to the system and is a critical role played by intermediaries.

Second, they guarantee the obligations of their clients. The need for this guarantee
arises when a client's position suffers a loss in value. If the client is unable to meet
the margin requirements on that position, the client's clearing firm will cover any
losses resulting from the close-out of that position.

Third, clearing firms mutualize the risks of losses from a default by a member of a
clearinghouse. At most clearinghouses, the overwhelming majority of the resources
in the default fund comes from the clearing members, rather than the clearinghouse
itself. In addition, most clearinghouses require members to replenish the fund if any
amounts are used to cover losses from a default.

From a structural perspective, the clearing system has the effect of

compartmentalizing risk. Rather than having a single point of failure, the clearing
system mutualizes risk across the membership of the clearinghouses and reduces
the risk that the clearinghouse might fail. In effect, the financial strength of the

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 The Role of Clearing Firms in the Futures Markets

clearinghouse membership is the foundation for confidence in the clearinghouse

itself. This is one of the main reasons why central clearing has proven to be so
resilient during periods of market stress.

Waterfall of financial resources that absorb losses from a default.

Defaulting
Member Initial
Margin
Defaulting
Member Default
Fund Contribution
CCP Skin
in the Game
Non-Defaulting
Members Default
Fund Contribution

PROTECTIONS PROVIDED BY INTERMEDIARIES

During the trading and clearing lifecycle, executing brokers and clearing firms offer
the following types of protections and functions:

Customer Protection – Intermediaries provide risk disclosures and ensure

that customers understand the risks of trading futures and options. They also
evaluate the creditworthiness of clients to lessen the likelihood of default.

See the following:

FIA FAQs for Protection of Customer Funds
FIA Risk Disclosure Template for Negative Contract Prices
FIA Regulatory Disclosures

Policing Illicit Activity – Intermediaries perform various regulatory

requirements designed to prevent the financial system from being used for
illegal purposes. These requirements include anti-money laundering controls
and know-your-customer rules.

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Market Access – Intermediaries offer centralized connectivity to multiple

markets. Some examples of clients that benefit from this access include:

• A food company that uses futures contracts listed on multiple

exchanges to hedge its risks – the Chicago Board of Trade and the
Minneapolis Grain Exchange for wheat, ICE Futures US for canola, the
CBOT for soy meal.

• A commodity trading firm that buys, sells and transports various types
of fuel and uses futures contracts listed on multiple exchanges to
hedge its risks – the New York Mercantile Exchange for gasoline and
heating oil, ICE Futures Europe for gasoil.

• A fund manager that uses equity index futures to manage exposure

to global stock markets – CME for the S&P 500 futures, the Osaka
Securities Exchange for Nikkei 225 futures, the Singapore Exchange
for the China A50 futures, and Eurex for the Eurostoxx 50 futures.

Execution Services – Intermediaries help their customers execute trades more

efficiently by providing algorithmic trading tools. Intermediaries also help their
customers reduce the market impact of large trades through off-exchange
mechanisms such as block trades.

Institutional investors active in futures markets typically use multiple intermediaries for
trading and clearing. A survey conducted by Greenwich Associates in 2021 showed that most
asset managers used more than half a dozen brokers to execute their trades, and more than
half used three or more firms to clear their trades.

Number of Number of
Executing Brokers Clearing Firms

11% 17% 11%

1
11% 1-2 2
3-6 17% 33% 3-4
7 or more 5-6
78% 7 or more
22%

Source: FIA-Greenwich survey

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Orderly Markets – Intermediaries help preserve orderly markets by maintaining

risk controls to prevent erroneous trades, market manipulation, and deceptive
conduct from passing through their systems.

See the following:

FIA Exchange Risk Controls
FIA Order Handling Risk Management Recommendations
FIA Guide to the Development and Operation of Automated Trading Systems

Trade Allocations – Clearing firms support the needs of asset managers by

implementing their instructions to allocate positions to the ultimate clients.
They also process give-up trades where a client has chosen to execute with one
broker and clear with another.

Segregation – Clearing firms are required to segregate client assets from their
own assets and protect client assets in case the firm fails. This is a foundation of
the current customer protection regime for the futures markets.

Margin Processing – After trades are executed, the resulting positions are
submitted to the clearinghouse for clearing. Clearing firms are responsible
for collecting collateral necessary to meet the margin requirements on their
clients’ positions. In addition, clearing firms assess the credit risk of each client
and may require additional margin above the minimum requirements set by the
clearinghouse. Examples of these requirements could include:

• Collateral transformation – clearing firm collects margin in one

currency, posts margin in another.

• Consolidated margin call – fund manager receives one margin call from
clearing firm, clearing firm takes responsibility for posting collateral to
multiple clearing houses.

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Initial Margin
This chart shows the total amount of initial margin clearinghouses were holding for all customer
positions outstanding at the end of 2021. Initial margin functions as the first line of defense against
losses from a default. The amount is generally equivalent to the CCP's estimate for the potential loss
on a position over a short time horizon, based on the current level of price volatility and historical data
on extreme price movements.

Source: FIA CCP Tracker

Default Fund Member Contributions

This chart shows the amounts contributed by clearinghouse members to the default funds maintained
by these clearinghouses. A default fund serves as a backstop in case losses from a member default
cannot be covered by that member's initial margin and default fund contribution.

Source: FIA CCP Tracker

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VALUE OF INTERMEDIARIES TO THE MARKET ECOSYSTEM

In addition to the functional aspects described above, intermediaries also provide
value to the exchange-traded derivatives markets in other ways.

For example, the presence of intermediaries strengthens market discipline by

providing an independent check on both the market infrastructures and the
customers. Having intermediaries as an independent layer in the ecosystem
avoids conflicts of interest that can arise when the functions of intermediaries are
combined with the functions of exchanges and clearinghouses in a single entity.

Intermediaries also bring human judgment into the risk evaluation process. They
have the ability to tailor their risk evaluations to different types of customers
and different types of financial strength. In a sense, they function as an extra set
of eyes on every customer, complementing the risk management processes of
clearinghouses.

CONCLUSION
Intermediaries offer a wide range of services to customers interested in trading
futures. These services cover every stage of the trading lifecycle, from the initial
entry of orders all the way through to the collection of margin days, weeks, and
even months after the initial trade. Intermediaries also are the financial backbone
of the clearing system, providing the capital that absorbs losses in case of a default
and protects the clearinghouses from collapse. This market structure has stood the
test of time, preserving the stability and resiliency of the global exchange traded
derivatives markets for decades, even during periods of extreme volatility and
financial crisis.

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About FIA
FIA is the leading global trade organization for the futures, options and centrally cleared
derivatives markets, with offices in Brussels, London, Singapore and Washington, D.C.
FIA’s mission is to:
» support open, transparent and competitive markets,
» protect and enhance the integrity of the financial system, and
» promote high standards of professional conduct.
As the leading global trade association for the futures, options and centrally cleared
derivatives markets, FIA represents all sectors of the industry, including clearing firms,
exchanges, clearing houses, trading firms and commodities specialists from about 50
countries, as well as technology vendors, law firms, and other industry service providers.

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