You might ask, “What happens if someone decides not to pay for the commodity as promised or if a particular farmer is unable to deliver the wheat?” This is a good question. If it were possible for people to back out of the trade without fulfilling their parts of the promises, the futures system would not work. People would lose confidence in the system, and it would not be attractive to either hedgers or speculators. Eliminating this uncertainty is the role of the clearing corporation.

Each exchange has a clearing corporation performing a critical duty: ensuring the integrity of the futures contract. Although trades originate between two specific individuals or institutions, the trades actually become sales to or by the clearing corporation. By interposing itself between buyer and seller, the clearing corporation becomes a party to every trade.

Futures contracts are promises, and promises must be kept. On active trading days, some individual accounts may fluctuate in value by more than a million dollars. Misfortune or incompetence sometimes forces an exchange member into bankruptcy, yet that member’s positions still constitute promises with other exchange members. It is the clearing corporation that assumes the responsibility for those positions when a member is in financial distress. If this were not the case, the integrity of the trading system would break down, and members would tend to trade only with the other members who were financially strongest. In such a situation, market prices probably would become less competitive.

It is difficult to overstate the value of a sound clearing system at a commodities exchange. The Chicago Mercantile Exchange publishes a short document entitled The Financial Safeguard System of the Chicago Mercantile Exchange. One section of this paper deals with the financial integrity of the marketplace:

The accounts of individual members and non-member customers doing business through the facilities of the CME must be carried and guaranteed by a clearing member. In every matched transaction executed through the Exchange’s facilities, the Clearing House is substituted as the buyer for the seller and the seller for the buyer. The Clea^ring House is an operating division of the Exchange and all rights, obligations and/or liabilities of the Clearing House are rights, obligations, and/or liabilities of the CME. Clearing members assume full financial and performance responsibility for all transactions executed through them and all positions they carry. The Clearing House, dealing exclusively with clearing members, holds each clearing member accountable for every position it carries regardless of whether the position is being carried for the count of an individual member, for the account of a non-member customer or for the clearing member’s own account. Conversely, as the contraside to every position, the Clearing House is ^-held accountable to the clearing members for performance on all open positions.’

Because of the possibility that the collective members of the clearing corporation might have to absorb large losses due to the default of one or more members, stringent financial conditions are a condition of membership. The clearing corporation strictly enforces these requirements. Good faith deposits (or performance bonds) are required from each member on each contract to help ensure the member’s financial capacity to meet the obligations in bad times.’ The good faith deposit is the initial equity requirement that must be deposited with an opening transaction in a futures contract.

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