Quote from Jachyra:
Here's a brief synopsis of how the system works:
Exchanges in general do not want to be taking orders from the "public" so to speak. Instead of having to take orders from hundreds of thousands, or even millions of different parties, they prefer to just have to work with a handful of business that they know are financially solvent. The primary reason for this is that if a rogue trader sends in an order that results in losses that exceed the available funds in their account, they want to know that someone is on the hook for the money. So most exchanges (not all, but most) will only accept orders from market participants who are members of the exchange (meaning they have purchased a membership), and those members are responsible for any and all losses that result from the trading activities of any trades that are sent in on their behalf. This means that the exchanges don't have to worry about rogue traders, busted trades as a result of margin calls not being met, plus, they avoid having to work with a large number of people (the public), and only have to work with a small handful of members.
Now these firms that are members of the exchange are commonly referred to as "clearing firms" since they essentially "clear" trades. Its important to understand that the primary function of the clearing firm is to guarantee the quality and integrity of the side of the trade that they're responsible for, so that when a trader gets a fill, they can be sure that they have in fact either bought or sold whatever they were trying to buy or sell, and no longer have to worry whether or not the party on the other side of the trade is going to meet their obligations... if the party on the other side of the trade fails to meet their obligations (i.e. a missed margin call), its the clearing firm that is responsible for the financial loss. This shifts the burden of guaranteeing the financial quality or integrity of the trade from the exchange to the clearing firm, so to the extent that the clearing firm remains solvent, the exchange has relatively mitigated risk.
The other function of the "clearing firm" is to hold customer funds. Because capital requirements are so much higher for clearing firms as opposed to brokers, they are considered to be more solvent, and as a result, only clearing firms can actually receive and hold funds. This is meant to keep customer funds in the hands of the largest market players, and out of the hands of the brokers who tend to come and go a lot more frequently than clearing firms.
Now on the the securities side I believe they call the clearing firms "Broker Dealers" or "BD's" for short. On the futures side, these clearing firms are called Futures Commissions Merchants or "FCM's". Now there are two types of FCM's: clearing and non-clearing. A clearing FCM is an FCM that has also purchased a clearing membership from the exchange. Non-clearing FCM's don't have clearing rights at the exchange and as a result, must then negotiate with a clearing member to clear their trades for them. However, both clearing and non-clearing FCM's can hold customer funds, and the clearing FCM is responsible for any losses incurred by trades sent on behalf of the non-clearing FCM and its clients.
Now, brokers, are typically glorified sales people that are licensed to introduce business to the clearing firm. On the securities side, they're referred to as "Registered Representatives" or "Stock Brokers"... on the futures side they're referred to as "Introducing Brokers" or "IB's" for short.
As far as IB's go, there are two types of IB's: Guaranteed Introducing Brokers (GIB's) and Independent Introducing Brokers ("IIB's"). A guaranteed introducing broker is a broker that enters into a "Guarantee Agreement" with the clearing firm, and can only introduce business to that one FCM. An IIB on the other hand, has higher capital requirements (as set by the NFA), is not guaranteed by any one FCM, and can introduce business to any FCM that they have an "Introducing Agreement" with. As far as I know, almost all IB's these days are pretty much independent, and very few are actually Guaranteed IB's anymore (although there still are some left from the old days).
So in the world of futures and derivatives trading... the FCM is the clearing firm, and the IB's are essentially sales people (similar or along the same lines as stock brokers).
So all this means that you should be less worried with the financial integrity of Global, who is the IIB, and more concerned with the financial solvency of the FCM that they place your account with. The solvency of the FCM, not the IB, is what will determine whether or not your money remains safe day to day.
Thank you so much for all the information. I learned a lot reading this. Thank you
