Base metal warrants may be pledged as collateral to banks in order to receive cash funds in the form of loans. Banks that offer this service or are engaged in such activity are often called CTF banks (Commodity Trade Finance banks).
Traditionally, this financing of base metal warrants occurs when base metal markets are in contango market structure, where the futures contracts are trading at a premium to the spot price, generating an upward sloping forward curve.
Warrants may be pledged by the trader to the financing bank. If the clearing broker (FCM – Futures Clearing Merchant) is different to the financing bank, they will facilitate this process but not transfer ownership of the warrants.
Any clearing member engaging in this service would have warrants put in lien status for the duration of the time the loan is outstanding. The warrants in lien status cannot be used for any deliveries until the financing bank indicates the lien can be removed.
A list of such warrants is sent the financing bank.
There is no tripartite agreement between trader, clearer and financing bank but rather one agreement between trader and clearer, and a tri partite agreement between Exchange, clearer and financing bank.
CME Group markets are regulated by the CFTC (Commodity Futures Trading Commission) and, to protect futures markets from excessive speculation that can cause unreasonable or unwarranted price fluctuations, the Commodity Exchange Act (CEA) authorizes the Commission to impose limits on the size of speculative positions in futures markets.
Core Principle 5, of Section 5(d) of the CEA, requires designated contract markets to adopt speculative position limits or position accountability for speculators, where necessary and appropriate, to reduce the potential threat of market manipulation or congestion, especially during trading in the delivery month.
The Commission and exchanges grant exemptions to their position limits for bona fide hedging, as defined in CFTC Regulation 1.3(z), 17 CFR 1.3(z). A hedge is a derivative transaction or position that represents a substitute for transactions or positions to be taken at a later time in a physical marketing channel.
Hedges must reduce risk for a commercial enterprise and must arise from a change in the value of the hedger's (current or anticipated) assets or liabilities. For example, a short hedge includes sales for future delivery (short futures positions) that do not exceed its physical exposure in the commodity in terms of inventory, fixed-price purchases and anticipated production over the next 12 months.
A long hedge includes purchases of future delivery (long futures positions) that do not exceed its physical exposure in the commodity in terms of the hedger's fixed-price sales and 12 months' unfilled anticipated requirements for processing or manufacturing.
In general, position limits are not needed for markets where the threat of market manipulation is non-existent or very low. Thus, speculative position limits are not necessary for contracts on major foreign currencies and other financial commodities that have highly liquid and deep underlying cash markets. A contract market may impose for position accountability provisions in lieu of position limits for contracts on financial instruments, intangible commodities, or certain tangible commodities, which have large open interest, high daily trading volumes, and liquid cash markets.
Information on position limits, position accountability levels are available on CME Group’s website and the CFTC website www.cftc.gov.