What is a Eligible Commercial Entity
An eligible commercial entity is a type of participant in a contract who has a specific set of abilities and responsibilities about futures trading. Their abilities include being able to force, or to take, delivery of the specified commodity and manage and incur risk, including price risk. This party may also regularly provide hedging services and may be a market maker for the specified commodities.
BREAKING DOWN Eligible Commercial Entity
Individuals cannot become eligible commercial entities, nor can instruments of the state. Eligible commercial entities may be a financial institution, an investment firm, or insurance brokers. Whether or not an entity is qualified to be an eligible commercial entity is determined by the regulations set forth under the Commodities Exchange Act (CEA).
Eligible commercial entities participate in futures trading. The U.S. Commodity Futures Trading Commission (CFTC) regulates futures trading. When people engage in futures trading, they are promising to buy, or sell, a specific product at a predetermined price on specified dates. Thus, the futures market has a basis on hedging and speculation and predictions of how the market will look at a certain point in the future.
How Eligible Commercial Entities Come Into Play
As an example of how eligible commercial entities can impact the market, imagine a national bread company suspects grain prices will rise in the next year. The company wants to lock in a reasonable price on future wheat it needs later in the year. The company contacts a financial institution which is an eligible commercial entity. A broker from that institution will be able to help the bread company secure a futures contract for wheat.
The broker should have a knowledge of the wheat market and a sense of how it fluctuates. With their specialized knowledge, the broker can advise the bread company to purchase 500 tons of wheat on the futures market, offering $175 per ton. If they enter into a contract, the company will pay that $175 price at a date six months from now. If the broker has reason to believe that the price of wheat will not dip significantly over the next six months, so this is a reasonably safe deal for the bread company.
If the broker is correct and the price of wheat does indeed rise, the company is happy paying a lower amount for the future wheat they require. However, if the broker is incorrect, and the price of the grain falls, the company will have an opportunity to sell their higher price future contracts, probably at a loss, and buy new contracts.
Over the next six months, the price of wheat on the open market could skyrocket or fall considerably. Either way, the bread company will not be affected by the new prices, because of the locked-in price of the futures contract.