By Bruce Roberts, Global Cleared Derivatives Management & Business Development, and Russell Levens, US Head of Customer Engagement, ION Markets – Cleared Derivatives
For a firm wishing to become a Futures Commission Merchant (FCM), it can sometimes take multiple years to obtain a license – that is, if they manage to pass the necessary and stringent regulatory requirements.
Most recently, it took a crypto-focused entity nearly two years to secure FCM approval from the National Futures Association (NFA). Granted, this was not a typical case, as the FCM is the first crypto-focused entity to offer regulated and leveraged crypto futures alongside traditional spot trading. However, this example highlights the stringent requirements for firms to operate as an FCM. Receiving approval from the NFA typically takes about 14 months.
While thorough, clear, and objective requirements help to ensure a healthy financial system, there is much to be said for lowering the entry barriers for new FCMs seeking membership.
Diluting the market
Before the 2008 financial crisis, there were more than 170 FCMs. The turmoil in the sector caused more than half to exit the market. The market now has a greater concentration of FCMs, and fewer clearinghouses. The changed structure can introduce more significant risk and negatively impact participants. Greater concentration results in a lack of competition in the market. By introducing more FCMs, competition increases, and clients benefit from better pricing alongside more diversification.
A higher number of FCMs helps to share the risk, distributing it more widely across the industry, reducing the potential for a single point of failure, and minimizing the systemic risk in too few dominant players. More FCMs can mean a broader range of services, products, and markets, leading to diversification opportunities for traders and investors.
The journey to becoming an FCM
There are multiple potential advantages for individual firms and the wider financial market from a greater number of diversified FCMs. So, why are there not more of them?
A primary consideration for a firm hoping to become an FCM is the capital requirement. FCMs must have sufficient capital to meet regulatory requirements and to support their operations. This can be a significant barrier for new entrants, especially for smaller, bespoke firms. What’s more, obtaining the necessary licenses and navigating complex regulatory frameworks can be challenging. As such, the firm must decide whether to buy an existing license, or to apply for a new one. FCMs must also comply with complex regulatory standards such as Dodd-Frank Act, SA-CCR, and Basel III, which aim to address various aspects of financial stability and risk management, particularly in the wake of the financial crisis. These regulations often increase the capital required to run clearing businesses.
Another barrier on the journey to becoming an FCM is implementing the correct and most suitable technology. For trading, clearing, and risk management, FCMs need an advanced technological infrastructure in place. Choosing whether to build these systems in-house or partner with technology providers is a critical decision.
The path to travel: two critical decisions?
Two critical decisions characterize the path to becoming an FCM. First, do I buy an existing license, or apply for a new one? While buying a license can be quicker, it is still subject to regulatory approval. Hence, there is no guarantee of success. One recent example was the acquisition of Cunningham Commodities by Plus 500 to expand into the American futures market. Ultimately, the decision to buy or apply depends on the specific needs and requirements of the business. There is no one-size-fits-all answer.
Second, should I partner with a technology vendor to build the necessary technological infrastructure, or build it in-house? While there are some benefits to building in-house, there are several risks associated with investing so much time and resources into developing infrastructure that risks not being as good as the options available to purchase. Especially when your firm is facing so much other uncertainty while becoming an FCM. As a result, most companies opt to outsource technology building and focus in-house resources on other mission-critical tasks and processes.
Breaking down barriers
Technology providers can play a crucial role in reducing the barriers to entry for firms looking to become an FCM. Given all the complicated decisions, it can be easier for firms to partner with a trusted third party to overcome key technology barriers. A recent Acuiti study found that building in-house technology is significantly more challenging than finding the right third-party partner.
By building and implementing suitable, tailored technology that supports a firm’s business strategy, regulatory requirements, and product requirements, a technology provider can help the FCM overcome two main hurdles. What’s more, building a partnership between a technology provider and the FCM can help ensure everything runs smoothly in the long run: supporting connectivity, streamlining business processes, insulating the firm from technological changes as a result of exchange and regulatory mandatory requirements, and achieving cost-efficient operations. All of this will help ensure that once the firm has become an FCM, it can survive and thrive in the market.
