The document outlines six principles for best practice in futures contract design: economic utility, correlation with the cash market, promotion of convergence, accountability, responsiveness, and transparency. It then discusses several aspects of contract design in more detail, including how contracts should reflect the underlying cash market, promote convergence between cash and futures prices, use appropriate position limits to reduce manipulation risk, and balance the interests of long and short traders. New contracts should be carefully launched and monitored to help ensure proper functioning.

1. Christa Lachenmayr, Division of Market Oversight
Kevin Piccoli, Office of International Affairs
Tracey Wingate, Office of International Affairs
December 2017
Futures Contract Design & Trading
U.S. COMMODITY FUTURES TRADING COMMISSION
OFFICE OF INTERNATIONAL AFFAIRS

2. 1997IOSCOTokyoCommuniqué
2
• Six Principles for Best Practice in Futures Contract Design:
• Economic Utility – price discovery and risk management.
• Correlation with Cash Market – reflect underlying physical
commodity; conform to most common commercial practices.
• Promotion of Convergence – cash and futures equivalence;
settlement reliability.
• Accountability – clear framework of design/review criteria and
procedures; responsible entity held accountable for continuing
compliance.
• Responsiveness – views of potential contract users should be
taken into account in designing commodity contracts.
• Transparency – rulebook and rule changes available to market
authorities and participants in a timely manner.
• See also 2011 IOSCO Principles for the Regulation and Supervision
of Commodity Derivatives Markets

3. EconomicUtility
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• For regulators, the chance of success or failure – or the
potential to have contract performance issues – can be
contingent upon whether the underlying commodity
• has a large and active cash market
• has risks dispersed across a wide range of producers,
merchants and consumers
• experiences a considerable amount of cash price volatility
• is subject to regulatory treatment that can interrupt supply
and demand.
• And the corresponding contract
• satisfies a hedging need
• tracks assets held by hedgers.

4. CorrelationwiththeCashMarket
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• Regulators need to observe whether the contract
effectively reflects
• size and structure of the market
• historical patterns of production, consumption and supply, including
seasonality, growth, market concentration, trade patterns
• quality or grade of the underlying commodity
• liquidity and cash pricing system (transparency, frequency)
• And accommodates for
• vertical integration of production and consumption among producers,
merchants & consumers
• existence of price controls, embargoes or other regulations

5. CorrelationwiththeCashMarket
5
• Deliverable Supply is generally defined as the quantity of the
commodity that potentially could be made available for sale on
a spot basis at current prices at the contract's delivery points:
• “The amount of the commodity that meets the contract's delivery
specifications, reasonably can be expected to be readily available to
short traders and salable by long traders at its market value in
normal cash marketing channels at the contract's delivery points
during the specified delivery period barring abnormal movement in
interstate commerce; and excluding supplies committed for long-
term contractual agreements.”
• NOT production. Deliverable supply:
• defines the commodity
• used for monitoring of trading in the spot month
• determines spot-month speculative position limit levels

6. CorrelationwithCashMarket
• Calculation of Deliverable Supply
• three-years of data, reported by contract month
• publicly available, government issued
• publicly available, exchange-reported
• 3rd Party, privately published
• eliminate stocks/supply that are not of deliverable quality, not
economically available, or are committed in long-term agreements
• Seasonal commodities – stocks or stocks and flow –
certificated/non-certificated stocks and the amount of the
commodity flowing through transportation hubs
• Continuously produced commodities – flow or production
limited by delivery capacity/infrastructure
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7. PromotionofConvergence
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• Convergence is paramount to the price discovery and risk
management functions of futures contracts and an important
part of the Commission’s role in protecting the public interest
• few deliveries actually occur, but the “credible threat” of delivery (and
associated arbitrage opportunities) keeps cash/futures prices in line.
• contract terms and conditions should reflect the operation of the
underlying cash market and avoid impediments to delivery
• Convergence is measured “basis”
Basis = Cash – Futures
• negative number, when cash is below futures, constitutes a “weak” basis
• positive number, cash above futures, constitutes a “strong” basis
• A compliant contract consistently “promotes” convergence,
rather than converging to a certain amount

8. PromotionofConvergence
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• Terms and Conditions
• trading hours – delineate the trading day
• minimum price fluctuation, a.k.a. minimum “tick” – should be equal to or
less than minimum price increment commonly observed in cash market
transactions of the underlying commodity
• price limits – should be levels that are not overly restrictive in relation to
price movements in underlying cash market and are for the purpose of:
• Reducing or constraining price movements that are not reflective of true market
conditions (over-reactions)
• Providing cooling off periods for market to respond to changes in supply and
demand fundamentals
• Allowing additional time for the collection of margins in times of large price
movements
• reportable levels – levels above which market participants are required to
report their positions

9. PromotionofConvergence
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• Terms and Conditions (Physically-Delivered Commodities)
• contract size and trading unit
• trading months – based on risk management needs of commercial entities and
deliverable supplies
• quality standards – economically significant characteristics or attributes of the
commodity
• Accepted/established by industry, government regulation or relevant laws
• Used in normal cash marketing channels, e.g. grade, quality, purity, weight,
class, origin, growth, etc.
• For multiple qualities with different cash market values, “par” and “non-par”
qualities should be identified with appropriate price differentials
• delivery pack – packaging or non-quality standards, such as origin
• inspection provisions

10. PromotionofConvergence
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• Terms and Conditions for Physically-Delivered Commodities (cont’d)
• delivery facilities – conditions placed on facilities to be eligible for delivery, i.e.,
“regular” and description of the ownership concentration
• last trading day and delivery period – adequate time after the last day of trading
for deliverers and receivers to acquire the commodity and make it available for
delivery
• delivery procedures – minimize or eliminate impediments to taking or making
delivery
• responsibilities of deliverers, receivers and required third parties
• allocation of costs between buyer and seller, such as load-out, taxes, duties, fees,
sampling, grading, weighing, storage, etc.
• required accreditation for third parties

11. PromotionofConvergence
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• Terms and Conditions for Physically-Delivered Commodities (cont’d)
• delivery points
• single or multiple locations where underlying commodity is normally
transacted or stored and where a viable cash market exists
• for multiple locations, “par” and “non-par” locations should be identified with
appropriate locational price differentials that fall within the range of commonly
observed commercial price differences
• delivery instrument
• warehouse receipt, shipping certificate, bill of lading
• provides for conversion into the cash commodity at a commercially-reasonable
cost
• transportation terms: FOB, CIF, freight prepaid to destination
• also limits on amount of instrument that can be held
• storage fees

12. PromotionofConvergence:CashSettlement
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Guidance from the Commodity Exchange Act:
“…[C]ash settlement of the contract is at a price reflecting
the underlying cash market, will not be susceptible to
manipulation or distortion, and is based on a cash price
series that is reliable, acceptable, publicly available and
timely.”
• pricing basis
• cash settlement procedure
• Determination of the index – reliability, availability and adequacy of sample
size
• Third party information providers
• Information-sharing agreement when a contract settles to another market’s
price

13. CorePrinciple5
13
“To reduce the potential threat of manipulation or congestion,
especially during trading of the delivery month, the board of trade
shall adopt position limitations or position accountability for
speculators, where necessary and appropriate.”
• spot month limits – not greater than 25% of deliverable supply in any
contract delivery month.
• single month limits
• all-months-combined limits
• limits on amount of the delivery instrument that can be held

14. Speculative
Position
LimitTypes
• Position Limits
• binding; appropriate for commodities with a
seasonal or fixed supply
• apply to all market participants – hedgers must
request and apply for an exemption or report their
cash positions to “offset” their positions (in
certain agricultural commodities)
• both federal and exchange-set
• Position Accountability Levels
• not binding – set lower than position limits; more
appropriate for commodities with a continuous or
abundant supply
• market participants face increased scrutiny and
may be asked/required to hold or reduce position
• exchange-set only and after a product has an
established trading history
• Spot Month – not
greater than 25%
of deliverable
supply in any
contract delivery
month
• Single Month.
• All-Months-
Combined
• Amount of the
delivery instrument
that can be held
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15. Balance Long Side
• Higher Quality
Specifications
• Contraction of
Delivery Territory
• Testing
methodology
• Condensing Load-
out
Period/Increasing
Load-out Rate
• …
Short Side
• Lower Quality
Specifications
• Storage rates
• Expansion of
Delivery Territory
• Allowing More
Regular Delivery
Entities
• ….
• A well-designed
contract (or contract
change) strikes a
balance between
provisions that
facilitate the short’s
ability to make
delivery the
commodity and
assuring the long that
the commodity will
be of merchantable
quality.
• BUT, every contract
change does not
necessarily need to
benefit market
participants equally.
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16. Launch
16
• Market Surveillance
• Large trader reporting and transaction reporting
• Familiarization with
• cash market
• product terms and conditions
• market participants
• delivery process and procedures
• reporting requirements, as necessary
• Risk Review
• margin requirements
• incorporate into risk modeling for market participants and the exchange