What Is an Eligible Commercial Entity?
In the commodities futures markets, an eligible commercial entity is a type of market participant that is authorized to make or take delivery of the commodities underlying one or more futures contracts.
- An eligible commercial entity is a company authorized to make and take delivery of commodities in commodities futures trading.
- They also play the role of advisors and market makers, adding liquidity to the marketplace.
- Their requirements are set out in the Commodity Exchange Act (CEA) and their activities are regulated by the Commodity Futures Trading Commission (CFTC).
How Eligible Commercial Entities Work
The definition of an eligible commercial entity, as well as the requirements for acting in such a capacity, are set out in the Commodity Exchange Act (CEA). According to these regulations, individuals cannot become eligible commercial entities, nor can instruments of the state. Instead, eligible commercial entities must be financial institutions, such as investment firms and insurance brokerage firms.
The commodities markets, which are regulated by the Commodity Futures Trading Commission (CFTC), allows market participants to lock in a price for a specified commodity to be delivered at a specified time in the future. In turn, this allows consumers and producers of commodities to manage their supply chains more effectively by reducing the risk that commodity-price fluctuations will undermine their profitability in ways they cannot control. The commodities futures markets also allow market participants to speculate on future commodity price and to hedge against their commodities exposure.
Eligible commercial entities play an important role in the commodities futures markets by effectively providing a reliable counterparty for other market participants. They have the financial and human resources necessary to facilitate commodities trading and to take delivery of commodities if necessary. In addition, eligible commercial entities can provide an advisory role on behalf of clients, while also adding liquidity to the marketplace by acting as market makers who buy and sell futures contracts for their own account.
Real World Example of an Eligible Commercial Entity
To illustrate how eligible commercial entities can impact the market, suppose you are the owner of a commercial baking firm that sells bread throughout the United States. You are intimately aware of your equipment, personnel and logistical costs, but because the price of wheat fluctuates on international commodity markets, you cannot be sure of what this essential price will be throughout the year.
To lessen this uncertainty, you decide to lock in a reasonable price for wheat by buying futures contracts that have wheat as their underlying commodity. These contracts are structured so that they mature at different parts of the year, giving you the option to either receive wheat at those maturity dates or sell the futures contracts, buying wheat elsewhere using the proceeds from the sale.
In order to complete this transaction, you turn to an eligible commercial entity—specifically, a brokerage firm—that offers specialized knowledge about the wheat futures market and advice on how best to execute the futures transaction. Once the details of the transaction have been finalized, the eligible commercial entity is authorized to carry out the transaction on your behalf.