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Commodity futures trade system

The Ministry of Economy, Trade and Industry and the Ministry of Agriculture, Forestry and Fishery (hereinafter referred to as “Competent Ministries,” authorized by the Commodity Exchange Law (Law No. 239, August 5, 1950), carry out the following procedures with regard to ensuring the sound operation of the commodity futures market in Japan and the protection of consignors who undertake commodity futures transactions:
  • Permission of establishment and supervision of Commodity Exchanges
  • Permission of establishment, and supervision of Commodity Transaction Clearing Organizations
  • Permission of activities, and supervision of Futures Commission Merchants (FCMs)
  • Permission of establishment, and supervision of the Commodity Futures Association, a self-regulatory organization of FCMs
  • Registration of Consignors Protection Business and supervision of Consignors Protection Funds

I. Entities

1. Commodity Exchanges

A commodity exchange opens a commodity futures market in Japan, and its establishment is permitted by the Minister of Economy, Trade and Industry and the Minister of Agriculture, Forestry, and Fishery (hereinafter referred to as “Competent Ministers”).

The forms of commodity exchanges are membership organizations and incorporations. Currently, all of the seven commodity exchanges are membership organizations.

The qualifications of a membership (in the case that the commodity exchange is a membership organization) or a trading participant (in the case that the commodity exchange is a stock company.) are categorized into four: i) commercials, ii) FCMs permitted in Japan and other countries, iii) those who notify Competent Ministers of their engagement in the business of OTC commodity futures trading, and iv) financial institutions.

Currently, among the seven commodity exchanges, the Minister/Ministry of Economy, Trade and Industry is the competent minister/ministry of the Tokyo Commodity Exchange (TOCOM), the Central Japan Commodity Exchange (C-COM), and the Osaka Mercantile Exchange (OSE). The Minister/Ministry of Agriculture, Forestry and Fishery is the competent minister/ministry of C-COM.

-A reference homepage

2. Commodity Transaction Clearing Organizations

The amendment of the CEL, effective on May 1, 2005, introduced an “outhouse” type of clearing house, established outside of commodity exchanges. Its establishment and operation necessitate the permission and overseeing of Competent Ministers.

As the outhouse clearing house, the Japan Commodity Clearing House (JCCH) was established, and began operation on May 1, 2005.

-A reference homepage JCCH :

3. Futures Commission Merchant (FCM)

A FCM is a broker which executes a transaction or brokers a transaction which it accepts from investors and commercials. The beginning of its business operation necessitates the approval of the Competent Ministers.

There were 90 FCMs as of Dec. 1, 2005, and two of these are still under consideration for approval, which all the existent FCMs are required to have under the amendment of the CEL.

FCMs shall register with the Commodity Futures Association of Japan all officers and/or employees thereof who engage in solicitation of the acceptance of consignment of any transactions, as sales representatives.

II. Major systems and rules

1. Margins and Commissions

When an investor begins transactions on the commodity futures market, trading margins and commissions shall be deposited by the investor.

(1) Trading Margins

i) Initial Trading Margins

When an investor begins transactions on the commodity futures market, the investor shall, in principle*, deposit trading margins with commodity exchanges and/or a commodity transaction clearing organization**, through FCMs as their agents. Initial margins, the minimum level of margins that all the investors shall deposit at the beginning of transactions, are set at 5-10 % of the prices of the listed commodities.

* The exception is articulated in the Brokerage Rule, authorized by commodity exchanges. ** In the system, there are two depositaries. However, in practice, JCCH, as the commodity transaction clearing organization, is the only depositary.

ii) Maintenance Trading Margins

When appraisal loss of transactions reach more than half of the initial trading margins, investors shall deposit with commodity exchanges and/or a commodity transaction clearing organization*, maintenance trading margins. The level of the maintenance trading margins is set by FCMs at between half of the initial trading margins and all of the appraisal loss.

* In the system, there are two depositaries. However, in practice, JCCH, as the commodity transaction clearing organization, is the only depositary.

iii) Other Trading Margins

Commodity exchanges set various kinds of trading margins, for example, spot month additional trading margins (for transactions on spot month, in consideration of no price limits on spot month) and extraordinary trading margins (in case of high volatility). Further information is provided by commodity exchanges.

(2) Commissions

An investor shall pay commissions, set by FCMs on the basis of transaction volumes, etc. Commissions have been completely liberalized since January 1, 2005, so the amount of commissions is set very differently by FCMs.

2. The Consignors’ Asset Protection and Consignor Protection Fund System

It is essential that consignors’ assets (specifically, trading margins and appraisal profits) shall be fully protected in order to assure the confidence of commodity futures markets.

Therefore, the amendment of CEL in FY 2004 achieved two major advancements. First, the margin system was fundamentally revised to ensure that an investor shall, in principle, deposit all the trading margins with a commodity transaction clearing organization. In other words, in normal cases, FCMs segregate consignors’ assets for one day, after they receive the assets from consignors and before they deposit the assets with commodity transaction clearing organizations. Second, the system of consignor asset protection was introduced to compensate for possible damage to consignors’ assets, in the case of the FCM’s insolvency. Under the system, the consignor protection fund shall compensate for damaged consignors’ assets up to 10 million yen per consignor, and each FCM shall be a member of the consignor protection fund set up to ensure enough funds for compensation, through dues paid by its member FCMs.

The National Futures Protection Fund got the registration of its consignor protection business on May 1, 2005.

3. Clearing and Settlement of Commodity Futures Transactions

The CEL requires commodity exchanges to have a system to minimize the impact of a default of its member on its market(s), so as to ensure that transactions on its market shall be safely carried out.

Members of Commodity Exchanges shall deposit guarantee money with commodity exchanges and clearing deposits with commodity transaction clearing organizations, to compensate for losses that a default of a member of a commodity exchange would result in for consignors, other members of the commodity exchanges, and other clearing members of the commodity transaction clearing organizations (in the case that the defaulted FCM is a clearing member of a commodity transaction clearing organizations).

In practice, the JCCH requires its clearing members to mark their positions in relation to the market with it once every business day. Therefore, if a default of a clearing member happens, its damage to other clearing members will be restrained to the extent of two business days’ appraisal losses.

4. Rules for Customer Protection and Self-Regulatory Organization

(1) Rules for Customer Protection

Before concluding contracts with customers, FCMs are obliged to explain the mechanism and risks of commodity futures transactions and to deliver to them the document, “A Guide for Consigning Commodity Futures Transactions,” the contents of which are also articulated in the CEL (Art. 217).

FCMs shall fairly and faithfully conduct their business operations for customers (Art. 213: Principle of Fairness and Good Faith). FCMs are not allowed to conduct solicitations which might not be appropriate in consideration of the knowledge, experience or status of assets of customers (Art. 215: Principle of Suitability). Several kinds of unfair solicitations (listed in the following) are articulated in the CEL (Art. 214). Bucketing is also prohibited (Art. 212).

The Competent Ministries established and made effective some guidelines for interpretation of these provisions, to ensure protection of consignors.

i) Unfair solicitation
  • Solicitation, by providing a customer with a definitive opinion which leads the customer to a false assumption that any profit will be assured;
  • Solicitation, by promising to a customer that a trader will bear the whole or part of any losses or assuring profits with respect to a transaction;
  • Solicitation, even though a customer has declared his/her intention of not making the consignment of a transaction;
  • Solicitation in a manner which may cause trouble for a customer;
  • Solicitation, before the main solicitation, by informing a customer of the trader’s trade name and that the solicitation is intended for a transaction, but without confirming the customer’s intention as to whether the customer will accept such a solicitation;
  • Solicitation, without informing a customer of the unit of a transaction, etc.

ii) Discretionary deal

Acceptance of the consignment of a transaction, without receiving any instructions from a customer as to the quantity, consideration or contract price, the kind of listed commodity or listed commodity index, the kind of transaction, the month in which the transaction is done, sale or purchase, new or liquidating sale [purchase], the date on which the transaction is done or the expiration date of the consignment contract

iii) Front running

iv) Denial or delaying of returning FCM’s liability to its customers

v) Proprietary transaction in reverse of customer’s transaction with respect to the position of the transaction, which leads to impairment of the customer’s interests

vi) Transactions in the customer’s account without receiving any instructions from a customer

vii) Denial of a customer’s order to liquidate his/her positions

viii) Fallacious description or inaccurate description of important items

(2) Self-Regulatory Organization

The Commodity Futures Association of Japan (referred to as “CFAJ) was established as a self-regulatory organization for FCMs, in order to ensure the fair and smooth acceptance of consignment of transactions as well as customer protection.

The CFAJ has established its own regulatory rules with regard to its members’ business operations of accepting consignments, monitoring and inspecting its members, and guiding, making recommendations to, and, if necessary, punishing its members that do not follow the CEL or the rules. The CFAJ ensures the resolution of complaints from customers, conciliates and, if necessary, mediates in regards to disputes between its members. The CFAJ also registers, trains, guide, and if necessary, punishes sales representatives of FCMs.

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