What Is an Exempt Commodity?
An exempt commodity is any exchange traded commodity that is not an excluded commodity or an agricultural commodity, such as energy and metal commodities. Transactions in an exempt commodity may only take place between eligible contract participants or commercial entities.
"Exempt commodity" serves as a residual term for any of the commodities not specified in the Commodity Exchange Act (CEA). These commodities are exempt from the rules outlined in the CEA; however, these transactions are still subject to the prohibitions against fraud and price manipulation.
- An exempt commodity is any exchange traded commodity that is not an excluded commodity or an agricultural commodity.
- Such commodities are exempt from the rules outlined in the CEA, but transactions involving them are still subject to prohibitions against fraud and price manipulation.
- Exempt commodities can only be traded by eligible contract participants and eligible commercial entities.
- Examples of exempt commodities include energy commodities, such as crude oil and natural gas, or metals such as gold and silver.
Understanding an Exempt Commodity
The Commodities Exchange Act (CEA) regulates the trading of commodity futures in the United States. The CEA, for instance, establishes the statutory framework under which the Commodity Futures Trading Commission (CFTC) operates. The CEA also establishes classifications for different types of futures contracts.
Futures contracts are legal agreements to either buy or sell a specific commodity or financial security at a set price at a specific time in the future. They are primarily used as a means to hedge price risk. Futures contracts are derivatives with the underlying asset being a commodity, such as wheat, corn, oil, or a financial component, such as an interest rate.
Exempt commodities are those that are neither agricultural commodities, such as livestock, wheat, or other grain, or excluded commodities, such as financial futures contracts, like interest rate futures. Examples of exempt commodities include energy commodities such as crude oil, natural gas, chemicals, and metals, such as gold and silver. Carbon emissions allowances and weather derivatives are also considered exempt.
Exempt commodities are considered exempt since they do not naturally fall under particular rules and guidelines that regulate agricultural commodities such as rules of standardization, quality control, physical storage, and transport. At the same time, they do not fit the mold of excluded commodities, such as financial instrument futures, which lack cash markets for the underlying assets.
Excluded Commodities vs. Exempt Commodities
The exempt commodity classification was created to stand apart from an excluded commodity. An excluded commodity does not fall under the regulation of the CEA and is one that does not have its own intrinsic value outside of the underlying asset that it is tied to, and cannot be traded on an exchange. These are commodities that are not susceptible to measures of influence or manipulation because they are not finite like physical commodities, such as oil and grain.
Excluded commodities include most financial products and any relevant event associated with the commodity that is outside the control of any interested party. Excluded commodities are created for assets that have no cash market. When an investor trades interest or exchange rate futures, currency contracts, or security indexes, that person is trading excluded commodities.
Trading Exempt Commodities
Exempt commodities may be traded on electronic exchange platforms. Exempt commercial markets are electronic trading facilities that trade exempt commodities on a principal-to-principal basis solely between persons that are eligible commercial entities or eligible contract participants.
An eligible commercial entity is a market participant approved by the CFTC that has a demonstrable ability to make or take delivery of an underlying commodity of a contract; incurs risks related to the commodity; or is a dealer that regularly provides risk management, hedging services, or market-making activities to entities trading commodities or derivative agreements, contracts, or transactions in commodities.
Though many companies and individuals buy or sell futures contracts with the idea of taking or providing delivery and benefiting from the price hedge, many investors or traders speculatively trade futures contracts as a means of seeking profit.
These traders are not interested in the asset but rather the price movements of the asset in order to capture profits. These trades need to be exited from before the contracts expire in order to avoid making or receiving delivery.