DMAXX

The Big Question: How to select an FCM?

: 13 Jun 2016

With the shrinking number of FCMs, it might seem a CTA has little choice, or in some cases, too many. Either way, you need to know the questions to ask, and if you’re not happy with the answers, move on.

When a commodity trading advisor first hangs out their shingle, the punch list is long and many items are of equal importance: infrastructure, back office software and compliance being the most common. But of course you’ll need a broker to execute and clear your trades. No doubt you already have the one you used while on your own, but as you grow your business, your brokerage needs will change, not only due to your trading and capital, but to satisfy your client’s needs as well. Here is a list of what CTAs, software vendors and brokers say you should discuss with prospective FCMs:

The Basics

1. Yes, size does matter. Although you may like the idea of having a Goldman Sachs or JP Morgan as your FCM, the truth is your options might be limited by your size. Especially as the number of brokers has dropped from almost 180 in 2007 to 72 today, many of these, especially bank-owned FCMs, will be out of your league. Size may be a main issue: CTAs with less that $100 million may not get a chance with a large bank FCM. But what is also important is how valuable (active) you are as a customer. As banks have to deal with constricting balance sheet capital due to Basel III, they have off loaded customers who don’t meet their ROI needs. If you have $100 million AUM but trade only a limited number of lots a month, you won’t make the cut. This isn’t necessarily a bad thing as many CTAs have been shifted to smaller non-bank FCMs. Although a large balance sheet might be nice, so is not dealing with a bureaucracy. 
   
   The reverse is also true. As you grow, a smaller FCM may no longer be able to accommodate your capital and trading needs. No matter what your size, it’s always smart these days to have relationships with multiple FCMs; to wit, the cautionary tales of customers who had all their money with MF Global or PFG.
   
   
2. Ask for a list of exchange memberships. It may seem a firm with more memberships is pricier, but if you trade globally and decide to go with a downstream broker, that firm will have to use another FCM to access those exchanges and you or your clients will be charged in the end. Also find out if the firm has a 24-hour CTA/Institutional desk. Even if you won’t normally need it, it’s nice to know it’s there in case of an emergency.
   
   Related to this are give up trades. Make sure your broker does or accepts them. Some brokers may be a perfect fit when you are trading as an individual, but a firm that won’t do or take give ups will complicate your growing CTA business.
   
   
3. Does the FCM permit net margining across all accounts? This means if you bring on a client who has multiple accounts with multiple CTAs, you want the FCM to be able to ‘net’ the margin across all those accounts and not require each CTA to be margined separately. This is not only across CTAs, but also across various fund accounts, and similar to net margining at an exchange, allows better use of collateral for your customer. 
   
   Also, make sure the FCM isn’t “margin padding” your account, that is insisting on much higher (3x-4x) margin needs than exchanges require. Although all FCMs request more margin than is required (in the interest rate glory days this was an income stream for FCMs), it shouldn’t be exorbitant. One CTA says a large bank FCM was requiring 3-4 times margin as a way to get rid of business that didn’t have a strong ROI. This may be an extreme case, but keep an eye on what they are charging, and be diligent after setting up an account that the broker doesn’t change the rules, and if they do, find out why. Also, find out  - due to balance sheet issues for bank FCMs - if they charge for “excess funds” held at the FCM.
   
   
4. Cap intro? In the “old” days many FCMS would make sure their asset allocation clients mingled with CTAs, but this is more rare today. Sure there are firms that have people who work to raise funds, but may only introduce them to CTAs they feel worthy. Think of FCMs like asset allocation targets: they have standards and just because you are a client doesn’t mean they will send clients your way. Some firms do have platforms (e.g., RJO’s Oasis) that allow asset allocators to review and invest in CTAs.

More Details

1. Find out the format and how end of day allocation files are handled.  Most FCMs will request that allocation files be sent to them at the end of each day although some want them at the end of each session or even after each trade.  Many are flexible with respect to symbology and price format, but not all are.  Also, just because you provide data files of your allocations, it does not mean those are not being manually keyed into another system by the FCMs staff; you should check to be sure that the files are being handled in an automated fashion otherwise clearing errors are sure to arise.
   
   
2. Online account viewing platforms and ability to provide trade prices (both actual fill and APS prices) at regular intervals during the day as well as at the end of the day.  Many firms don’t provide anything more than and end of day feed that summarizes all the trades done during the day. Ideally, the feed would be automatically generated and provided in the format and use the delivery method (sFTP, eMail, etc) that works best for you.
   
   
3. Ask about which trading platforms are supported, such as Trading Technologies, CQG, TradeStation, Cunningham, etc.  Make sure your FCM supports your trading platform, as not all FCMs are equipped to handle all platforms.

Finally, you should always check with the National Futures Association (www.nfa.futures.org) website to see if any actions have been brought against an FCM. Also, the CFTC site carries monthly financial info on all FCMs (http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm).  That can provide you an overview before getting into the details when interviewing the FCM.

Remember, just as you are diligent about the rest of your business, your FCM/broker partnerships are lifelines that need to be reviewed often and analyzed on a regular basis. After all, “know your customer” goes both ways in all vendor relationships.

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Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: [email protected]