What Is an Eligible Contract Participant?
An eligible contract participant (ECP) is an entity or individual allowed to engage in certain financial transactions that are not open to the average investor. ECPs are often corporations, partnerships, organizations, trusts, brokerage firms, or investors that have total assets in the millions. There are very stringent requirements before one can reach eligible contract participant status.
- An eligible contract participant is allowed to invest in a number of markets that are not typically available to the average investor.
- Financial institutions, insurance companies, broker-dealers, and investors with more than $10 million in assets can become ECPs.
- The requirements are fewer if the main activity of the ECP is hedging: $5 million in assets if hedging investment risk and $1 million if hedging commercial risk.
- The specific guidelines for ECPs are spelled out in Section 1a(18) of the Commodity Exchange Act.
Understanding Eligible Contract Participants
The Commodity Exchange Act outlines the qualifications for ECP eligibility (in Section 1a(18) of the CEA). Eligible contract participants—like financial institutions, insurance companies, and investment management firms—have sufficient regulatory status, but others can become ECPs as well. These are typically professionals and investing more than $10 million (on a discretionary basis) on behalf of customers.
Eligible contract participants can use margin, which can be used for hedging purposes or in an attempt to achieve higher returns.
While the minimum for individuals, partnerships, and corporations to become an ECP is $10 million in assets, that figure drops to $5 million if the ECP contract is being used to hedge risk. Government entities, broker-dealers, and commodity pools (with more than $5 million of assets under management) are sometimes eligible contract participants as well.
ECPs are allowed to use margin after meeting certain requirements. First, the amount invested, on a discretionary basis, must exceed $5 million. Second, the purpose of margin trading is to manage the risk of an existing asset or liability.
An ECP typically uses margin, not to enhance returns, but to reduce the risk of an existing asset or position. That is, the ECP is using margin to create protective positions or hedges that reduce risks associated with existing holdings.
Advantages and Disadvantages of ECPs
The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in response to the financial crisis in 2008, prohibits non-ECPs from engaging in certain over-the-counter derivative transactions. The requirements were put in place as part of a broader effort intended to help prevent a repeat of the financial crisis, which was partly blamed on the growing use of derivatives. An eligible contract participant, on the other hand, is allowed to engage in the derivatives market for different purposes, including to hedge or manage risk.
In sum, an eligible contract participant has a wider range of investment choices and financial options compared to a standard investor. An ECP can engage in complex stock or futures transactions such as hedging, block trades, structured products, excluded commodities (with no cash market), and other derivative transactions.