Commodity Futures Trading Commission

The Commodity Futures Trading Commission (CFTC) is an agency of the federal government charged with regulating commodity and financial futures and options contracts and markets. The CFTC serves three key functions. Its first mission is to protect market users and the public from fraud, manipulation, and abusive practices related to the sale of these instruments. Second, the CFTC regulates financial practices in the market to ensure that the entire market remains financially sound and that the markets continue to function with financial integrity. Third, the CFTC uses its regulatory powers to help the markets fulfill their key social functions of providing a means for price discovery and the hedging of price risk.

Organized commodity futures markets arose in the United States about 1850 with the establishment of the Chicago Board of Trade and the Chicago Mercantile Exchange, still two of the largest futures exchanges in the world. At their outset, these markets traded futures based exclusively on agricultural commodities such as corn and wheat. These markets first came under federal regulation in the 1920s, and Congress charged the CFTC with the regulation of these markets in 1974.

Since the 1970s, futures and options markets have expanded in size and scope, with trading of futures and options on many nonagricultural commodities. These now include oil, gold, and financial instruments, such as foreign currencies, stock indexes, and Treasury debt instruments. The markets regulated by the CFTC are of huge financial size and importance, [Page 358]with many billions of dollars being traded in these markets annually. The instruments traded in these markets are complex, as are the markets themselves. In addition, the markets are important to the financial system and the economy in general.

Futures and options markets serve two main social functions. First, the markets aid in the process of price discovery, the discernment and communication of information about the future direction of prices for commodities and other goods. The markets serve this function because futures prices prove to be among the best predictors of actual future cash prices for the underlying goods, such as oil, grains, interest rates, and foreign currency values. Thus, transactions in these markets generate observable prices, and the prices reported have a valuable social role because of the information they provide. Second, through a process known as hedging, futures and options prove to be extremely powerful instruments for managing and reducing commercial risks that arise in the ordinary conduct of business. In the classic example of a hedge, a farmer reduces uncertainty about the price to be received for a future harvest by trading in the futures market to establish a certain future sale price for the crop. The same kind of risk-reducing strategy works for financial futures and options to reduce financial risk and uncertainty.