What is an eligible contract participant?
An Eligible Contract Participant (ECP) is an entity or individual authorized to engage in certain financial transactions that are not open to the average investor. ECPs are often companies, partnerships, organizations, trusts, brokerage firms or investors with total assets in the millions. There are very strict requirements before reaching the status of eligible participant in the contract.
Key points to remember
- A Qualifying Contract Participant is permitted to invest in a number of markets that are not generally accessible to the average investor.
- Financial institutions, insurance companies, brokers and investors with over $10 million in assets can become ECPs
- The requirements are less if the main activity of the ECP is hedging: $5 million in assets if hedging investment risk and $1 million if hedging commercial risk
- Specific guidelines for ECPs are set out in Section 1a(18) of the Commodity Exchange Act.
Understanding eligible contract participants
The Commodity Exchange Act describes the eligibility requirements for the CEP (in section 1a(18) of the CEA). Participants in eligible contracts, such as financial institutions, insurance companies and investment management companies, have sufficient regulatory status, but others may also become ECPs. They are generally professionals who invest more than 10 million dollars (on a discretionary basis) on behalf of customers.
Eligible contract participants can use margin, which can be used for hedging purposes or to attempt to earn higher returns.
While the minimum for individuals, partnerships, and corporations to become an ECP is $10 million in assets, that figure drops to $5 million if the ECP contract is used to hedge risk. Government entities, brokers, and commodity pools (with over $5 million in assets under management) are sometimes also eligible contract participants.
ECPs are allowed to use margin after meeting certain requirements. First, the amount invested, on a discretionary basis, must exceed $5 million. Second, the purpose of margin trading is to manage the risk of an existing asset or liability.
An ECP typically uses margin, not to enhance returns, but to reduce the risk of an existing asset or position. In other words, the ECP uses margin to create protective positions or hedges that reduce the risks associated with existing holdings.
Advantages and disadvantages of ECPs
The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in response to the 2008 financial crisis, prohibits non-ECPs from engaging in certain over the counter derivative transactions. The requirements were put in place as part of a wider effort to help prevent a repeat of the financial crisis, which has been partly blamed on the growing use of derivatives. A qualifying contract participant, on the other hand, is permitted to engage in the derivatives market for different purposes, including hedging or managing risk.
In summary, an eligible contract participant has a wider range of investment choices and financial options than a standard investor. An ECP may engage in complex equity or futures transactions such as hedging, block transactions, structured products, excluded commodities (without a cash market) and other derivative transactions.
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